You have probably just found out you are going to be receiving a bonus. Good job, you’ve probably worked hard to get it!
While it is exciting to hear the good news, it can be a letdown to hear you won’t receive all of it due to tax. Luckily there is one method of avoiding the tax on your bonus which we will talk about later. Let’s take a look at how bonuses are taxed for employees in the UK.
Quick Overview
In the UK, bonuses are taxed just like your regular paycheck. This means that a part of your bonus will go towards Income Tax and National Insurance. The exact amount depends on which tax bracket you fall under.
How Bonuses Are Taxed In The UK
Bonuses in the UK are taxed in the same way normal earned income is. You will pay Tax and National Insurance on your bonus as an employee. How much tax you pay on your bonus will depend on the tax bracket you are currently in. This is all dealt with through your employer before you receive the bonus.
Let’s take a look at how much you will be paying in Tax and National Insurance depending on your income bracket.
UK Tax Brackets
| Tax band | Income range | Tax rate |
|---|---|---|
| Personal allowance | Up to £12,570 | 0% |
| Basic rate | £12,571 to £50,270 | 20% |
| Higher rate | £50,271 to £150,000 | 40% |
| Additional rate | Over £150,000 | 45% |
In Scotland, tax rates differ slightly:
| Tax band | Income range | Tax rate |
|---|---|---|
| Personal allowance | Up to £12,570 | 0% |
| Starter rate | £12,571 to £14,667 | 19% |
| Basic rate | £14,668 to £25,296 | 20% |
| Intermediate rate | £25,297 to £43,662 | 21% |
| Higher rate | £43,663 to £150,000 | 41% |
| Top rate | Over £150,000 | 46% |
60% Tax Bracket Trap
There is in fact a “60% Tax Trap” in the UK which many people don’t know about. It happens when your income falls within the £100,000 and £125,000 range. While you still fall within the 40% tax bracket, earning above £100,000 causes you to start losing your Personal Allowance. This is the tax-free amount you can earn before you start to incur debt.
What happens is, your personal allowance is reduced by £1 for every £2 you earn over £100,000. This means you will be losing a portion of your personal allowance for everything you earn from £100,000 to £125,540.
You will effectively be paying an extra 20% tax on any earnings within this range, while also paying your 40% tax in the Higher Rate tax bracket.
This means if you earn £100,000 and get a £10,000 bonus, you would only receive £3,800 after Tax and National Insurance.
Here’s how that breaks down:
- £4,000 Income Tax (4% Tax Bracket)
- £200 National Insurance
- £2,000 Extra as you lost £5,000 of your Personal allowance. That £5,000 now also gets taxed at 40%
Total Tax: £6,200
Now when you look at an example like this, your bonus suddenly looks less appealing. However, as we mentioned above there is one way to avoid paying tax on your bonus.
How To Avoid Paying Tax On A Bonus
To avoid paying taxes and National Insurance on your bonus, you can put it straight into your pension fund. While this won’t put tax-free cash into your bank account immediately, it will boost your pension savings.
If you are investing for retirement, which you should be, this is an option to look into for all or a portion of your bonus.
This is known as a “Bonus Sacrifice”. Your employer will pay your bonus directly into your employer pension or SIPP.
How A Bonus Sacrifice Works
Rather than paying you your bonus net of Tax, National Insurance, and other Contributions your Employer pays your bonus directly into your pension pot.
The downside is that you are unable to get that cash until you retire. The earliest that will be is 55 (57 from 2028).
When you reach retirement you can take 25% of your pension as tax-free cash and the remaining will be paid at your standard tax rate at that time.
The benefit of this is that you are investing for retirement and letting your bonus grow tax-free over time. Check out our compound interest calculator to calculate how much your bonus could be worth when you retire.
You may also be able to receive even more than your bonus amount as your employer will save on employer National Insurance. You can ask them if they would also be willing to put this towards your pension if you do a bonus sacrifice.
Can You Sacrifice A Portion Of Your Bonus?
Yes, you don’t have to sacrifice your whole bonus. Instead, you can decide to take a portion of it as income and put a portion into your pension. To do this simply ask your employer and they can take care of the rest.
By doing this you can invest in your future while receiving tax savings and also taking a portion of your bonus to enjoy.
An example might look like this:
You receive a bonus of £10,000, sacrifice 50% and take 50% as income. £5,000 will go to your pension. The other £5,000 will have tax and national insurance deducted based on your current tax bracket.
In the basic rate band, this would amount to £1,000 Tax and £600 National Insurance leaving you with a payment of £3,400.
Limits On How Much You Can Contribute To Your Pension
There are limits when it comes to how much you can contribute to your pension.
Each year you can pay up to £60,000 or 100% of your salary (whichever is lower) per year into your pension tax-free.
If you have not hit this limit for 3 years, you can carry forward your unused allowance meaning you can make a larger contribution. If you had not contributed in 3 years you could invest £180,000 into your pension in a single year.
Earning over £260,000 per year also leads to you losing some benefits. For every £2 above this figure, your pension contribution limit reduces by £1 to a minimum of £10,000. This means you will always have a £10,000 allowance.
How National Insurance Affects Your Bonus
National Insurance will also affect your bonus. National Insurance is simply calculated on a flat rate basis. You can view the National Insurance rates for each bracket below.
| Income range | National insurance rate |
|---|---|
| Up to £12,570 | 0% |
| £12,571 to £50,270 | 12% |
| £50,271 to £150,000 | 2% |
| Over £150,000 | 2% |
How Student Loan Repayments Affect Your Bonus
Just like your regular salary, you will also pay student loan repayments from your bonus. This will be a percentage of your income based on how much your earn and will all be handled by your employer.
How Pension Contributions Affect Your Bonus
If you have opted into a workplace pension scheme that contributes a percentage of your salary to a pension, this will also get taken from your bonus. If you are not opted into this it will not affect your bonus.
Will A Bonus Increase My Tax Bracket
Yes, getting a bonus can increase your tax bracket. For example, if you earned £45,000 per year and received a £10,000 bonus that would push you into the Higher Rate tax bracket which is a 40%.
However, it is a common misconception that your whole income gets taxed at the new tax bracket. That is not true.
Only income above the limit of £50,270 will get taxed at a higher rate. So on the £10,000 bonus above £5,270 of it would be taxed at the 20% rate and the £4,730 remaining would get taxed at 40%.
Final Thoughts
Ultimately earning a bonus is great. It’s a month on the calendar where you receive more than you normally would. How you decide to take your bonus is going to depend on your own personal financial circumstances.
If you don’t necessarily need the money and are aggressively saving for retirement like myself then using the Bonus Sacrifice may be the best choice.
If you need the money for say a wedding or house deposit, you’ll ultimately just have to stomach the tax hit.
