Considering a Bonus Waiver
December is often the month when employees in the city find out about 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 of the 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 both you and your employer will typically contribute into a pot which 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 is increasing to 57 from 2028.
- When accessible, usually, a 25% lump sum of the pension can be taken tax-free, with the remainder being taxed at your marginal rate. This lump sum doesn’t all have to be paid out at once, you can take it in tranches to meet your retirement needs.
- Following the payment of your tax-free cash, there are a huge number of options as to how you can draw your pension in retirement, including but not limited to taking out smaller amounts to meet your ongoing income requirements and keeping the remainder invested, or purchasing an annuity with some or all of your funds, which would provide a set level of guaranteed income over the annuity term.
- Most people do not get serious about pensions until later in life and potentially miss out on reinvesting any returns made sooner, known as interest 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 make contributions into 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 £40,000 (2022/23). 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 and your adjusted income is more than £240,000 in a given tax year then you may find that your annual allowance is tapered to less than £40,000. This reduces on a sliding scale.
- Where the adjusted income exceeds £312,000, then you will receive the maximum reduction and be left with an annual allowance of just £4,000!
- Payments in excess of the Tapered Annual Allowance will be subject to an income tax charge. 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 3 years.
Lifetime Allowance (LTA):
- The lifetime allowance is the total amount you can build up in a tax-advantaged environment (i.e. pensions).
- This is currently £1,073,100 and is frozen until April 2026, although it had been increasing with inflation in recent years.
- The Lifetime Allowance Charge for any excess fund taken as an income is 25%, and this is deducted before the fund is used to provide an income. If the excess fund is taken as a cash lump sum, the Lifetime Allowance Charge is 55% of the excess fund over the LTA.
- This 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.
If you have any questions at all or would like to book a meeting to discuss your individual circumstances, please send us an email at email@example.com.