Understanding Tax on Bonuses: What You Need to Know

tax on bonuses for employees

If you’ve received or are expecting a bonus from your employer, you might be wondering how much of that extra cash you’ll actually take home. While bonuses can be a great way to boost your earnings, many people are surprised to learn how much is deducted for tax.

tax on bonuses

In this blog, we’ll break down everything you need to know about tax on bonuses, helping you understand exactly what to expect and how you can plan ahead.

What is a Bonus?

A bonus is an additional payment made by your employer, often as a reward for hard work, meeting targets, or being part of an incentive scheme.

Bonuses are typically seen as a perk and can come in the form of cash, shares, or vouchers. However, just because it’s a bonus doesn’t mean it’s tax-free. In the eyes of HMRC, bonuses are treated as part of your earnings, which means they’re subject to tax.

How is Tax on Bonuses Calculated?

Your bonus is added to your normal salary, and the total is then taxed based on your income tax rate. In the UK, there are three main income tax bands:

tax on bonus tax rates

When you receive a bonus, it gets lumped together with your salary and taxed at the same rate. For example, if your salary is £40,000 and you receive a £5,000 bonus, the bonus pushes you into the higher tax bracket for part of that amount.

So, while part of your bonus will be taxed at the 20% basic rate, a portion might also be taxed at 40% depending on your total earnings.

How Bonuses Impact Your National Insurance Contributions

In addition to paying tax on bonuses, National Insurance Contributions (NICs) also apply. NICs are calculated as a percentage of your earnings and, like tax, they are deducted from both your salary and any bonuses you receive.

Currently, employees pay NICs at 12% on earnings between £12,570 and £50,270 and at 2% on earnings above this threshold. Your bonus will be subject to the same rates of National Insurance as your salary.

Why Does It Feel Like Bonuses Are Taxed More?

One of the most common questions people ask is: “Why does it feel like my bonus is taxed more than my salary?” The answer lies in the way bonuses are often processed.

tax on bonuses national insurance

Since bonuses are usually one-off payments, employers often deduct tax at a higher rate as a precaution, assuming the bonus could push you into a higher tax bracket. This can sometimes result in higher initial deductions, but don’t worry – you’ll pay the correct tax rate by the end of the tax year, and any overpayment can be refunded through your PAYE (Pay As You Earn) system.

If you think too much tax has been taken from your bonus, you can check your tax code or contact HMRC to ensure you’re not overpaying.

Example: Tax on Bonus

Let’s say you earn £30,000 a year, and in December, you receive a £2,000 bonus. Here’s a simple breakdown of how tax on your bonus would work:

  • Your salary is taxed at the 20% basic rate, meaning you pay £3,486 in tax for the year.
  • When you receive the £2,000 bonus, this is added to your income, making your total earnings for the year £32,000.
  • Since £32,000 is still within the basic rate tax band, the entire bonus is taxed at 20%, meaning you’ll pay £400 in tax on the bonus alone.
  • Additionally, you’ll pay National Insurance at 12%, which works out to £240 on the £2,000 bonus.

So, out of your £2,000 bonus, you would take home £1,360 after tax and National Insurance.

Can You Reduce the Tax on Your Bonus?

While it’s impossible to avoid paying tax on your bonus entirely, there are some strategies you can use to reduce the amount of tax you pay:

  1. Salary Sacrifice Pension Contributions: One way to lower the tax on your bonus is to opt for salary sacrifice pension contributions. You can arrange with your employer to pay part (or all) of your bonus directly into your pension. This reduces the amount of taxable income you receive, meaning you pay less tax in the short term while boosting your retirement savings.
  2. Charitable Donations: If you donate to charity through Gift Aid, this can reduce the amount of tax you pay on your total income, including your bonus. The government effectively tops up your donation by giving the charity 25% more from the tax you’ve already paid, and if you’re a higher-rate taxpayer, you can claim additional tax relief on your self-assessment tax return.
  3. Check Your Tax Code: Sometimes the wrong tax code can mean you’re paying more tax than you should be. If you’ve changed jobs recently, been promoted, or had a change in salary, it’s worth checking your tax code is correct with HMRC.

What Happens If You Receive a Bonus When Leaving a Job?

If you’re leaving a job and receive a bonus as part of your final pay, the same tax rules apply. The bonus will be added to your total earnings for the year and taxed according to your tax band.

tax on bonuses leaving a job

However, it’s important to remember that any unused personal allowance or allowances for the year can still be applied to reduce the tax on your final bonus.

Summary

Receiving a bonus can be a fantastic reward for your hard work, but understanding how tax on bonuses works is essential to avoid surprises.

Whether you’re in the basic, higher, or additional tax band, your bonus will be taxed as part of your earnings, and National Insurance will also apply. Knowing how tax on bonuses is calculated can help you plan ahead, make the most of your income, and even explore ways to reduce your tax bill.

tax on bonuses employment

If you’re unsure about how much tax you’ll pay on your bonus or want to explore options for reducing your tax bill, we’re here to help. At Blue Spire, we specialise in providing clear, jargon-free advice that helps you manage your finances with confidence. Get in touch today for tailored advice on all aspects of tax, including tax on bonuses.

For more information on managing your bonus tax effectively and optimising your finances, please don’t hesitate to get in touch with our team.

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