Are UK bonuses taxed?
Getting a bonus payment can feel a bit like a lottery win. A nice little lump sum for treating yourself to something. But, unlike the lottery, that bonus payment is subject to income tax just like your regular salary.
In this article, we’ll explore the UK tax rules on bonuses, and what you can do to keep more of your bonus money instead of losing it to tax.
So how much tax will I pay on my bonus?
The tax you pay on a bonus will factor in your standard earnings plus bonus earnings. This confirms which tax bracket you fall in to, determining how much tax you pay on your earnings including bonuses.
Let’s take Aaron as an example:
His standard salary is £35,000 per year. This means he’s a basic rate tax payer; he pays 20% tax and 12% national insurance on his earnings over £12,570. Remember: the first £12,570 for most people’s earnings is tax-free and national-insurance free.
Aaron has performed well and is told he’ll get a bonus of £3500. This takes his salary for that particular year up to £38500.
He is still classed as a basic rate tax payer, so that £3500 bonus will be taxed at 20% income tax and 12% national insurance contributions.
Aaron’s £3500 is effectively reduced to £2380 with deductions of £700 in income tax and £420 in NI contributions.
So the tax on my bonus is the same as my normal salary?
For many employees, yes. But you could be in a situation where your bonus actually takes you ‘over the fence’ into a higher tax rate bracket.
Let’s take Hannah as an example:
Hannah earns £48,000 per year.
After a strong performance, she gets a gross (before tax) bonus of £7000.
Her standard salary makes her a basic rate tax payer, like Aaron.
However, her bonus earnings give her total earnings in that particular year of £55,000. This means she’s now classed as a higher rate tax payer.
Any earnings over £50,270 fall into the higher rate tax bracket.
So for Hannah, some of her bonus – the amount between £48,000 and £50,270 - will be taxed at the basic rate. And the remainder of the bonus – the amount between £50,270 and £55,000 - will be taxed at the higher rate.
Let’s break down the sums:
· £2270 taxed at 20% income tax and 12% NI contributions
· £4730 taxed at 40% income tax and 2% NI contributions
So Hannah will lose £2713 to the government, meaning her net (take-home) bonus will be £4287.
Quite a difference from the original £7000.
The key to working out what bonus you’ll actually receive is to know your tax brackets.
Check out the government website for the current income tax rates.
As you can see, tax on bonuses can be pretty brutal if you’re a high earner.
Other things like child benefits and student loan repayments can also potentially affect or be affected by your bonus.
Can I reduce the tax I pay on my bonus?
There is actually a very simple way of getting a tax-free bonus. It’s called Bonus Sacrifice.
It means you sacrifice your bonus by putting it straight into your pension. So you pay no tax or national insurance contributions on the bonus.
In other words, Aaron and Hannah could put their entire bonuses straight into their pension without losing any of it to tax.
On top of keeping the entire bonus, the employee’s company will be making savings on employer national insurance contributions. And these savings are often passed onto the employee. So a bonus could actually be worth more if placed into a pension.
This sounds too easy for a tax-free bonus. Is there a catch?
Pensions are very tax efficient because the government wants to encourage people to save for their retirement. Workplace pensions effectively give you free money.
The drawback is that you’re locking away that bonus until 55, at the earliest. And with the state pension age increasing, it’s more likely to be 57 or 58 if your retirement is a long way off.
Sacrificing your bonus may not be practical if your regular income relies on bonuses.
Putting part of your income into a pension may potentially impact how much you can borrow for a mortgage, or any type of loan that’s assessed on gross (before tax) earnings.
So don’t rush into a bonus sacrifice. Think about your personal circumstances before trying to avoid tax on your bonus.
A flexible approach could be an option. For example, put 50% of your bonus into your pension and keep 50% in your pay check, meaning only 50% is subject to tax. Decide the split between pension and pay however you like.
There are also limits on how much you can pay into your pension.
· You get a £40,000 annual pension contributions allowance – you can roll this over for up to 3 years if you’ve got any unused allowances.
· There is a current lifetime allowance of £1,073,100. If you pay more than that into your pension over your lifetime, you could face a charge.
So for a high earner getting regular bonuses, these allowance are something to bear in mind. But for one off bonuses now and then, you’ll probably stay within the allowances if you use bonus sacrifice.
How do I make a bonus sacrifice in practice?
Bonus sacrifice is a pretty simple process:
· Your employer lets you know when you’re getting your bonus
· Work out how much of your bonus to sacrifice into your pension
· Tell your employer how much of your bonus you wish to sacrifice into a pension
· Your employer pays some or all of your bonus into your pension scheme
· The tax relief is applied automatically. You don’t need to do anything else.
Think of a bonus as an extension of your regular salary. You’ll pay income tax and national insurance contributions on it in exactly the same way.
A simple way of getting a tax-free bonus is to pay it directly into your pension.
Remember, finance is personal. So always think about your individual circumstances when deciding what’s best for your income.