Why a bonus could dent your finances
The next three months are typically when workers receive bonus payments with March being the most popular month, ahead of February and April.
The latest figures from 2016/17 reveal the average bonus amount was £1,600 and a total of £46.4bn was paid out, averaging 6.2% of pay.
When Greggs announced in January that staff would receive a £300 bonus following its ‘phenomenal year’, rather than be overjoyed, many workers were left disappointed because of its impact on Universal Credit payments.
These workers would only take home around £75 as benefit payments reduce as earnings increase, leading to Labour leader Jeremy Corbyn calling for Universal Credit to be scrapped.
Sarah Coles, personal finance analyst at Hargreaves Lansdown, said: “Greggs may have paid the most talked-about bonuses of the year so far, but they’re not the only people expecting a little extra dough at the moment. Bonuses are being dished out across the country, and bonus season is set to rise to a peak next month.
“But there are some people for whom a bonus isn’t an unalloyed joy. Whether it reduces your Universal Credit, pushes you into a new tax bracket, or leaves you with a pension headache, your bonus can cause unexpected problems.
“It pays to know the risks, and what you can do to avoid them.”
Below, Coles explains how a bonus can impact your finances…
This emerged as Greggs staff digested the impact of their £300 bonuses. Increased earnings feed through into the Universal Credit system, so you receive lower payments. It means after tax and National Insurance, Greggs staff could be left with as little as £75 more in their pockets as a result of their £300 bonus.
If a bonus takes the income of one of the parents over £50,000 they will be subject to the higher income tax charge, which means they have to pay back 1% of their child benefit for every £100 they earn over £50,000 – until those who earn £60,000 or more have to repay it all.
Higher tax bracket
The bonus can push you over a tax limit and into paying 40% (£50,000) or 45% (£150,000) on a chunk of your income – so you receive a far smaller lump sum than you expected.
For those on higher incomes (£110,000+), if your income, benefits and pension contributions exceed £150,000, the limit on what you can pay tax-efficiently into a pension each year can drop from £40,000 to just £10,000 because of the pensions taper. The earnings limit includes your bonus, so if it pushes you over the threshold you could face a tax bill.
HMRC can change your tax code if you get a pay rise. It adds up everything you’ve earned over a specific period and uses that as a basis for your earnings for the rest of the year.
The problem is that it doesn’t differentiate between a bonus and salary. This can be a problem particularly for those who receive a bonus early in the new tax year.
As an example, you’re paid £3,000 a month, and in the second month you get a £10,000 bonus (so £46,000 overall). The system calculates you’ve made £19,000 in the first three months, extrapolates that, assumes you’ll make £76,000 in the year, and changes your code to show you’re a higher rate taxpayer.
What can you do?
Check your tax code
HMRC will send you a note when it changes your code – including an estimated annual income, so if you know it has been wrongly triggered by a bonus you can call to have it corrected. But there’s no need to wait for the note. You can log into your Personal Tax Account, check it and correct it there.
Tell your employer you want to sacrifice some or all of your bonus and have the difference paid into your pension. You get full tax relief on this, so you avoid paying a higher rate of tax. It also brings down your total pay for the year, which can help you keep the right side of the child benefit limit. But this means you’ll need to wait to get your hands on the money in your pension.
If your bonus is at the start of a new tax year, it puts you in a better position to plan. You can work out whether you’ll be moving into a higher tax bracket, or bust the £50,000 child benefit limit as a result of your bonus. As such, you can use salary sacrifice to pay more into your pension and bring your salary down below the threshold limits.
The exception: This doesn’t solve the problem of the tapered annual allowance for pensions, which has been designed specifically to stop people using pension contributions to get round it – by including them in the overall £150,000 limit.
Alternatives: The only way around the impact of the taper is to avoid paying too much into your pension to begin with. This is easier said than done if you get a bonus later in the tax year, because you need to factor an unknown quantity into the maths from the outset.
Alongside the pension, you can put your money into alternative tax-free investments like stocks and shares ISAs or Lifetime ISAs (if you qualify).
If you have a large and diverse portfolio, you can also consider tax advantageous investments such as venture capital trusts and enterprise investment schemes. These are high risk investments, so if you’re considering them don’t let the tax tail wag the investment dog – make sure it’s right for you.