Bonus Sacrifice How to save tax

If you’ve ever made a bonus and seen how much income tax you’ve paid then it’s highly likely you’ll have wanted to reduce your tax burden. One way of becoming tax efficient is by making additional pension contributions through bonus sacrifice.

Bonus sacrifice is the process of paying your bonus into your pension fund instead of your bank account. You reduce tax and national insurance whilst making pension contributions.

The bonus you’re paid counts as earned income and you’ll pay income tax on those earnings. For example, if you earn £40,000 a year and are paid a bonus of £5,000 you’ll pay 20% income tax and 12% national insurance contributions on that bonus. Paying your bonus into your pension pot may be a better option for you.

How do I sacrifice my bonus into my pension?

The first thing to do if you want to sacrifice your bonus is to check if your plan will accept payments from your employer. If they do, then before your money is paid, you’ll need to instruct your employer to pay an agreed percentage of your bonus into your pension pot.

If your plan doesn’t allow employer payments or bonus sacrifice, you can still deposit your bonus when your employer pays you. You won’t avoid taxes or National Insurance, but you will get pension tax relief.

What are the Benefits of Bonus Sacrifice?

There are many benefits to Bonus sacrifice:

  1. Bonus sacrifice is a highly tax efficient way of saving money, you never pay income tax and national insurance on the income because you don’t receive the money.
  2. The more you earn, the more you stand to save with bonus sacrifice.
  3. If your employer pays the additional national insurance payment into your pension contribution then you’ll have more.

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How is Bonus Sacrifice different from Standard Pension Contributions?

The difference between standard pension contributions and bonus sacrifice is that standard pension contributions are automatically deducted at source from your monthly salary and transferred into your pension pot while bonus sacrifice is a choice to make additional contributions into your pension pot.

Standard pension contributions paid into your pension scheme is money paid from taxed income so dont have the benefit of tax relief, meaning you pay income tax and you dont save national insurance. Contributions made through bonus sacrifice save tax by being paid prior to you receiving the income.

Bonus sacrifice vs salary sacrifice – what are the differences?

The difference between bonus sacrifice and salary sacrifice is that with bonus sacrifice you can only make an additional pension contribution into your pension scheme while salary sacrifice, sometimes called salary exchange, is exchanging some of your salary for a non cash benefit, which can include pension contributions but could also other salary related benefits such as a company car or cycle to work scheme.

Salary sacrifice does afford you tax savings by helping you save national insurance and tax, however you won’t be eligible for salary sacrifice if using the scheme would take your earnings below the national minimum wage

What are the tax and national insurance thresholds

Because your bonus is taxed as earned income, the amount of income tax and national insurance you’ll pay on your bonus will be based on your total earned income for the tax year, each tax bracket is shown below:

Name Income Income Tax National insurance
Non Tax – Payer £0- £12750 0% 0%
Basic Rate Tax Payer £12,751 – £50,270 20% 12%
Higher Rate Tax Payer £50,271 – £100,000 40% 2%
60% Tax Trap £100,001 – £125,000 60% 2%
Higher rate Tax Payer £125,001 – £150,000 40% 2%
Additional Rate Tax Payer £150,000 45% 2%

How John made a return by paying into his pension

John works in London for a blue chip company and earns £105,000 per year. He pays 5% of this into his pension and has just been given a bonus of £10,000.

He’s checked and is eligible for bonus sacrifice with his current pension scheme.

He is a higher rate taxpayer so he pays 60% tax (where his income above £100,000 is taxed at 60%).

He has decided to use bonus sacrifice and put the entire £10,000 into his pension scheme. His employer will pay it into his pension scheme, plus the employer NIC savings.

Without bonus sacrifice:

If John took the bonus as cash, he would pay Income tax of £ 6,000 (60%). National insurance contributions of £200 (2%)

This means that John pays a total of £6,200 in taxes on his £10,000 bonus, equivalent to losing 62%.

With bonus sacrifice:

By sacrificing the total bonus into his pension, he will pay no tax, and, John’s employer is going to pay his National Insurance savings into this pension. This gives John an additional £1,380 (13.80%).

So in total, John would have £11,380 in his pension.

That’s £7,580 more than if he took the bonus in cash.

That’s nearly a 200% return (199% to be precise).

How do I avoid paying income tax on my bonus

By making a 100% bonus sacrifice into your employee pension contributions you will not pay national insurance or income tax on those earnings all all.

You will still pay income tax based on your earnings in that tax year as normal and your employer pension contribution will remain the same.

How we can help you with bonus sacrifice

Here our Middlesbrough based financial advisers Joslin Rhodes we take a holistic approach to tax planning and can advise you on the best way to be tax efficient.

By taking the time to fully understand what you really want right now and in the future we’ll help you make the best decision so you can get to exactly where you want to be.

Speak to one of our financial advisors today to find out how we can help you.

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