Recognising their employees’ hard work is an important way that business owners can increase morale and make sure they retain the best people.
To this end, you might receive a bonus occasionally, especially at certain times of the year including Christmas, after a performance review, or at the end of the tax year.
If you’ve received a bonus recently, or expect one in the near future, you might be wondering what to do with it. Contributing it to your pension so you can build your retirement savings faster is one option you may consider.
Read on to learn how this works and whether it could be the right choice for your financial plan.
You could use “bonus sacrifice” or make a personal contribution to your pension
If you receive a bonus and want to pay it into your pension, you have two options; use “bonus sacrifice” or receive the cash and then make a personal contribution. Bear in mind that these options only apply if you are enrolled in a defined contribution (DC) scheme. If you pay into a defined benefit (DB) scheme, you can’t normally contribute your bonus.
Bonus sacrifice
Bonus sacrifice allows you to ask your employer to pay some or all your bonus directly into your pension. Effectively, you “sacrifice” a portion of the bonus in exchange for pension contributions. You might decide to sacrifice 50% of the bonus, for instance, and then receive the rest as a cash payment. Alternatively, you could ask for 100% of the bonus to be paid into your retirement pot.
Your employer pays the portion of the bonus you sacrifice directly into your pension. As such, you won’t pay Income Tax or National Insurance contributions (NICs) on this amount because it doesn’t form part of your income.
However, the payment is treated in the same way as an employer contribution, so you won’t benefit from tax relief as you would when making a personal contribution (more on this later).
You’ll need to ask your employer whether they offer a bonus sacrifice scheme and pre-determine how much of your bonus you want to contribute to your pension.
Personal contribution
Instead of using bonus sacrifice, you could receive the bonus as a cash payment and then make a personal contribution to your pension.
If you choose this option, remember that your bonus is considered part of your income. As such, you may pay Income Tax and NICs on the amount, if you’ve already used your Personal Allowance of £12,570 within that tax year.
Once you receive the bonus, you can then make a one-off contribution to your pension. When you do this, you automatically receive 20% tax relief. This means that £100 going into your pension only “costs” you £80 because the government tops up the other £20. You may also be able to claim another 20% or 25% on top through self-assessment if you’re a higher- or additional-rate taxpayer.
Effectively, the government is refunding the Income Tax you paid on the bonus earlier and adding it back into your pension pot.
Whether you opt for bonus sacrifice or make a personal contribution, it’s important to consider the pros and cons of paying a bonus into your pension.
Contributing bonuses to your pension could significantly increase the size of your retirement pot
The obvious benefit of paying your bonus into your pension is that you can increase the size of your retirement pot. This could mean that you’re able to reach your retirement savings goal and finish work sooner than initially planned. Alternatively, if you retire at your planned date, you could enjoy a better quality of life as you have a larger pension pot to draw from.
Research from PensionBee demonstrates the difference paying a Christmas bonus into your retirement pot each year could make. A 45-year-old contributing an extra £200 each Christmas could have an additional £7,230 in their pension at age 66.
This assumes annual growth of 5%, 2.5% yearly inflation, and a 0.7% management fee deducted each year.
If the same person contributed £400 each Christmas, they’d have an extra £14,463 at age 66. This demonstrates how a relatively modest bonus could make a significant difference to the size of your retirement pot if you contributed it to your pension each year.
You may receive more bonuses throughout the year, and may be paid higher amounts, meaning you could grow your retirement fund even faster.
It’s important to be aware of your Annual Allowance
While paying your bonus into your pension could help you increase your savings, it’s important to consider whether you have reached your Annual Allowance.
This is the total amount you can contribute to your pension – including employer contributions and tax relief – each year without triggering a tax charge. In 2024/25, the Annual Allowance stands at £60,000 or 100% of your earnings, whichever is lower.
However, if you’re a high earner or have flexibly accessed a DC pension, your Annual Allowance may be reduced.
In some cases, paying a bonus into your pension could take you over the Annual Allowance and may trigger a tax charge. As such, it’s important to check your total contributions for the year so far and if you are likely to exceed the Annual Allowance, you may want to consider alternative ways to use your bonus.
You may have other important financial goals you want to achieve
Increasing your retirement fund might be a priority for you, but you may have other financial aims you want to achieve too.
For instance, you might want to overpay your mortgage, make renovations to your home, or take a dream trip with your family. A lump sum from a bonus could help you reach these goals.
So, before you pay a bonus into your pension, consider what’s important to you and decide whether the funds might be better spent elsewhere.
Get in touch
If you have a lump sum from a bonus or elsewhere, we can help you decide on the most suitable way to use those funds.
Please get in touch to find out how our team of VouchedFor Top Rated planners could help today.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.