Unexpected large bonus

spicycactus

Hi everyone, first time post here

two weeks ago, the small company I worked for was sold, and as part of the acquisition, every employee has been given a one time bonus of £25k. (on a salary of 40k). As a financial newbie (24 y/o), I have no idea what to do with this, should this go in my pension to remove the income tax, or am I likely to hit the £1m LTA?

Thanks in advance for your advice
Tom

AnotherJoe

Aged 24 I suggest you worry about the one million pound+ LTA in 30 years time (when it probably wont exist anyway)

I would spread the money. Some in pension, some in cash for if you plan to buy a house, some have some fun with, nice holiday whatever.

kidmugsy

£40k + £25k = £65k.
Threshold for higher rate income tax = £46,350.

To avoid higher rate you therefore need to make gross pension
contributions in tax year 18/19 of £18,650. That would include any pension contributions you are already making every month.

If your employer lets you contribute by salary sacrifice that would be a good way to do it. Or if your employer would match some of any extra contribution you make that would also be good.

If neither applies, you might open a personal pension of some sort. We find Hargreaves Lansdown good for our small SIPPs (other people here like AJ Bell, Cavendish Online, Charles Stanley Direct, ....). Here's how you might do the sums.

I'll pretend that your pension contributions at work are going to equal £1,650 gross, so your gross contribution to your new pension will be
(£18,650 - £1,650) = £17k. So your net contribution i.e. the amount you transfer to HL or whomever is 0.8 x £17k = £13,600.

Two things happen next: (i) the provider (HL or whoever) claims the tax relief that HMRC adds to your pension "pot" i.e. £17,000 - £13,600 = £3,400, (ii) you claim back from HMRC a further £3,400, which you do by reporting to them - (by phone at 8:00 a.m. on a Saturday morning is apparently a good way) - that you have just made a gross contribution of £17k to your new SIPP at HL.

If you take an overall look at the sums then you've avoided any 40% income tax and should still have left over a surplus of (£46,350 - £40k) less 20% income tax and 12% NIC. You still have to pay the 2% employee NIC on your pay above the higher rate threshold. I think that all works out to leave you with an extra £3,945 in your pocket (plus of course an extra £17k in your pension).

If you didn't have a decent emergency cash reserve, then you do now. All you need do is look at savings account/current accounts/regular savers that pay good interest.

You are also in the happy position that for the next few years you might not feel any urgency about making any more pension contributions above the amount that you make either (a) to get the max employer contribution, or (b) to avoid higher rate tax. So there's a potential burden off your shoulders.

But suppose you already have a good emergency cash reserve. What to do with the approx £4k burning a hole in your pocket? Do you hope to buy a first property in the next few years? If so, consider opening a Lifetime ISA (LISA). The deal is that you subscribe £4k and the taxpayers give it a £1k boost. Happy days. You can get the money out without penalty either by using it to buy your first property, or by waiting to age 60, or by being terminally ill. Otherwise if you need it out in an emergency the penalty for taking it out would sting but it isn't draconian. (You lose the taxpayers' boost plus 6.25% of your own money.)

Cash LISAs are currently offered by two BSs: the Skipton, and the Nottingham.

Note that to take advantage of the pension or the LISA you need to act before the end of the tax year on 05/04/2019. So you have ample leisure to turn this over in your mind.

Now then, what if you are already saving well to buy that first property? Then you have probably just acquired some extra cash that you could spend on - I dunno, a winter sunshine break in the Canaries in January, a skiing holiday in the Alps, .....

squirrelpie

Two things happen next: (i) the provider (HL or whoever) claims the tax relief that HMRC adds to your pension "pot" i.e. £17,000 - £13,600 = £3,400, (ii) you claim back from HMRC a further £3,400, which you do by reporting to them - (by phone at 8:00 a.m. on a Saturday morning is apparently a good way) - that you have just made a gross contribution of £17k to your new SIPP at HL.

