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Pay a Bonus Into Your Pension: Keep More of Your Money

  •  By
  •  Murray Humphrey

Every employee loves receiving a bonus. In fact, it’s one of the most sought-after employee benefits in the UK. The only downside is all that extra tax. Luckily, there’s a way to stay tax-efficient available to almost all UK workers - your pension. Are bonuses pensionable and could you slash your tax bill by adding your bonus into your pension?

In this article we’ll explain the pros and cons of putting your bonus into your pension and how this can affect your pensionable earnings.

Tax on bonuses, how does it work?

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 bonus tax in the UK actually work?

For all intents and purposes, any bonus you receive is treated as income when it comes to tax. That means your bonus is subject to the same tax as your salary. You’ll pay:

  • income tax (at your marginal rate)
  • national insurance
  • personal deductions (like a student loan)

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.

Can I put my bonus into my pension?

If you have a defined contribution pension, you have the option of ‘sacrificing’ your bonus into your pension. Rather than going straight to your bank account, your bonus will be added into your pension, ready for your retirement.

If you‘re enrolled in a defined benefit (or final salary) 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.

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.

Pros 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.

To illustrate, Amira earns £35,000 a year and is expecting to receive a £4,000 bonus. By taking it as cash, she ends up losing 32% of her bonus - that’s £1,280! When paying the bonus into a pension, Amira keeps everything.

A financial comparison table titled 'Pension Bonus Sacrifice' based on a salary of £40,000 and a bonus of £4,000. It shows two columns for 'Taken as cash' and 'Paid into pension.' Under 'Taken as cash,' it lists £4,000 with subsequent deductions for Income Tax at 20% (£800) and National Insurance at 12% (£480), resulting in a 'Bonus After Tax' of £2,720. The 'Paid into pension' column shows £0 taken as cash, £4,000 paid into pension with no income tax or national insurance deducted, resulting in a 'Bonus After Tax' of £4,000.

The higher your earnings, the more you will save in taxes when you pay your bonus into your 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!

As an example, Ritesh earns £60,000 a year and received the same £4,000 bonus as above. He loses 42% of his bonus, or £1,680.

A financial comparison table titled 'Pension Bonus Sacrifice' based on a salary of £60,000 and a bonus of £4,000. The table compares taking a bonus as cash versus paying it into a pension. In the 'Taken as cash' scenario, £4,000 is reduced by a 40% income tax (£1,600) and 2% national insurance (£80), leaving a 'Bonus After Tax' of £2,320. In the 'Paid into pension' column, the entire £4,000 bonus is allocated to the pension without any deductions, resulting in a 'Bonus After Tax' of £4,000.

You can also choose to put a portion of your bonus into your pension for the tax savings, while taking some as cash. This is a great option for those who like to treat themselves a little when the bonus comes in.

Cons of paying a bonus into your pension 

While it can seem like a no-brainer to tuck your bonus away inside your pension, there are restrictions in place which can impact high earners.

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 a bonus into your pension

Once you receive confirmation of your bonus, you’ll need to speak to your employer and let them know how much of your bonus you wish to pay into your pension. Assuming your pension plan accepts payments from your employer, your pension provider will then take care of the rest.

How your bonus might affect your 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.

Bonuses and pension summary

The answer to ‘are bonus payments pensionable’ is yes! You can save a significant amount of tax if you choose to sacrifice your bonus, particularly if you‘re a higher earner. You can also choose to only sacrifice a portion of your bonus. All you need to do is speak to your HR team.

Have you lost track of pensions from previous jobs. Discover how easy it is to bring all your old pots together in one app with Penfold.

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Murray Humphrey

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