How are Bonuses Taxed: Essential Guide for 2024

Dominic Hay
November 29, 2023
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We are approaching bonus season and anyone entitled to earn a bonus is being super nice to their managers and directors. Can you relate? A lot of corporate professionals spend November and December completing their performance reviews to ensure they tick of all their tasks and goals to earn a bonus.

Earning a bonus can be an exciting accomplishment, as it signifies recognition for hard work and effort. However, it’s natural to be concerned about the amount of tax that may be deducted from this additional income. Like regular salary, bonuses are treated as earnings and therefore are subject to income tax, the employer National Insurance Contributions’ (NIC), and other possible deductions such as student loans. Fortunately, these deductions are typically managed by employers through their payroll systems.

While tax implications can be worrisome when receiving a bonus, there are lawful methods to potentially reduce or avoid paying taxes on this extra income. To better understand these techniques and how much tax is, it is crucial to first explore the various deductions that apply to bonuses and how they can impact your overall financial situation.

Key Takeaways

Bonuses are subject to income tax, National Insurance Contributions, and other possible deductions.
Employers typically manage all required deductions through their payroll systems.
Understanding tax implications can help in finding legal ways to reduce or avoid paying taxes on bonus income.

Income Tax

For Higher Earners

Income tax rates vary based on your location within the UK. In England, Wales, and Northern Ireland, you can expect the following to pay income tax rates:

Personal allowance: Up to £12,570 – 0% tax
Basic rate: £12,571 to £50,270 – 20% tax
Higher rate: £50,271 to £125,140 – 40% tax
Additional rate: Over £125,140 – 45% tax

For residents of Scotland, the tax rates are slightly different:

Personal allowance: Up to £12,570 – 0% tax
Starter rate: £12,571 to £14,732 – 19% tax
Basic rate: £14,733 to £25,688 – 20% tax
Intermediate rate: £25,689 to £43,662 – 21% tax
Higher rate: £43,663 to £125,140 – 42% tax
Top rate: Over £125,140 – 47% tax

It’s important to note that for individuals earning between £100,000 to £125,000 annually, there is a concealed tax, often referred to as the 60% tax trap. As a higher earner in this range, the personal allowance of £12,570, which is usually tax-free, becomes reduced by £1 for every £2 earned over £100,000. Once the £125,140 threshold is reached, the personal allowance is completely eliminated.

Consequently, earnings between £100,000 and £125,140 are taxed at an above rate tax of additional 20%, paired with the existing 40% (or 41% in Scotland) as a higher rate taxpayer, effectively resulting in a 60% overall tax rate.

National Insurance

When it comes to calculating National Insurance on bonuses, the process is relatively straightforward. Based on your income range, you will then pay national insurance at a specific rate on your received bonus amount. For example, if your annual salary is £35,000 and your bonus is £5,000, your bonus falls within the £12,571 to £50,270 range, making it subject to a 12% National Insurance rate.

Here is a brief overview of National Insurance rates based on income ranges:

Up to £12,570: 0%
£12,571 to £50,270: 12%
£50,271 to £150,000: 2%
Over £150,000: 2%

Using different formatting options, like bold text and bullet points, helps to convey this information efficiently and clearly.

Additional Deductions

Child Benefit

Repayments for student loans will be deducted from bonuses, similar to regular salary deductions. Pension contributions, on the other hand, may not automatically be taken from bonuses; as these payments and other variable incomes, such as overtime, are often not included in automatic contributions. In cases where employers utilize a system that factors in total earnings, pension and student loan contributions will be deducted from bonuses.

Pensions can help maximize the amount of money retained from bonuses. Meanwhile, the High Income Child Benefit Charge is applicable for individuals with children living at home, who claim Child Benefit and have earnings over £50,000. If both partners earn over £50,000, the one with the higher income is responsible for paying the charge.

This charge equates to 1% of the Child Benefit payment for each £100 of income over £50,000, and at basic rate tax and an income level of over £60,000, the Child Benefit is effectively lost.

How to Minimize Taxes on a Bonus?