I'm confused by this. If HL has already reclaimed the tax relief, why is Tom also able to claim it hinself?

wjr4

squirrelpie wrote: »

I'm confused by this. If HL has already reclaimed the tax relief, why is Tom also able to claim it hinself?

Because he will be a higher rate tax payer. The providers only apply basic rate tax relief.

atush

I an in concensus with the above.

Increase ension contribs to take yourself out of HRT. Then save the rest as cash, or consider LISA if you already have a good size cash pot.

Mr.Saver

Since you said that it's a small company, I assume that:
* Your employer doesn't operate any salary sacrifice scheme, and
* Your employer won't match your pension contributions other than the minimal 2% on eligible earnings required by law.

You will need to ask your employer to confirm all of the above.

For the simplicity, I did not do the NIC calculation below, please use the NIC calculator to figure this out. The calculator is located at http://nicecalculator.hmrc.gov.uk/Class1NICs1.aspx
Assume your NIC category letter is A, you are paid monthly £3,333.33, the 25k bonus is paid in one payroll. Your total NIC in this tax year should be £4,342.09

So, the most tax (in)efficient way of handling the money is:

* You have an annual income of £25k + £40k = £65k in this tax year
* You have £65k - £46,350 = £18,650 income in the 40% tax band, pay £7,460 tax on it
* You have £46,350 - £11,850 income in the 20% tax band, pay £6,900 tax on it
* In total, you pay £14,360 tax + £4,342.09 NIC = £18,702.09 to the government if you do nothing about it. This is nearly 29% of your 65k!

Now, let's do something about it.

* Your eligible earnings for workplace pension auto enrollment is £46,350 - £6,032 = £40,318
* You should make 3% of the eligible earnings contribution to your workplace pension to get the employer contribution, which is £1,209.54 gross, or £967.632 net (Your employer will make 2% contribution = £806.36, but it doesn't change your tax position)
* You will have £65k - £18,702.09 - £967.63 = £45,330.28 in your pocket by the end of the tax year, and £1,209.54 + £806.36 = £2,015.90 (in reality, this should be £2,016, because the contributions are made £168 * 12 months) in your workplace pension
* You will need to make further £18,650 - £1,209.54 = £17,440.46 gross pension contributions to reclaim all the 40% tax you've paid
* This means that you will need to pay a further £17,440.46 gross * 80% = £13,952.36 net into a pension, this can be an SIPP, your workplace pension, or other pension schemes. Please do your own work to find the one that fits you the best.
* After paid the addition pension contribution, you will have £31,377.92 left
* You will need either call your local tax office or finish a self-assessment online to claim your tax relief on the pension contribution, the tax relief you can claim back is £18,650 gross * 20% = £3,730
* Now you have £31,377.92 + £3,730 = £35,107.92 in your pocket, and £19,456.36 in your pension, total £54,564.28 out of the £65k, this is nearly 84%.

Without the bonus, you would have £30,580.88 in your pocket, which means you still have £4,527.04 additional in your pocket. Let do something about it too.

* Assume that you are going to buy a house using the LISA, you can now put £4k into an LISA, and get additional £1k from the government. This would make you £55,564.28 out of the £65k, that's a bit over 85%.

Now, you can treat your self with the remaining £500. (Or save it / invest it)

So, congrats! You will be able to make £55.5k from the £65k!

Kynthia

I made a similar sized contribution to a private pension last year. I rang the HMRC and told them it was a contribution to a private pension scheme net of higher rate tax relief. They said it was too much to deal with by phone and asked me to write a letter including proof. So I sent a letter with screen shots and copies of the relevant pension scheme details and received a refund a few weeks later.

OP makes sure you save most of it as lump sums like that don't cone around very often. However maybe treat yourself with a little of it too. Perhaps go visit somewhere amazing as once you have children there's a few years of family holidays while they are young, so take the opportunity now.