Four strategies to mitigate the impact and five bear traps to watch out for this bonus season

Bonuses are most common in March, but this can cause problems with taxes and pensions

We examine four strategies to safeguard your hard-earned cash.

Bonus season is in full swing, so employees who are waiting for a reward will want to do everything in their power to protect it from the taxman.

According to the Office for National Statistics (ONS), the majority of bonuses are paid between December and March. In the UK, the median bonus for the 2024 - 2025 tax year was £2,000.

Receiving an annual bonus, however, may have unintended consequences for your finances, such as putting you in higher tax brackets.

Investment platform Hargreaves Lansdown's head of personal finance, Sarah Coles, told BFIA: "There's every indication that many companies are keeping a lid on pay increases more generally so they can reward their top performers handily.

Bonus season will be something to celebrate for some because pay policies have been impacted by the lifting of the cap on bankers' bonuses. But even if you're eligible for a bonus, you still need to be mindful of the dangers. The "

Here are four strategies to lessen the impact and five potential negative side effects that bonuses may cause.

Bonus bear traps: five.

Paying a greater tax rate.

If a bonus is large enough, it may put you in a higher income tax bracket or increase the amount of your income that is subject to higher taxes.

The 40 percent income tax bracket, which is applicable to taxable income between 50,271 and 125,140 in England, Wales, and Northern Ireland (income tax bands differ in Scotland), would be triggered, for instance, by a 5,000 bonus on a 50,000 annual income. This implies that 270 of your taxable income would be subject to the 20 percent basic tax rate and 4,730 would be subject to a 40 percent tax rate. This indicates that 5,000 would require paying 1,946 in income tax.

Since the income tax band freeze has been extended until 2031, more bonus recipients may be forced to pay higher tax rates as a result of growing incomes.

Benefit concerns.

If their bonus exceeds the 60,000 annual income threshold, those with higher incomes who receive Child Benefit may be required to repay more.

Once you exceed this cap, Child Benefit must begin to be repaid to HMRC through the High Income Child Benefit Charge (HICBC). After you reach 80,000, the taxman takes away all of your benefits.

In the meantime, if a parent's income exceeds £100,000, they will no longer be eligible for tax-free childcare and free childcare hours because these programs are not available to those with adjusted net incomes above £100,000.

Problems with pensions.

A bonus may result in a decrease in your annual pension allowance.

You are eligible for tax relief on pension contributions up to £60,000 per fiscal year. Higher earners receive a tapered allowance, though.

If your adjusted income exceeds 260,000 and your threshold income exceeds 200,000, your annual allowance is typically tapered.

The adjusted income is all of your income plus the amount your employer contributes to your pension or the amount your defined benefit pension has increased by, whereas the threshold income is usually all of your income less the amount you contribute to a pension.

Every two times your adjusted income exceeds 260,000, the standard allowance of 60,000 is reduced by one.

Incorrect tax assessments.

To determine how much tax you should pay, HMRC totals all of your earnings over a given time period and extrapolates that amount for the remainder of the fiscal year.

Nevertheless, the system it employs is unable to distinguish between an ongoing salary and a one-time pay increase brought on by something like a bonus.

In the months that follow a bonus, you might be taxed more than you should be due to a change in your tax code.

Danger of lifestyle creep.

Receiving sizable bonuses may lead you to decide to start living a more opulent lifestyle by raising your spending obligations.

You may experience a shortfall in income if you receive a lower-than-anticipated reward the next year.

How to lessen the effect.

There are strategies to mitigate the impact of taking a hit after getting your bonus, according to Coles.

Give up a portion of your bonus to reduce taxes.

Usually, a bonus is given to you along with your salary after taxes have been subtracted. For instance, if a higher rate taxpayer received a bonus of £10,000, they would have to pay £4,000 in taxes.

As long as you haven't gone over your annual pension allowance of £60,000, you can ask your employer to deposit your bonus into your pension instead, where it will receive tax relief. Additionally, your National Insurance premiums will be reduced.

By lowering your total annual individual income, this can also help parents stay below the 60,000 or 80,000 High Income Child Benefit Charge thresholds.

Note that if you are eligible for the tapered annual allowance for pension savings, this trick will not be effective.

Make a plan.

Instead of squandering your bonus money, take advantage of the opportunity to pay for necessary expenses that could result in long-term cost savings.

You could use the bonus to settle any outstanding debt or use the extra money to create an emergency savings account.

Additionally, you could use your annual 20,000 tax-free ISA allowance and allow the funds to compound over time.

Keep in mind that the value of your capital is at risk if you decide to invest in an ISA for stocks and shares.

Alternatively, you could deposit the funds into a savings account or top-paying cash ISA.

Either way, you don't want to let the money sit around in a current account with no interest.

Think about alternatives to pensions.

You could invest the excess funds in a venture capital trust (VCT) if you have maxed out your annual ISA allowance and do not wish to add your bonus to your pension.

VCTs provide 30% income tax relief on investments up to 200,000 and invest in small, early-stage businesses.

But since VCTs are regarded as high-risk investments, only invest in one if you have extra money.

See what your tax code is.

If your tax code has changed, HMRC will contact you to let you know if you will be paying excessive taxes the month after receiving a bonus.

Having said that, you can check your personal tax account, make sure everything is correct, and ask HMRC to make any necessary corrections without having to wait for the taxman to contact you.