Maximise Your Bonus: Boost Your Pension and Save on Tax

There’s nothing quite like the joy of receiving a bonus at work. But there’s also the sting of watching a hefty slice disappear into tax deductions. The good news? There’s a smart way to keep more of your hard-earned bonus while building your financial future: pay it into your pension.

In this guide, we’ll show you how paying some or all of your bonus into your pension can reduce your tax bill, grow your savings, and even earn extra contributions from your employer.

Why Are Bonuses Taxed So Heavily?

If you’ve ever been lucky enough to receive a bonus from your job, you may have been disappointed with the final amount that actually lands in your pocket after tax. So, how does tax on bonuses in the UK actually work?

Bonuses are treated as regular income for tax purposes. That means your bonus is subject to the same tax as your salary. You’ll pay:

• Income tax (at your marginal rate)
• National Insurance (NI)
• Personal deductions (like student loan repayments)

Your bonus may also impact your pension contribution for the month, but that’s only if your employer uses your total earnings when calculating contributions. Speak to your HR team or pension provider if you aren't sure.

It all means that the amount of your bonus you actually receive may be a lot less than you expected. For example, someone earning £75,000 who earns a £10,000 bonus would only end up receiving £5,675! And that’s without any further reductions for things like a student loan.

Check out this handy bonus calculator to see your breakdown. Luckily, if you’d like to keep a larger share of your bonus, you do have a way around it – your pension.

The Pension Solution: Keep More of Your Bonus

Instead of taking your bonus as cash, you can ask your employer to pay it into your pension. Known as ‘bonus sacrifice,’ this approach allows you to avoid income tax and NI on your bonus. Here’s how it works:

• Defined Contribution Pension: You can contribute all or part of your bonus to your pension. The bonus is paid directly into your pot before tax is deducted.
• Defined Benefit Pension: You won’t be able to pay your bonus into your pension. This is because the majority of defined benefit pensions pay either a percentage of your final salary or an average of your salary as the final amount. This applies to final salary schemes too.

The good news is adding your bonus to your pension is easy – you just need to let your employer know ahead of time. But before you do, there are a few things you’ll want to check. Here are the pros and cons of a pension bonus sacrifice.

Benefits of Paying a Bonus into your Pension

The biggest benefit of paying your bonus into your pension are the tax savings. If you receive your bonus as cash, then you’ll need to pay the corresponding National Insurance and Income Tax at your marginal rate. However, when you elect to add your bonus to your pension, it’s completely tax-free. You get to keep the full amount.

Example - Amira’s Bonus Boost: Amira earns £40,000 a year and receives a £4,000 bonus.

By contributing her bonus to her pension, Amira saves £1,280 and keeps the full £4,000 for her future.

Example - Ritesh’s Higher Tax Savings: Ritesh earns £60,000 a year and receives the same £4,000 bonus.

As a higher-rate taxpayer, Ritesh saves even more by contributing his bonus to his pension, even as NI contributions drop to 2% for higher-rate taxpayers.

Plus, your employer will not be liable to pay NI contributions on your bonus and in many cases, they will pass these savings onto you. That’s more money for your pension pot!

Flexible Contributions: Not ready to commit your entire bonus? No problem. You can split your bonus, contributing part to your pension for the tax savings while taking some as cash to enjoy now.

Things to Watch Out For

While bonus sacrifice offers many benefits, there is a few restrictions to keep in mind. There is an annual allowance of £60,000 a year that can be paid into a pension, or up to 100% of earnings. This includes employer and employee contributions. For those with a large annual bonus, you’ll need to make sure you’re under these limits or you could face a tax charge.

However, if you’ve been part of a pension scheme for a few years, it’s also worth noting you can temporarily boost your annual allowance by carrying forward your pension allowance from previous years.

How to Pay Your Bonus into Your Pension

If you’d like to save more and slash your tax bill, here’s how to get started:

• Check with Your Employer: Speak to HR or payroll to confirm your company allows bonus sacrifices into a pension.
• Set Your Contribution: Decide whether you want to contribute all or part of your bonus.
• Confirm Before Payday: You’ll need to arrange this before your bonus is paid to benefit from the tax savings.

How Your Bonus Might Affect Pensionable Earnings

Depending on the method your employer uses to calculate pensionable earnings, your bonus may form part of your contributions to a workplace pension scheme.

If your scheme uses ‘qualifying earnings’ or ‘total earnings’, then your bonus will form part of your contributions, increasing your pensionable earnings. This means your one-off contribution for the month you receive your bonus will be higher.

Boost Your Savings and Reward Your Future

Putting your bonus into your pension is a win-win: you keep more of your money today and secure a more comfortable future. Whether you contribute your entire bonus or just a portion, it’s a smart move to grow your pension pot while cutting down on taxes.

If you’re looking for an easy way to keep track of your pensions or consolidate old pots Penfold can help. Start today and make your savings work harder for you!