Are you a Higher Rate taxpayer? One way to lower your tax bill is via bonus sacrifice. Yet how does it work, exactly – and what are the benefits? In this guide, our team at WMM explains how the rules work regarding bonus sacrifice, how bonuses are taxed and some common pitfalls to look out for in 2022-23. We hope this is helpful and get in touch if you want to learn more.
How does bonus sacrifice work?
When you receive a bonus from your employer, it comes via your PAYE salary. This means that the amount is subject to income tax and National Insurance. In some cases, this can push you into a higher tax bracket. For instance, if you earn £48,000 per year then everything over £12,570 is taxed at the 20% Basic Rate. Should you receive a £5,000 bonus, then most of this will be subject to the Higher Rate at 40%. By contrast, bonus sacrifice would put this amount straight into your pension.
Why would I engage in bonus sacrifice?
The benefit of putting a bonus straight into your pension, as an employer pension contribution, is that the bonus will not be taxed. The full amount goes into your retirement fund. In some cases, this can help a taxpayer avoid the 40% or 45% income tax rates. You can also side-step needing to pay child benefit tax charges, student loan repayments and National Insurance on the bonus.
Employers are not obligated to offer bonus (or salary) sacrifice, though most will allow it, and some even pass on the employer National Insurance saving into your pension too.
Drawbacks of bonus sacrifice
So far, so good. However, putting your bonus into a pension needs to be considered carefully. Bear in mind that you will be unable to access the money until age 55 (or, 57 in 2028; when the Normal Minimum Pension Age is expected to rise). So, make sure you do not need the money for a while. Higher earners also need to take care with the Tapered Annual Allowance, which lowers the amount you can contribute to your pension each tax year – depending on earnings. Here, your annual allowance is reduced by £1 for every £2 of “adjusted income” over £240,000. You can exceed this in certain scenarios (e.g. using “carry forward” to access unused annual allowance from the past three tax years), and everyone always retains an annual allowance of at least £4,000 per year. However, you need to ensure that bonus sacrifice does not put you over your limit for how much you can put into your pension. Otherwise, you risk a tax penalty.
Considerations for financial planning
If you have already received your bonus, don’t worry. You can still pay it into your pension to reduce your tax bill. The bonus sacrifice process is usually straightforward. Your boss notifies you about an upcoming bonus; you decide how much you want to put into your pension and let them know; the amount is put into your scheme.
We have already mentioned your annual allowance. However, also be mindful of your Lifetime Allowance when putting bonuses into a pension. This limits how much you can hold in total across your pensions, tax-free (£1,073,100). Also, your employer may require that you put any bonus sacrifice into your workplace pension – not another scheme such as a personal pension, where the fees and investment choices may be better.
Finally, remember that bonus sacrifice reduces your income, in effect. This could impact other areas of your finances such as how much you can borrow for a mortgage. It may also lower certain employee benefits. Life cover and sick pay are often calculated based on your income, for example. Seek financial advice to ensure you balance these various considerations.
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This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult us here at WMM (financial planning in Oxfordshire).
