A bonus or a burst of overtime arrives and the extra pay looks disappointing. Part of the tax shown on that payslip is not the final tax. Knowing the difference can save you from a nasty surprise, or from a wrong conclusion.
Withholding is not the final bill
Your employer deducts tax as they pay you. For regular pay, the system estimates your yearly tax and spreads it evenly. A bonus is irregular, so some systems tax it with a separate method, for example a flat withholding rate on supplemental pay in the United States. The rate used for withholding can be higher or lower than your real rate. Any difference is settled when your yearly tax is finally worked out.
Why it feels like a large cut
The extra income is added on top of your usual earnings, so it is taxed at your highest rate, your marginal rate, not your average rate. Social insurance contributions apply too. The result is that the portion of a bonus you keep is often smaller than the portion of your normal pay that you keep. It is still extra money, and it is never taxed so heavily that you lose by earning it. See our tip on marginal and effective rates.
Overtime and pay periods
Overtime is added to the pay for a particular period. In a period with a lot of overtime, the system can assume the higher amount will repeat every period of the year and withhold as though your annual income were higher, which can overstate the tax for that payslip. Over the year, the correct total is worked out, but you may see a refund or an adjustment later.
How to plan
Treat a bonus as part-spent before it arrives. A few habits help:
- Run the extra amount through our calculator, added to your annual pay, to see roughly how much you keep.
- Put some of it toward a goal straight away, such as extra pension contributions, which can reduce the tax on it.
- If you can choose when the bonus is paid, check whether paying it in a different tax year changes the result.
- Do not spend the gross figure. Spend the net.
Pension contributions from a bonus
Some employers allow you to send part or all of a bonus into your pension before tax. In the UK this is often done through salary sacrifice, and in the US a bonus can usually be included in 401(k) contributions, depending on your plan. This can reduce tax on the bonus and increase your retirement savings. Ask your payroll team what is possible and check any annual limits.
Keep the right records
Keep the payslip with the bonus in it and your year-end statement. If you think the wrong amount of tax was withheld, those are the documents the tax office will want to see.
Calculators for this guide
More tips
- How to Read a Payslip, Line by Line
- Hourly, Weekly, Monthly or Yearly: Converting Pay Without Mistakes
- Marginal and Effective Tax Rates: Why a Pay Rise Never Costs You Money
- Retirement Contributions and Take-Home Pay: Before Tax or After?
- How to Compare Two Job Offers Properly
- Why Your Real Payslip May Differ From an Online Estimate
- How to Build a Budget From Your Take-Home Pay
- States With No Income Tax: What That Does and Does Not Mean
- Moving for a Job: Will You Really Be Better Off?
- Self-Employed? How Much Should You Set Aside for Tax
- Asking for a Raise: Using Take-Home Numbers to Plan the Conversation
- Student Loan Repayments and Your Take-Home Pay
- A Yearly Tax Check-Up in Thirty Minutes
- All tips and guides
These guides are general information and estimates to help you plan. They are not tax advice. Rules and rates change, so check the official tax authority for your country.