In today’s working environment, where it’s becoming increasingly difficult to retain talented employees, bonuses have become an essential part of the overall comprehensive package.
But, how are bonuses taxed in the UK, and can you avoid paying taxes on your bonus check?
Let’s find out.
Anyone earning an income in the UK is required to pay an income tax, National Insurance, and a bonus tax if they receive additional compensation.
This applies to both cash bonuses, which include monetary bonus payments to employees in the UK like an annual bonus, signing bonus, or a referral bonus, and non-cash bonuses, such as medical and dental insurance, travel vouchers, and use of company cars.
In the UK, employees pay income tax on earnings that exceed £12,570 in a year. Both your income tax rate and your bonus tax rate are based on your earnings.
If your base salary is between £12,570 and £50,270, then you’ll be required to pay a 20% income tax, excluding your Personal (tax-free) Allowance of £12,570. Those with a salary of £50,270 or higher, pay a 40% tax.
Let’s consider an example.
If your base salary is £25,000 annually and you take out the £12,570 of personal tax-free allowance, you’re left with a taxable income of £12,430.
20% of the £12,430 will be deducted for income tax. You’ll also have to pay an additional 13.25% for National Insurance, which will be applied to £15,120 of the income.
If at the end of the year, you get a bonus of £2,000, that sum will be added on top and taxed at those same rates. In this case, you’ll end up with a £1,335 bonus after taxes.
The only way to avoid paying tax on a bonus in the UK is to consider bonus sacrifice, which involves investing your bonus payment into your pension.
In addition to avoiding a bonus payment tax and National Insurance, paying your bonus into your pension could also potentially allow you to skip on student loans and child benefit tax charges.
So, how does bonus sacrifice work exactly?
Let’s assume that your salary is £50,270 and receive a bonus of £10,000.
If you choose to pay taxes, you’ll pay £200 in National Insurance Contribution (NIC) and £4,000 in income tax. If you have kids, you’ll also pay another £1,788, which will leave you with £4,012.
On the other hand, if you don’t pay National Insurance you’ll need pay a penalty.
If you opt to pay the bonus into your pension, the entire sum (£10,000) will be paid into your pension. Your employers also won’t have to pay any National Insurance contributions and would likely pass the money they would have paid on to you.
Keep in mind that if you decide not to pay a bonus tax in the UK and choose to add it to your pension, you’ll have to notify your employer. They will pay the pension directly into your pension scheme.
Paying a bonus into your pension can also save you more money if you earn more than £100,000 annually.
Under tax law, those that earn £100,000 a year pay 60% tax. What’s more, for every £2 you earn above £100,000, you lose £1 of your Personal Allowance. That means that if you earn £125,140, you lose your entire Personal Allowance and pay tax on the entire salary.
If you opt for bonus sacrifice and send it into your pension, not only will you pay less in taxes, and avoid a tax on your bonus, but you’ll also regain your Personal Allowance.
However, if the bonus pushes your ‘threshold income’ above £200,000, you might be affected by the Tapered Annual Allowance.
The Tapered Annual Allowance limits the amount of tax relief that high earners can claim and can reduce annual allowance to as low as £4,000. This means that if you exceed the threshold, you’ll still have to pay taxes.
The main difference between standard pension contributions and bonus sacrifice is that the latter allows you to avoid paying a tax on bonus payments altogether.
Standard pension contributions are paid into your pension scheme after taxes.
The workarounds for non-cash bonuses, compared to cash bonuses, are limited.
Employers can make tax-free contributions to their employee’s health savings accounts or pay for certain medical treatments which are tax-free under UK law, such as overseas medical insurance, general check-ups, and medical treatments that don’t exceed £500.
Other tax-free non-cash bonus options include free meals on the company’s premises, weekly childcare vouchers (that are worth no more than £55), and paid courses.
The maximum amount that you can put into your pension with a bonus sacrifice scheme, without having to pay tax, is £40,000.
This includes contributions from your employer as well.
If you have any unused allowance from the previous three tax years, you can add a total of around £160,000 to your pension plan. However, if your income exceeds £200,000, your pension allowance might be reduced.
The lifetime allowance is the total amount an individual can build up across all their pension savings, without a tax change.
If you go over the current limit of £1,073,100, you’ll have to pay a tax charge on the excess when you take a lump sum or income from your pension pot. Lump sums are taxed at 55% and income at 25%.
The earliest you can take money out of your pension pot is once you turn 55.
You can take out up to 25% of the entire sum as a tax-free lump sum. The rest of the pension can be invested, used to buy an annuity, set up as regular monthly income, or cashed in
If available, you can ask your employer to reduce your entitlement to cash pay in return for a non-cash benefit. The employer has to pay taxes on these benefits, but some are tax-free, such as safety equipment, payment into pension schemes, childcare vouchers, and pension advice.
Tax on bonuses in the UK is paid at the same rate as the income tax, which varies depending on the bracket you fall into. If you want a tax free bonus, you can put your bonus into your pension, but you might still have to pay tax if you earn more than £200,000 a year.
UK tax on bonuses is high because bonuses are considered supplemental income. What’s more, the bonus is added on top of your salary, which means it can put you in a higher bracket, where the tax is higher.
Bonuses tax is calculated at the same rate as your income tax. This varies based on your income, between 40% and 60%. If you want to avoid paying tax on your bonuses, you can put them in your pension.
Bonuses are taxed alongside your income. The amount depends on the bracket you fall into once the bonus is added to your salary.
No, they aren’t.
Bonuses are taxed based on the income bracket. When you receive a bonus, the amount is added on top of your salary and calculated based on the tax rate bracket.
My name is Marija, and I'm a financial writer at DontDisappointMe. Although finance might not be everyone's cup of tea, my 10+ years of working in one of the biggest banks in my country, and my interest in extensive research on everything finance/investment-related, have made me somewhat of an expert in the field (if I do say so myself). No longer having the passion to work in a corporate setting, I decided that I couldn't let all of this knowledge go to waste so I started writing. And, here I am! Today I try to share my knowledge with my audience in the hopes of making this topic as simple and interesting as possible. In my leisure time, I like spending time with my family and travelling to new locations.