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Redundancy – is it safe to proceed?

Redundancies are an unfortunate consequence of current times, with the Government’s furlough scheme coming to an end the expectation is that there will be more employers making cuts to their workforce.

Remember: “Redundancy isn’t personal, personal identities should not be tied with your professional image

If you are facing redundancy, it is important to understand exactly what is included in the package being offered to you, how it’s taxed and the impact it may have on your tax allowances and benefits.

Please read through the 10 key points I have listed below, each will hopefully help you understand what you should know in relation to your redundancy payment and most importantly help you plan for the future

1. What may be included in the ‘redundancy package’?

  • Statutory or enhanced redundancy pay for loss of office. Remember: The first £30,000 received is tax free.
  • Other pay received for duties performed before leaving employment: salary, bonus, commission, and holiday pay.
  • Payment in lieu of notice (PILON). Paid where you do not work the full notice period and are entitled to be paid for the period between actually leaving and the end of the notice period.
  • An employer pension contribution. Any contractual pension contributions which your former employer is obliged to make for the balance of any notice period
  • Statutory or enhanced redundancy pay for loss of office. Remember: The first £30,000 received is tax free.
  • Payments in respect of a ‘restrictive covenant’. A payment for not doing something after leaving e.g. you agree not to take clients from your ex-employer, or work for a competitor.

2. How is it taxed?

Your ex-employer should deal with the tax due on their termination payment through the PAYE system, but it’s still important that you understand how they’re taxed and the wider impact this has on their tax related allowances and benefits.

  • Statutory and enhanced redundancy payments are free of tax and NI for the first £30,000 and has no effect on the tax rates paid on other income. The excess above £30,000 is fully taxable, but employees pay no NI on this. Employer NI at 13.8% is payable on the excess amount, potentially increasing the attractiveness of a sacrifice arrangement to pension, as we will see later. Note: it’s not possible to spread the payment over two or more tax years.
  • Salary, holiday pay and PILON payments, generally fully taxable and no part is tax free, even if the full £30,000 tax free amount available. They are also subject to employer and employee NI.
  • Employer pension contributions are not taxable in the hands of an employee, and they’re not subject to employer or employee NI.
  • Restrictive covenants are normally taxed in the same way as pay, but professional advice should be sought.

3. Higher tax rates.

Whilst the first £30,000 of the redundancy payment is tax free, the taxable elements can frequency fall into higher tax brackets.

The order of taxation means that the redundancy package can push savings income, dividends and capital gains into higher rates, because these all sit on top of earned income.

The personal savings allowance might also be reduced from £1,000 to £500, or lost altogether if total income exceeds £150,000.

4. Personal allowance.

The personal allowance can also be reduced when someone receives a redundancy package.

For every £2 of adjusted net income over the income limit of £100,000, £1 of your personal allowance will be lost. This means that, in the current tax year, personal allowance is wiped out when adjusted net income exceeds £125,000. This generally gets picked up when you complete your self-assessment or start a new job.

5. Child benefit.

Child benefit is reduced if adjusted net income exceeds £50,000 and is totally lost if it exceeds £60,000.

  • The amount of child benefit is dependent on the size of the family – for example, a family of 3 children could lose around £2,500 a year.

6. Pension annual allowance.

The standard annual allowance is £40,000 but can be tapered down to a minimum of £4,000 if you are a high earner. For this tax year, if your threshold income is more than £200,000 and adjusted income is more than £240,000, your annual allowance will be reduced.

  • The reduction is £1 of for each £2 of adjusted income over £240,000.

7. Pension tax relief.

It might seem counter intuitive to make a pension contribution at a time when easy access to cash is a priority. But this could deliver better financial outcomes if there are other assets that could be used to cover your current income needs.

The tax relief on pension contributions make them the most tax effective way of saving for retirement. A £20,000 addition to pension savings comes at a net cost of £12,000 for a higher rate taxpayer.

This might be even more if extra savings can be made where the personal allowance is restored or child benefit can continue from making a pension contribution.

And potentially much more can be paid into a pension in a single tax year than the next best home, an ISA, particularly in the year of receipt of a redundancy package.  

8. Reducing tax rates and reinstating allowances

Making a pension contribution, whether as a personal contribution or an employer contribution through salary sacrifice, will reduce tax rates paid on total. It could also help reinstate the personal allowance which on its own is  worth £5,000 to a higher rate taxpayer. The same is true for child benefit.

9. Pension funding by salary sacrifice.

Your ex-employer may offer or agree to a sacrifice on some or all of the redundancy payment. The advantage for them is that pension contributions are not normally subject to NI (and they may be willing to pass this saving on to you).

Therefore, it makes sense to make the sacrifice from those parts of the redundancy payment that are subject to NI in the first instance.  The optimum order may be:

  • PILON payments, (because these are subject to both employer and employee NI), then
  • the taxable part of the redundancy payment for loss of office (because employer NI is due on these).
  • While the £30,000 tax free element could be sacrificed, there are no tax or NI advantages in doing so. And as discussed it may be better to pay it as a personal contribution.

In particular, higher earners choosing the redundancy sacrifice option can sometimes cause the annual allowance to be tapered, restricting the amount that can be paid into pension without incurring a pensions annual allowance tax charge. This is because any new sacrifice arrangement is included in your threshold income. This is in contrast to an individual contribution .

10. Pension funding by individual contribution.

While you may benefit from NI savings made under a sacrifice arrangement, not all employers may be willing to offer this option.

A personal contribution still makes sense, and may even be preferable if your annual allowance would otherwise be tapered. There are several things to consider when making an individual payment into a pension.

National Insurance – there are no NI savings to be made, unlike a sacrifice.

Relevant UK Earnings – you must have enough relevant UK earnings to get full tax relief on the contribution. Relevant UK earnings are broadly any pay taxable in the UK, including benefits in kind.

The taxable part of the redundancy package will obviously boost earnings and the potential for a large pension contribution. However, the £30,000 tax free part of the termination payment, plus dividends, rent, earnings from abroad and savings income are the main items excluded from relevant UK earnings.

If you do not have sufficient relevant earnings (or annual allowance) you could think about making a contribution to your spouse/partner’s pension – provided they themselves have the scope to do so.

Annual allowance – you must also have enough annual allowance available otherwise the tax relief given on any excess will be clawed back through self-assessment.

Unused allowances from the last three tax years can be added to the annual allowance for the current year. But obviously receiving a taxable lump sum on redundancy can mean that the adjusted income limit of £240,000 is breached, resulting in a reduced annual allowance for the current year.

To remedy this, an individual contribution may be enough to reduce ‘threshold income’ to below £200,000, restoring the full £40,000 annual allowance. As mentioned above, this is not possible if the pension contribution is made by sacrifice.

Summary

The prospect of redundancy can be difficult time for many people. But, equally, for some it can be a welcome cash injection that could mean retirement plans can be brought forward or savings boosted if they can quickly find suitable new employment. Remember to plan in advance where you can – with the right tax planning, those retirement and savings ambitions could be further enhanced.

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