Bonus sacrifice

If you receive an annual bonus you might baulk at the amount of tax you pay on it. Often there’s emergency tax to pay and even when that’s been sorted out, you might still be down 40 or 45 percent. For higher rate taxpayers, a £10,000 bonus will be reduced to £5,800 by income tax and national insurance. If the bonus increases total income to between £100,000 and £125,140 for the tax year there will be loss of personal allowance which equates to 60% tax on that element.

Bonus sacrifice could be a better way to use your bonus, reduce your overall tax bill, avoid higher tax brackets, and boost your pension contributions without changing your monthly income.

It’s all a balancing act of course and if you have immediate plans for your bonus, such as holidays, paying off a debt, improving the house, or mortgage overpayments, then saving these funds for your future may not be right for you. Here’s why you might want to consider it though, especially if you’re giving a lot of thought to providing for your retirement.

What is bonus sacrifice?

Bonus sacrifice involves asking your employer to pay some of or all of your bonus directly into your pension. This protects this income from income tax and National Insurance Contributions (NICs), and works just like salary sacrifice – but specific to bonus payments. There may be further tax savings, if you are in receipt of certain benefits.

How does Benefit Sacrifice work?

Any bonuses are usually added to your income for the year and taxed at your marginal rate. Bonus ‘sacrifice’ means exchanging this income for a non-cash benefit – in this case additional pension contributions. By sacrificing the bonus, your employer is effectively paying the bonus payment directly to your pension plan avoiding paying income tax and NI, with the full value of the bonus added to your pension pot.

For example, if you earned an income of £50,000 and were entitled to a bonus of £10,000 and you didn’t sacrifice any of it, your net income after tax and NI deductions would be £45,357.40. If you decided to sacrifice your bonus and ask your employer to pay it directly into your pension, you would have £39,519.60 plus £10,000 in your pension, so total income received is £49,619.60 – more than £4,000 better off than the first scenario.

How it is calculated:

(Scottish income tax rates and tax bands are different):

If your £10,000 bonus went straight to your pension pot, your net income would be:

This method gives you the opportunity to extend your tax band and could save you paying higher levels of tax.

Other advantages

Employers NI on a Bonus will also be 13.8% (15% – post budget value) and some employers may pass all or part of the Employer NI saving into the contribution as well. This means a £10,000 bonus could be uplifted to as much as £11,500 depending on how much Employer NI saving the employer is willing to give up. A discussion with your employer should quickly establish an outcome here.

How Bonus Sacrifice can affect tax and other benefits

As bonuses are treated as income, they can also affect your eligibility for other benefits. Statutory benefits like maternity or sickness pay have no means-test, but do have specific income rules to check eligibility. Your bonus could affect any salary-related benefit, such as:

Saving for the future

We’ve mentioned some of the benefits of Bonus Sacrifice, but it’s important to remember that you cannot access pension funds until you are aged 55 (or 57 from 2028). Using bonuses in this way could also potentially impact upon any benefit entitlement or lending affordability. For example, bonus sacrifice may affect how much you’re able to borrow through a mortgage. However, some lenders may take your salary before salary exchange into account, rather than your lower salary and may consider pension contributions too.

There’s no limit on how much you can save into your pension each year – but there is a limit on how much you can contribute tax efficiently. One aspect is your annual allowance (currently £60,000) – this includes pension contributions from all sources including your employer and if exceeded means a tax charge applies to the excess. But if you have any unused Annual Allowance from the previous 3 years, you may benefit from Carry Forward allowance, as long as you had a pension in place in those earlier years. In addition to the annual allowance, there is also a limit on just your own pension contributions – they will only receive tax relief as long as they don’t exceed 100% of your earnings (or £3,600 if more).

For those with a total income exceeding £100,000 per annum, the Personal Allowance is tapered and lost altogether when total income exceeds £125,140, resulting in an effective tax rate of 60% in that range. In this case contributing to a pension with any bonuses could help keep your income below ANI of £100,000, as an instant way of reducing your tax bill.

Sounds complicated? Pension allowances and income tax can be confusing, and more so with the Tapered Annual Allowance. For those with a total income of over £200,000 per annum – and certainly those with total income in excess of £260,000 – the Annual Allowance reduces from £60,000 to £10,000.

Benefit of compounding

If you do choose to use Bonus Sacrifice, not only do you save tax and national insurance but benefit from compounded returns on these monies and tax efficient growth. Giving your pension funds as long as possible to benefit from growth can make a real difference – even making contributions at the beginning of the tax year rather than at the end can help.

A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can down as well as up which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.

The information contained within this article is based on our understanding of legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change.