Clare Stinton, head of workplace saving analysis, Hargreaves Lansdown: “If you are lucky enough to get a bonus you will no doubt be making plans for what to do with it. That is, until it hits your bank account and the sum staring back at you is far smaller than you expected. The reason? Income tax and National Insurance will nibble away at the edges meaning that a basic rate taxpayer receiving a £5,000 bonus would only take home £3,600 of it. Rather than hand over a bigger chunk of your hard-earned cash to HMRC, consider using your pension to keep more of what you earned. If you’re not in need of the cash, choosing to pay some or all your bonus into your pension offers both big tax savings, and it will supercharge your retirement in one tax-smart move – it’s a win-win for present and future you.
Here’s why your pension offers the best home for your bonus.
1. It can prevent you going up a tax bracket
Thanks to income tax bands being frozen at 2021/22 levels, millions of people have been pulled into higher tax brackets and are paying more tax. Crunch the numbers before deciding what to do with your bonus – if it pushes your total earnings over £50,270 you’ll suddenly find yourself paying 40% tax on anything above the threshold. Should it drive you beyond £125,140 then the tax rate jumps again to 45%. You’re effectively taxed 60% for any money that falls within the range of £100,000 -£125,140. – That’s 40% income tax combined with the gradual loss of your personal allowance, which you lose at a rate of £1 for every £2 you earn over £100,000. Contributing to your pension can turn this tax trap to your advantage with every £100 in this earnings bracket that goes into your pension costing you, just £40.
2. Keep more of what you earn
Bonuses are taxed in the same way as salary which means a hefty chunk could be deducted before you see it. One way to keep more of what you earn, is transferring some or all your bonus to your pension as soon as the money lands in your account. It’ll be topped up with 20% basic rate tax relief automatically by your pension provider, and any higher rate taxpayers can reclaim an additional 20-25% from HMRC via their tax return. Most of us can pay up to £60,000 into our pension each year, though tax relief is limited to 100% of your earnings. However, carry forward enables you to take advantage of any unused allowances from the previous three years, which could enable you to contribute as much as £200,000 to your pension this tax year, assuming your income is sufficient.
3. Bonus sacrifice
If offered by your employer, bonus sacrifice provides even more powerful tax savings. Like salary sacrifice, this method means you save both the income tax and National Insurance on what you contribute to your pension. It can offer tax savings of up to 47% (62% if the bonus falls into earnings between £100,000 - £125,140). Bonus sacrifice can also help you stay within thresholds for state benefits like Child Benefit. If you contribute enough to your pension that you downslide from the higher rate tax band to the basic rate, you’ll unlock access to an increased personal savings allowance, as well as reduced tax rates on capital gains and dividends.
4. Boost your retirement plan
The earlier any money is deposited into your pension, the sooner it can be invested and the longer it has to potential to grow tax-free. Take a bonus sum of £3,000 that’s been sacrificed into a pension, if it achieves 5% investment return annually, after 5 years this grows to £3,829, after 10 years it’s £4,886, and after 20 years it’s added £7,959 to the pension. Let’s remember, had the £3,000 bonus been paid out to a basic rate taxpayer, they would have received a maximum of £2,160 (20% income tax and 8% National Insurance). Paying your bonus into your pension makes your money work harder, so you don’t have to.”
|
