Bonuses: how are they taxed in the UK and can you avoid it?

We look at how bonuses are taxed for employees and whether there is anything you can legally do to stop it from getting taxed.

A bonus is taxed in the same way as your standard income.

So, your PAYE, national insurance and student loan payment (if applicable) will be adjusted for the month you receive your bonus to account for the higher amount.

This means you won’t get to keep your full bonus unless your income, including the bonus, is under the tax-free personal allowance of £12,570. Let’s see how this works in practice.

You earn £30,000 per year with student loans and a 5% cent pension contribution and receive a £1,000 annual bonus.

Typically, you pay around £266 in tax and £116 in national insurance on your gross monthly income of £2,500.

But during your bonus month, you’ll be taxed on a gross income of £3,500 and pay around £460 in tax and £200 in national insurance. 

You pay national insurance and income tax on all earned income, including bonuses, which can push you into a higher tax bracket, so you pay an even higher tax rate on some or all of it.

If your annual income is £45,000 and you get a £10,000 bonus, £4,730 will be taxed at 40%. 

Someone on a salary of £45,000 is likely to have a take-home pay of around £2,690 per month, depending on their pension contributions, student loans, and any other deductibles.

During the month you get your bonus, you’re likely to take home around £8,770 — losing around £3,920 in tax, national insurance, and student loan payments. 

It’s frustrating when your bonus is hugely reduced by tax, although there is a way to keep all of it in your pocket if you’re happy to wait for it.

You can opt for a bonus sacrifice, which involves paying up to 100% of your bonus into your pension pot.  This will be tax-free if the rest of the year’s pension contributions are under the tax limit.

The annual tax-free limit for pension contributions is £60,000 per year (or 100% of your salary) if you earn under this amount.

Check your P60 to see how much you’ve contributed, as you can carry over any unused allowance from the last three tax years.  

There’s just one catch to paying your bonus into your pension. You won’t be able to access it until you’re at least 55 (this will rise in the future), or you’ll pay a big tax penalty.

Many employers will let you designate a portion of your bonus to be sacrificed to your pension, so you can still enjoy some of your bonus now.

If someone on a £45,000 salary paid half of their £10,000 bonus into their pension, they’d lose less through tax.

As your bonus is paid by your employer, who must take tax off your gross income before it’s paid, there aren’t any other legal routes to reduce the tax you pay on your bonus.

Anyone who offers a solution is simply not telling the truth. Your employer could be in trouble for not correctly taxing you, and you’ll have to repay any tax you owe later.  

Need personal tax advice? You can find a qualified accountant via Unbiased.

They’ll help you be tax-efficient and understand your obligations, particularly if you plan to set up your own business or become self-employed.

Banner image source:  Photo by Frugal Flyer on Unsplash