UK workers receiving a Christmas bonus could see more than 40 per cent of the payment lost to income tax and National Insurance.
The warning comes as many employees prepare to receive year-end rewards alongside rising festive costs.
Income tax and National Insurance (NI) deductions can significantly reduce the value of a bonus once it is paid through payroll.
In one example, a worker earning £75,000 who receives a £10,000 bonus would take home £5,675 after tax and National Insurance.
The final amount could be lower if additional deductions, such as student loan repayments, apply, as bonuses can be taxed at a higher marginal rate than regular monthly pay.
Chris Eastwood, chief executive officer and co-founder of pension provider Penfold, said many workers are unaware of how heavily bonuses are taxed.
He said employees should consider using a process known as bonus sacrifice to reduce the tax impact.
Bonus sacrifice allows workers to redirect part or all of their bonus into a pension before deductions are applied.
Income tax and National Insurance deductions can significantly reduce the value of a bonus
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Mr Eastwood said: “December is a time of giving, but it’s also when financial pressures peak.
“A Christmas bonus can be a welcome boost, but also often easy to lose to tax and short-term spending.”
Mr Eastwood said redirecting a bonus into a pension can significantly increase its value over the long term.
“However, in redirecting a bonus into your pension, you can make the reward go much further.”
Under a bonus sacrifice arrangement, the employer pays the bonus directly into a defined contribution pension scheme.
Because the payment is made before tax and National Insurance, the full amount is invested in the pension.
Mr Eastwood said: “Through bonus sacrifice, UK workers can redirect some or all of their bonus into a defined contribution pension pot before tax and NI are taken.
“This can save thousands in tax, grow long-term savings, and in many cases increase employer contributions where NI savings are shared.”
The approach differs from receiving a bonus as cash, where a significant portion can be lost immediately to deductions.
With bonus sacrifice, the entire sacrificed amount is preserved for retirement savings
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Employers can also benefit from the arrangement, with companies not paying employer National Insurance contributions (NIC) on amounts redirected into pensions, some choose to pass those savings back to employees in the form of additional pension contributions.
“Employers also benefit by avoiding paying NI on the bonus, with many often passing these savings back into employees’ pensions as extra contributions.”
Setting up a bonus sacrifice requires employees to act before the bonus is processed through payroll.
Arrangements cannot be made after a bonus has already been paid.
Employees need to contact their payroll or human resources department in advance to request the change.
Mr Eastwood said securing your future is the ultimate gift
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Workers can choose to sacrifice the full bonus or only a portion of it, but early communication with employers is essential to ensure the arrangement is applied correctly.
He encouraged workers to consider the long-term impact of bonus sacrifice rather than focusing solely on short-term spending.
Mr Eastwood said: “While you’re busy giving to others this holiday season, consider giving yourself the ultimate gift: a stronger financial future”.
He added: “Redirecting a short-term windfall into long-term gain is one of the smartest moves in planning for the future, without sacrificing festive cheer”.
