Tax on Redundancy Payment – Is it Tax Free?

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Over the last year we have seen a lot of changes because of the Coronavirus pandemic, and as a result we have seen an increase in redundancies across industries. If you find yourself in this position you may have been offered a redundancy package and be wondering how best to utilise it.

Depending on how much you have been offered, you have several options. We go into these below.

 

Tax free payments

The first £30,000 of any redundancy payment is tax-free. These funds will likely be used to cover any immediate capital and income requirements. They do not count towards your taxable income.

 

Eating into income

Any redundancy payment in excess of £30,000 is taxable at your marginal rate of tax. For example, if you earn £50,000 a year and receive a £60,000 redundancy payment, the first £30,000 of the payment is tax free, and the next £30,000 is taxed at the 40% Higher Rate tax band. Therefore, on a £30,000 taxable payment, £12,000 is taken as tax and £18,000 is received by you.

However, if your earnings and / or the redundancy payment is higher, the taxation of the payment can be more severe. Assume you earn £80,000 a year and receive a £60,000 redundancy payment. Again, the first £30,000 is tax free and does not count towards earnings or your marginal rate of tax. The next £20,000 is also taxed in the same way as the above example, at 40% and pushes your earnings to £100,000.

However, the remaining £10,000 increases your earnings over £100,000, which causes a reduction in your personal allowance. The net effect of this is that the £10,000 earnings are taxed at 60%.

Therefore, in this example, on the £30,000 taxable payment, £14,000 is taken as tax and £16,000 is received.

 

Making use of pensions

You can request your employer to pay some or all of the payments in excess of the tax-free amount into a pension. This could be through your employer making a final pension contribution to your workplace pension before you leave the company. This will not only save any immediate liability to income tax, but also all income and gains earned in a pension can roll up tax-free, at which point 25% of the funds can be taken tax-free, up to your lifetime allowance. In future years, you can draw the funds out, making use of your annual personal allowance and choosing your desired level of income, for example only drawing within the 20% basic rate tax band. This can further reduce the potential taxation.

 

An added bonus

A further, potential benefit of having redundancy payments made as employer pension contributions is that if an employer were to make a redundancy payment to you via PAYE, they would have to pay National Insurance at a rate of 13.8%. By making pension contributions employers can save National Insurance. We have seen many instances where, when requested, employers share or pass on the full amount of these savings to staff, resulting in an uplift to the redundancy offer. If you currently going through redundancy proceedings, you should be talking to your employer about this now.

 

The devil is in the detail

Although the examples above may indicate the decision to contribute excess redundancy payments to a pension is relatively simple, the truth of the matter is that it rarely is. There are many factors not mentioned in this text that have to be considered before deciding on how best to proceed.

Age is the most obvious, as the pension can only be accessed at age 55 under current rules. If you are still some time away from being able to access a pension, it may make more sense to have the funds readily accessible.

However, pensions are also incredibly complex and significant contributions have a high likelihood of affecting several pension-related allowances. This could cause unforeseen consequences unless your full financial situation is properly reviewed. If not, then poorly thought-through decisions could lead to larger tax bills than those you are trying to save.

Therefore, we believe it is vital to receive professional and experienced advice on the subject of redundancy payments. It will also likely be prudent to review all of your provisions for retirement planning.

If you would like to book in some time to speak with a wealth manager, please email wealthmanagement@tidewayinvestment.co.uk or click the button below to book a free guidance session.

The content of this article is for information purposes only and should and should not be construed as financial advice.
The information contained in this document related to tax are correct at the time of issue; however, tax legislation and the levels of relief are subject to change at any time.

We always recommend that you seek professional regulated financial advice before investing.


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