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Considering a bonus waiver

By Edward Backhouse

  • Financial Planning

December is often the month when employees in the city find out their hard-earned bonuses. Typically, there will be an option to have this paid out as cash or to waive it, so it goes directly into one’s pension. The information below explains more, including some key things to be aware of when considering a bonus waiver.

An introduction to your pension:

A bonus waiver is where you sacrifice some of your bonus into your defined contribution pension.

  • Pensions are a fantastic way of saving where you and your employer will typically contribute into a pot that grows free of tax over time.
  • You benefit from tax relief on these contributions at your marginal rate of tax.
  • You can access your pension currently at 55, but this will increase to 57 from 2028.
  • When accessible, 25% of the pension can be taken tax-free, with the remainder at your marginal rate of tax.
  • There are many options for how you can draw your pension in retirement, including taking out smaller amounts to meet your ongoing income requirements and keeping the majority invested, purchasing an annuity with some or all of it and many others.

Most people do not get serious about pensions until later in life and miss out on compounding. Starting early can make a huge difference. For example:

A 25-year-old with a salary of £45,000 and a contribution of £3,600 this year. At 45 years old, they would have to contribute £9,500 to match this.

What is a waiver of bonus?

  • With a waiver of your bonus, it is possible to exchange part/all of your bonus for an equivalent pension contribution.
  • This is the easiest way to contribute to your pension – no tax is deducted, so there is no tax to reclaim.
  • You benefit automatically from full tax relief at your highest marginal rate (e.g., 20%/40%/45%) as the gross bonus amount is paid to your pension.
  • You also benefit from National Insurance savings as you would have paid both tax and NI should the amount have been paid into your bank account.
  • Depending on earnings, you will benefit from 32% – 62% tax relief, so it is extremely tax efficient!

The below example illustrates the benefits for a higher-rate taxpayer:

What do I need to be aware of?

  • The HMRC rule is that the election must be made prior to you becoming entitled to the benefit for the waiver to be effective for tax purposes.
  • Speak to your HR Department if you have any questions about this.

Annual Allowance considerations:

  • Everyone can contribute to their pension up to 100% of their earnings each year or up to the annual allowance of £60,000 (2023/24). As such, the total of any personal pension contributions, employer contributions and government tax relief received cannot exceed the annual allowance.
  • Should your threshold income exceed £200,000 in a given tax year, you may find that your annual allowance is tapered to less than £60,000. This reduces on a sliding scale.
  • Where the income exceeds £360,000, then the annual allowance will just be £10,000!
  • Payments in excess of the Tapered Annual Allowance will be subject to an income tax charge.
  • For those impacted by the Tapered Annual Allowance, it is possible to carry forward unused allowances from previous years.
  • Unused allowances can be carried forward for three years – you must always fund the maximum allowance in the current year first before using unused allowances.
  • This gives the opportunity of a larger lump sum contribution, or it is possible to carry on paying higher regular contributions using allowances from the previous year.

Lifetime Allowance (LTA):

  • The lifetime allowance is the total amount you can build up in all your pension savings without incurring a tax charge.
  • This is currently £1,073,100, although there is no tax charge for the current tax year.
  • The lifetime allowance has been abolished for the 2024-25 tax year. Jeremy Hunt confirmed this in the recent budget with more details about what will come in the Autumn Finance Bill.
  • Labour shadow chancellor Rachel Reeves had committed to reinstating the lifetime allowance, although what is in their election manifesto remains to be seen.
  • There will be an election in the UK at some point in 2025, which will certainly be one of the discussed topics.
  • Whether or not it remains, the Lifetime Allowance shouldn’t stop you from saving into a pension and is often considered a ‘tax on growth’ but is something to bear in mind if you think you may exceed the tax-privileged limit.

This blog does not constitute financial advice.