While some lucky workers will have already received their annual bonus for 2024 – as January is a popular time to pay it – other companies issue a pay bump in summer, or sometimes in December ahead of Christmas.
These bonuses can add a hefty sum to your income. The average bonus in the UK is about £2,000, according to the Office for National Statistics, but workers in the finance and professional services industries can see an extra six figures added to their pay.
There is a catch for those expecting a financial boost, however. The taxman would swipe £4,200 of a £10,000 bonus directed to a higher-rate taxpayer, while any reward pushing you over the top-rate tax band would be just over half the size by the time it reached your bank account.
But there are things you can do to keep more of your windfall – and ways to make the most of the money that reaches your bank account. Here, Telegraph Money shares some tax-efficient tips.
Make a sacrifice
Sacrificing money coming your way may sound counter-intuitive, but it can actually be a smart financial decision that can lower your tax bill while bolstering your pension pot.
The idea is that you forgo your bonus (or some of it), and have the money paid into your pension instead. This means your bonus becomes tax-free, because the money is paid into your pension before income tax is deducted.
Most companies are happy to offer salary sacrifice schemes because they would typically pay National Insurance contributions on bonus sums, so it saves them money too. Some firms may even funnel their own contribution savings into your pension.
If you did receive your employer’s National Insurance, your £10,000 bonus would become a £11,380 pension contribution, according to the accountants Moore Kingston Smith.
While it may seem a no-brainer in pounds and pence terms, there are things to consider.
Firstly, committing extra bonus cash to your pension means you lock the money away until you are at least 55. Salary sacrifice schemes also lower your overall income, which can impact your ability to get credit and the affordability checks when applying for a mortgage.
If you’re on a higher income, you’ll have to keep an eye on your annual pension contributions; these are capped at 100pc of your salary, or £60,000 – whichever is lower. A hefty bonus payment may mean you’ll risk exceeding your tax-free contribution limit.
Tax paid on a £10,000 bonus: £0
Tax saved (for a higher-rate taxpayer): £4,200
Swap the money
You could also look at a bonus exchange agreement. Like salary sacrifice, this arrangement has to be put in place before you receive the money.
Under these agreements, the employer holds on to the bonus and uses the money to fund something for the employee, typically a car. For example, the company might use the funds to pay for a corporate car lease.
“This means that the employee is effectively paying the lease costs for the car out of their gross salary (pre-tax), and the only cost to the employee is a tax charge on a benefit-in-kind,” said Tim Stovold, head of tax at Moore Kingston Smith.
This tax charge would be calculated as 2pc of the list price of the car. On a £40,000 car, for example, this would be an £800 bill.
Tax paid on a £10,000 bonus: £800
Tax saved (for a higher-rate taxpayer): £3,400
A treat for the future
If you have already received your bonus, you can still use the money in a tax-efficient way by putting the lump sum into your pension pot.
While you won’t be able to claim back the National Insurance contributions that have been deducted from your bonus – £200 on a £10,000 bonus paid to a higher-rate taxpayer – you will be able to claim back any income tax paid.
The first 20pc of tax relief is added “at source”, which means it is done automatically when you pay into your pension and will be added to your retirement savings. You will need to claim via a tax return for the extra 20pc or 25pc if you are a higher or top-rate taxpayer, and this will be paid directly to you through a reduced income tax bill.
“If you are subject to higher or additional-rates of income tax, it is vital that you complete a self-assessment tax return and disclose your personal pension contributions on it,” said Jason Hollands from the wealth manager Evelyn Partners.
“A caveat with pension investing is that while the tax reliefs are highly attractive, there are restrictions on when you can start to access your pension.”
Tax paid on a £10,000 bonus: £200
Tax saved: £4,000
Shield from tax with an Isa
If you want better access to your bonus, but still want to save it in the most tax-efficient way, then Shaun Moore, head of tax policy at Quilter, recommends utilising your Isa allowances.
“This can help shield your wealth from tax,” said Mr Moore. “While you will still end up paying income tax and National Insurance on the bonus, you can ensure that any income of growth avoids tax.”
You can pay up to £20,000 a year into your Isa, and any money within the wrapper is free from income tax, capital gains tax (CGT) and dividend tax.
Mr Moore said: “Leaving money outside these wrappers, can result in you being out of pocket, and use up your tax-free allowances.
“For example, 3pc capital growth on £20,000 wastes 20pc of the capital gains allowance, 2pc dividend yield would waste 80pc of your dividend allowance and 1pc interest on your savings uses up 40pc of your personal savings allowance.”
Tax paid on a £10,000 bonus: £4,200
Tax saved: £0 on bonus, but has future tax benefits
Get the tax back
If you have a higher risk tolerance when it comes to investing, you could consider looking at tax-efficient investment schemes.
Mr Hollands suggests a Venture Capital Trust – specialist investment companies that invest in small, earlier-stage British growth companies which are unquoted or issuing shares on the Alternative Investment Market (AIM).
“These are regarded as higher risk investments,” said Mr Hollands. “But to incentivise people to back such business, the government provides a co*cktail of tax perks.”
If you invest in a VCT new share issue, you can claim a 30pc income tax credit off the sum invested via your tax return. Therefore, if you invested £10,000, you could wipe £3,000 from your tax bill. You need to hold the shares for five years, otherwise you would have to repay the tax credit.
Tax paid on a £10,000 bonus: £1,200
Tax saved: £3,000
Use the money wisely
Whether you’re keeping all or just some of your bonus, consider using the cash to save you money elsewhere. For example, Nimesh Shah, from the accountancy firm Blick Rothenberg, suggests using the money to overpay your mortgage.
Assuming a 5pc interest rate, paying £10,000 towards your mortgage costs would reduce your bill by £500 a year, for example.
“Given higher interest rates, people may be attracted to use their bonus to overpay on their mortgage,” said Mr Shah. “Unfortunately, there’s no tax relief for making overpayments, but it should reduce your monthly interest cost and allow you to pay off your loan sooner.”
Mr Shah also suggests making a gift to your children, which is a tax-efficient option for estate planning. Gifts are free from inheritance tax after seven years so, providing you live for the next seven years, a £10,000 gift to them now would save a potential £4,000 inheritance tax bill if the money formed part of your estate in the future.
Tax paid on a £10,000 bonus: £4,200
Tax saved: £0 on bonus, but has future tax benefits