The Solution

One way to avoid paying tax or effectively reduce the tax liability on a bonus is by directing the payment into your pension plan through a process known as bonus sacrifice. By doing this, you can avoid paying income tax and National Insurance Contributions (NICs) on the bonus. However, it’s important to note that this means you won’t get access to the cash until retirement age, which is currently 55, and expected to rise to 57 in 2028.

To implement this solution, simply inform your employer that you want your bonus paid into your pension plan. The employer will take care of the process, and they may even contribute your bonus payments from their NIC savings and additional pension contributions, potentially increasing the total amount of your bonus.

Possible Limitations

Although the bonus pay and sacrifice approach has its benefits, there are some limitations to be aware of. First, the maximum amount you can contribute to your pension tax-free is either £60,000 or 100% of your annual salary, whichever is lower. However, if you have unused allowances from the previous three years, you can use the ‘pension carry forward’ mechanism, potentially allowing you to contribute up to £160,000 in one year if you haven’t made any contributions in the last three years.

Additionally, tax on your bonus amount, if your annual income exceeds £260,000, your pension contribution allowance gets reduced by £1 for every £2 above this threshold. The minimum allowance remains £10,000, regardless of your income level.

Deciding on Your Bonus

Taxation can be a complex subject, with bonuses at its very core. Ultimately, the choice is yours whether to receive your bonus in cash or allocate it to your pension. For individuals earning between £100,000 to £125,000, it is worth considering the a pension scheme option, as bonuses could be taxed at 60% within this income range.

Though we have aimed to make this topic more digestible, you might still have questions. In that case, consult with your employer, as they have likely navigated these waters before and can provide the guidance you need.

Opting to place your bonus into a pension isn’t a questionable decision; rather, it’s a more tax efficient and practical approach for securing your future retirement. The only trade-off is holding off on immediate expenses, like that shiny new car, for now.

Frequently Asked Questions

What is the tax rate on bonuses in the UK?

In the UK, bonuses are taxed similarly to regular income. Your tax rate on bonuses depends how much tax on the income tax bracket you fall under:

Basic rate (20%): £12,570 – £50,270
Higher rate (40%): £50,271 – £150,000
Additional rate (45%): Over £150,000

Can bonuses be contributed to a pension to reduce tax?

Yes, contributing your bonus to a pension plan can help reduce your overall tax liability. Pension contributions can be used as tax relief, paying tax but potentially reducing your taxable income and even moving you into a lower tax bracket.

Are there tax-free bonuses for employees?

Some bonuses may be tax-free, including certain non-cash awards, such as employee achievement awards and long service awards. However, these tax exemptions typically have conditions and thresholds associated with them, so it’s essential to refer to the specific HMRC guidelines to determine whether a particular bonus is tax-free.

How does a bonus impact my overall tax liability?

Receiving a bonus can impact your overall tax liability by the same way:

Increasing your taxable income for the year
Potentially moving you into a higher tax bracket
Affecting the amount of National Insurance contributions you owe

Is there a tax trap on high-income bonuses?

Yes, there is a potential tax trap for high-income earners. If your income exceeds £100,000, you will begin to pay tax and lose your personal allowance, which is the portion of your income that is tax-free. This loss happens at a rate of £1 for every £2 above the £100,000 threshold, effectively increasing your effective tax rate on income above this level.

What is the process for calculating taxes on bonuses?

To calculate taxes on bonuses, follow these steps:

Determine your total income for the year, including your bonus.
Subtract your personal allowance (£12,570 for the 2023 tax year) from your total income.
Determine the tax rate applicable to your taxable income (based on the income tax brackets provided earlier).
Apply the appropriate tax rate to your bonus amount to calculate the taxes owed on your bonus
Conclusion

In conclusion, navigating the taxation landscape of bonuses in 2024 may seem intricate, but armed with a clear understanding of the key principles, individuals can make informed decisions to optimize their financial outcomes. Earning a bonus is undoubtedly a rewarding experience, but the associated tax implications necessitate careful consideration.

How are Bonuses Taxed: Essential Guide for 2024 - Ambitious Investor (2024)