Avoiding a tax cliff edge on bonuses

The latest forecast of the UK’s economic growth is set to be published by the Office for Budget Responsibility on 26 March 2025 and the Chancellor will no doubt be focused on the options to solve the country’s ongoing productivity puzzle. 

Growing the UK’s labour force, retaining talent, and increasing real wages are all topics likely to be under scrutiny at the Treasury. Employers and workers alike could be forgiven though for questioning whether our current tax system allows for the meaningful incentivisation and recognition of their labour. There will likely be many employers considering their bonus policies as we approach the end of the financial year, and, for many individuals on relatively modest salaries, a bonus could push them over a tax cliff edge.  

Below, we highlight a few different examples of how workers in England could be impacted.

Employee on £50,000

Take, for example, someone on a salary of £50,000 and paid a bonus of £5,000 (10% of their salary). They would broadly pay tax at a rate of 41% on this bonus (income tax and employees’ National Insurance contributions) and take home slightly more than £2,900. 

Graduates with plan 2 student loans

The effective tax rate is higher for graduates now repaying plan 2 student loans back at a rate of 9% on employment income over £27,295. The effective rate on a £5,000 bonus increases to just over 50%, leaving a net take home pay of slightly less than £2,500 from their gross bonus. 

Working parents with plan 2 student loans

However, a bigger tax hit may be incurred by those on an annual salary of between £60,000 - £80,000 who claim child benefit. For example, an individual on an annual £60,000 salary before a bonus, claiming child benefit for two children and repaying a plan 2 student loan would pay an effective 62% rate of tax on a £6,000 bonus (10% of their salary). They would find that 30% of their child benefit would be recovered through a High Income Child Benefit Charge (HICBC), an additional cost equating to £664 for two children for receiving the bonus. This additional tax bill could also come as a nasty surprise next January as the charge is unlikely to be deducted at source from the bonus and paid to HMRC by the employer. 

By comparison, an individual on a salary of £80,000, in receipt of child benefit for two children, and repaying their plan 2 student loan, would have an effective rate of 51% on an £8,000 bonus (equal to 10% of their salary). 

But what is the bigger picture to all this? Perhaps it is that whilst government may proclaim that we have a fair and progressive tax system that looks to encourage hard work and support people back into employment while raising a family, it is not unreasonable or unfair for some to challenge this view. Some of those the government seeks to encourage back into the UK workforce may question whether work is worth the reward.  

In the short term, for those close to the edge of a higher tax rate, they may be able to mitigate their rate of tax by having their bonus paid as a pension contribution or by making substantial gift aid donations. There is little that can be offered though to those who require as much disposable income as possible. The government previously ruled out changing the HICBC so that it is calculated in reference to household income, due to the costs associated with such a reform. It may not be an eye-catching measure but if the Chancellor can reconsider and introduce reforms to the tax system that lessen the impact of these cliff edges in the tax system, that may go some way to helping achieve her wider economic objectives.