With bonus season in full swing, workers awaiting a reward will want to do everything possible to shield it from the taxman.
The vast majority of bonuses are paid between December and March, according to the Office for National Statistics (ONS), with the UK median bonus worth £2,000 in the 2024/25 tax year.
However, getting an annual bonus can have knock-on effects on your finances – such as tipping you into higher tax bands.
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Sarah Coles, head of personal finance at investment platform Hargreaves Lansdown, told MoneyWeek: “There’s every sign lots of businesses are keeping a lid on pay rises more generally, so they can reward their top performers handsomely.
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“The lifting of the cap on bankers’ bonuses has also fed through into pay policies, so for some, bonus season will be something to celebrate. However, if you’re in the frame for a bonus, you still need to be aware of the risks lying in wait.”
Here are five possible negative side effects that can be triggered by a bonus, and four ways to minimise the blow.
Five bonus bear traps
Paying a higher rate of tax
If handsome enough, a bonus can tip you into a higher income tax band, or could mean more of your income is taxed at a higher rate.
For example, a £5,000 bonus on a £50,000 annual income would push you into the 40% income tax bracket, which applies on taxable income between £50,271 to £125,140 in England, Wales and Northern Ireland (income tax bands are different in Scotland). This means £4,730 of your taxable income would be subject to a 40% tax rate, while £270 would be taxed at the 20% basic tax rate. This means the total income tax payable on £5,000 would be £1,946.
The freeze on income tax bands has been extended until 2031, meaning more people receiving bonuses could be dragged into paying higher rates of tax due to rising salaries.
Benefit issues
Those on a higher income receiving Child Benefit may have to pay more back if their bonus pushes them over an annual income threshold of £60,000.
Child Benefit has to start being paid back to HMRC once you breach this limit, via the High Income Child Benefit Charge (HICBC). Once you earn £80,000, all of the benefit is clawed back by the taxman.
Meanwhile, a bonus taking a parent’s income over £100,000 will see them lose their entitlement to free childcare hours and tax-free childcare as these schemes are not open to people with adjusted net incomes over £100,000.
Pension problems
A bonus could potentially lead to a reduction in your pension annual allowance.
Each financial year, you get tax relief on any pension contributions worth up to £60,000. However, this allowance is tapered for higher earners.
Your annual allowance is usually tapered if both your ‘threshold income’ is over £200,000 and your ‘adjusted income’ is over £260,000.
The threshold income is typically all your income minus the amount you pay into a pension while the adjusted income is all your income plus the amount your employer pays into your pension or the amount your defined benefit pension has grown by.
The standard allowance of £60,000 reduces by £1 for every £2 of adjusted income you have over £260,000.
Erroneous tax charges
HMRC adds up everything you have earned over a specific period and extrapolates that figure for the rest of the financial year to work out how much you should be paying in tax.
However, the system it uses can’t tell the difference between a one-off increase in pay, caused by something like a bonus, and ongoing salary.
This may trigger a change in your tax code meaning you’re taxed more than you should be in the months following a bonus.
Risk of lifestyle creep
Getting large bonuses could mean you choose to start living a more expensive lifestyle, as you increase your spending commitments.
If you then get a smaller-than-expected reward the following year, you could be faced with an income shortfall.
How to minimise the impact
Faced with taking a hit after receiving your bonus, there are ways to lessen the blow, Coles said.
‘Sacrifice’ some of your bonus to save tax
A bonus is typically paid alongside your salary with tax already deducted. For example, a higher rate taxpayer getting a £10,000 bonus would have to pay £4,000 in tax on it.
However, you can ask an employer to pay your bonus into your pension instead where it will benefit from tax relief, so long as you’ve not exceeded your £60,000 annual pension allowance. It also means you’ll pay less National Insurance.
If you’re a parent, this can also keep you under the £60,000 or £80,000 High Income Child Benefit Charge thresholds by reducing your total overall individual income for the year.
Do note, this trick won’t work if you’re subject to the tapered annual allowance for pension savings.
Plan ahead
Rather than frittering your bonus money away, use the payment as an opportunity to get on top of essential costs that could save you money in the long-term.
If you’ve got any debt built up, you could use the bonus to pay it off, or you could use the extra cash to set up an emergency savings fund.
You could also make use of your tax-free ISA allowance, which is £20,000 per year, and let the money compound over time.
If you’re going to put money into a stocks and shares ISA, remember the value of your capital is at risk.
Alternatively, you could put the money into a top-paying cash ISA or savings account.
In any case, you don’t want to leave the money languishing in a current account paying no interest.
Consider pension alternatives
If you don’t want to add your bonus to your pension and have maxed out your ISA annual allowance, you could put the extra money into something like a Venture Capital Trust (VCT).
VCTs invest in small, early-stage companies and offer 30% income tax relief on investments made up to £200,000.
However, VCTs are considered high risk investments so only put money into one if you have the extra cash spare.
Check your tax code
HMRC will get in touch with you if it has changed your tax code, so you’ll know if you’re set to pay too much tax the month after receiving a bonus.
That said, you don’t have to wait for the taxman to get in touch – you can log into your personal tax account, check it is correct and get HMRC to correct it if not.
