Your pension - the smart way to put your bonus to work

If you are lucky enough to get a bonus, you will no doubt be making plans for what to do with it. That is, until it hits your bank account and the sum staring back at you is far smaller than you expected. The reason? income tax and National Insurance will nibble away at the edges meaning that a basic rate taxpayer receiving a £5,000 bonus would only take home £3,600 of it – even less if they’re still paying back a student loan.

Rather than hand over a bigger chunk of your hard-earned cash to HMRC, consider using your pension to keep more of what you earned. If you’re not in need of the cash, choosing to pay some or all your bonus into your pension offers both big tax savings, and it will supercharge your retirement in one tax smart move – it’s a win-win for present and future you.

This article isn’t personal advice. If you’re not sure what’s right for you, please ask for advice. Pension and tax rules can change, and benefits depend on your circumstances. Money in a pension is usually accessible from age 55 (rising to 57 in 2028). Investments rise and fall in value, so you could get back less than you put in. If you’re a Scottish taxpayer, tax rates and bands differ, and so different rates of tax relief apply.

Here’s why your pension offers one of the best homes for your bonus.

1. It can prevent you going up a tax bracket

Thanks to income tax bands being frozen at 2021/22 levels, millions of people are being pulled into higher tax brackets and are paying more tax. Crunch the numbers before deciding what to do with your bonus – if it pushes your total earnings over £50,270, you’ll suddenly find yourself paying 40% tax on anything above the threshold. Should it drive you beyond £125,140 then the tax rate jumps again to 45%.

You’re effectively taxed 60% for any money that falls within the range of £100,000 - £125,140. That’s 40% income tax combined with the gradual loss of your personal allowance, which you lose at a rate of £1 for every £2 you earn over £100,000. Contributing to your pension can turn this tax trap to your advantage, because every £100 in this earnings bracket that goes into your pension will cost you just £40.

2. Keep more of what you earn

Bonuses are taxed in the same way as salary which means a hefty chunk could be deducted before you see it. One way to keep more of what you earn, is paying some or all of your bonus into your pension as soon as the money lands in your account. It’ll normally be topped up with 20% basic rate tax relief automatically by your pension provider, and any higher rate taxpayers can reclaim up to an additional 20-25% from HMRC via their tax return.

If you have a workplace pension that uses salary sacrifice, then your employer deducts your pension contributions before you pay any tax, meaning you save the income tax, as well as the National Insurance on what you pay in. This method simplifies administration for higher earners, because there is no need to claim any additional tax relief.

Most of us can pay up to £60,000 into our pension each year, though tax relief on personal contributions is limited to 100% of your earnings. However, carry forward enables you to take advantage of any unused allowances from the previous three years, which could enable you to contribute as much as £220,000 to your pension this tax year (2025/26), assuming you earn that much.

Remember that the higher rates of relief will generally be given as a refund at the end of the tax year or by reducing your tax bill, and won’t be added to your pension.

To find out how much tax relief you could get, try the HL pension tax relief calculator. All you need to do is confirm your earnings, and how much you’d like to pay into your pension.

Try our tax calculator

3. Bonus sacrifice

If offered by your employer, bonus sacrifice provides even more powerful tax savings. You can sacrifice all or part of your bonus – it works just like salary sacrifice, meaning you save both the Income Tax and National Insurance on what you pay into your pension. It can offer tax savings of up to 47% (62% if the bonus falls into earnings between £100,000 - £125,140).

Bonus sacrifice can also help you stay within thresholds for state benefits like Child Benefit. If you contribute enough to your pension that you downslide from the higher rate tax band to the basic rate, you’ll unlock access to an increased personal savings allowance, as well as reduced tax rates on some, or all, of any capital gains and dividends.

4. Boost your retirement plan

The earlier any money is deposited into your pension, the sooner it can be invested and the longer it has the potential to grow tax free of UK income tax and capital gains tax.

Take a bonus of £3,000 that’s been sacrificed in exchange for a pension contribution, if it achieves a 5% investment return annually, after 5 years this grows to £3,828, after 10 years it’s £4,886, and after 20 years it’s added £7,959 to the pension. Of course, with investing nothing is guaranteed – values could be higher or lower than this based on the performance of the investments ultimately chosen and the charges that apply. These figures do not take into account inflation or charges.

Let’s remember, had the £3,000 bonus been paid out to a basic rate taxpayer, they would have received a maximum of £2,160 (after 20% income tax and 8% National Insurance). Paying your bonus into your pension makes your money work harder, so you don’t have to.

The HL SIPP

When you open a SIPP with HL, the UK’s largest direct SIPP provider, you can look forward to pension tax benefits. As well as getting tax relief, your pension can also grow free from UK income and capital gains tax.

You’ll also get access to a wide range of investments to pick from, including the HL Ready-Made Pension Plan. And both secure and flexible retirement options – the choice is yours.

Explore the HL SIPP