Getting a bonus this year? Did you know that paying your bonus into your pension plan could save you on potentially hefty tax and National Insurance (NI) deductions? Here’s why bonus sacrifice could mean you keep more of your bonus and why you might thank yourself later.
If you’re lucky enough to get a bonus this year, you might want to consider paying it into your pension plan. Doing this could mean you get to keep more of it, maximise your pension benefits before tax year end and potentially reap the rewards in the years to come.
First let’s take a look at the tax and NI benefits of bonus sacrifice.
The benefits of bonus sacrifice – in numbers
Nicola is a 35-year-old office manager, earning £40,000 a year. She’s due to get a bonus of £8,000 at the end of March.
If she takes all of her bonus in her pay, she’ll pay 20% tax on all of it, as well as 12% NI payments (be aware that tax rates are different in Scotland).
But if Nicola opts to use bonus sacrifice to pay all of her bonus into her pension plan, she’ll get the full amount of £8,000 invested.
Her employer may also be willing to pass on some of the employer NI payments which may have already been taken from her bonus, which would mean more than £8,000 going into her pension plan.
If you pay tax at the higher or additional rate, your tax savings could be even more, although bear in mind that you pay a lower rate of NI on earnings above £50,000 – 2% rather than 12%.
Tax rules and legislation can change, and personal circumstances and where you live in the UK also have an impact on your tax treatment.
Don’t underestimate the power of compound growth
Remember your pension plan is invested. Which means you can potentially get additional growth on any investment growth you get from that lump sum. This is thanks to compound growth.
In a nutshell, compound growth is the ‘snowballing’ effect of receiving growth on any growth. It means that each year you have the opportunity to achieve growth, not only on the money you’ve invested, but also on the growth you might have already experienced.
As an example, let’s say you have £100 and invest it. Any growth you get is applied to the £100. In the next year though, any growth is applied not only to your original £100, but also to the investment growth that you achieved from that £100. This happens year on year and every year the impact is slowly magnified.
This difference may be small over one year but, given time, compounding can build up significantly. And over longer time periods, it could make a significant difference to the value of your investment, although that’s not guaranteed. And, you don’t pay tax on any of that potential growth while your pension plan is still invested – you only pay tax when you come to take money from it.
Remember the value of investments can go down as well as up and you may get back less than was paid in.
Give your pension plan a boost
We're at the beginning of a new tax year, so now could be the perfect time to use your bonus, or any extra savings you have, to make the most of any new tax free allowances.
For most people the total amount you, your employer or any third party can pay into your pension plan in a tax year is £40,000 or the equivalent of your annual salary, whichever is lower. This is known as the pension annual allowance.
It's also worth checking how much you used in the last few years. You might be able to carry over any unused allowances from the previous three tax years and maximise your pension payments.
Bonus sacrifice vs salary sacrifice – what’s the difference?
Salary sacrifice and bonus sacrifice sound similar, and work in a similar way when it comes to your pension plan. In both cases you can save on tax and NI deductions, but there are some key differences.
Bonus sacrifice is when you arrange to pay some, or all, of your bonus into your pension plan. This must be done before you receive it in your pay packet. You don’t have to commit to doing this every time you get a bonus and you don’t need to agree the amount you’re contributing with your employer.
A salary sacrifice scheme is an arrangement between you and your employer where you agree to have your salary reduced by a set amount. In return, that amount is paid into your plan as a pension payment. Not all employers will offer salary sacrifice and it isn’t right for everyone. If you’re not sure, you should speak to a financial adviser before making any decisions. There’s likely to be a cost for this.
How do I sacrifice my bonus into my pension plan?
If you think bonus sacrifice is right for you then first you need to make sure your plan accepts payments from your employer. If it does, then all you need to do is speak to your employer before your bonus is paid and let them know how much you would like to sacrifice. Your employer will then pay some or all of your bonus into your pension plan.
If your plan doesn’t accept employer payments, or if your employer doesn’t offer bonus sacrifice, you can still pay your bonus in to your pension plan after it has been paid to you in the same way you would pay in a single payment. You won’t avoid tax and NI deductions this way, but your payment will benefit from pension tax relief.
Our pension calculator helps you see if your pension savings are on track for the future you want. Using this simple tool can help you see if any extra payments could help increase the amount you’ll have in the future.
You can keep track of your Standard Life pension plan, including its value, by logging in or registering for online services.
A pension is an investment and its value can go down as well as up and may be worth less than was paid in.
Your own personal circumstances, including where you live in the UK, will have an impact on the tax you pay. Laws and tax rules may change in the future.
The information here is based on our understanding in February 2022 and shouldn’t be taken as financial advice.