In the current climate, redundancy is a hot topic with so many companies struggling and unfortunately having to let staff go.
Currently, you will become entitled to redundancy if you have been working as an employee for a company for two years or more. The statutory minimum redundancy that your employer must pay you depends on your age. The following amounts are therefore payable:
- half a week’s pay for each full year you were under 22
- one week’s pay for each full year you were 22 or older, but under 41
- one and half week’s pay for each full year you were 41 or older
The maximum service that you can receive redundancy on is capped at 20 years.
The weekly pay used to calculate your redundancy is the average you earned per week over the 12 weeks before the day you got your redundancy notice.
Importantly, in the current climate, if you were paid less than usual because you were ‘on furlough’ because of coronavirus, your redundancy pay is based on what you would have earned normally.
How much can I receive?
If you were made redundant on or after 6 April 2020, your weekly pay is capped at £538 and the maximum statutory redundancy pay you can get is £16,140.
Will I pay tax on my payment?
Any redundancy pay received up to £30,000 is not taxable. However, any holiday pay or unpaid salary will be taxable at your marginal rate.
Clearly, this means that under the statutory minimums, you should receive the redundancy package tax-free. However, some employers may offer an enhanced package in excess of £30,000 and any redundancy received over this amount is fully taxable. Many employers have offered more generous redundancy packages than the statutory minimum in the past although under current circumstances it would be understandable if most employers were not overly keen on paying more than the minimum.
What are the planning opportunities?
Given that any payment in excess of £30,000 will be taxable, this can have knock on effects. For example, the excess payment when added to other income could take someone who would normally be a basic rate taxpayer in the higher rate band. If any excess is taxed at 40% rather than 20% then this will have a big effect on the amount that you actually receive at a time when you may need the money most.
In addition to this, there are other thresholds that the additional payment could take your income over.
The child benefit tax charge
If you are entitled to receive child benefit, but have earnings in excess of £50,000, the amount that you are entitled to reduces by 1% for every £100 earned in excess of £50,000. This means that if the redundancy payment takes your earnings to £60,000 or more, you will lose all of your child benefit entitlement.
A general point here – for those who earn or will earn more than £50,000 in any tax year and are in receipt of child benefit, the tax charge is not deducted automatically. You need to either stop receiving the child benefit or pay the tax charge at the end of the tax year via self-assessment. This is very important as if you do not do this then the tax charge can mount up over a number of years until HMRC become aware of this and it can result in a large one-off tax bill at this point. It is important to consider your options here as the option chosen can have effects on other benefits if care is not taken. For more info, please see our separate post about the child benefit tax charge which covers this in more detail.
The Personal Allowance Taper
If you earn in excess of £100,000, your Personal Allowance (the first £12,500 of your income that is not taxable) is tapered away by £1 for every £2 earned in excess of £100,000. This means that if you earn £125,000, your full Personal Allowance will be lost. The effective tax on earnings between £100,000 and £125,000 is therefore 60%. We have covered this in more detail in a separate post.
What options are available to reduce the tax payable on my redundancy payment?
One of the best ways to reduce the taxation on your redundancy payment is to pay any entitlement in excess of £30,000 into a pension. This will qualify for tax relief and therefore effectively give you back any tax paid on receipt of the payment. For example, if you paid basic rate tax on £1,000 of redundancy payment in excess of £30,000, you would receive £800 after tax. If you were to pay this £800 into a pension, tax relief of £200 is automatically added so £1,000 is actually invested.
If you arrange with your employer to pay the excess directly into your pension before deduction of tax then the money will be paid in gross so the full amount is credited to your pension and if you are a higher rate tax payer then this saves you having to claim higher rate tax relief.
Importantly, pension contributions act as an income reducer for tax purposes. If you had income of £50,000 before a taxable redundancy payment of £10,000, you would lose your entire child benefit entitlement. If you were due to earn £100,000 but you receive a taxable payment of £25,000, you would lose your full Personal Allowance. However, if you pay this excess income into a pension, it has the effect of reducing your taxable income to £50,000 and £100,000 in each scenario respectively.
Not only would you save higher rate tax in both circumstances, but you would also reclaim your full child benefit and personal allowance respectively.
This means that if you have two children and your earnings will amount to £60,000 once a £10,000 taxable redundancy payment is included, not only would you save £4,000 in tax by making a £10,000 pension contribution but you would also be able to reclaim child benefit of £1,820 giving total effective tax relief of £5,820 or 58.2%. Put another way, it would cost you £4,180 to invest £10,000 into your pension. For those with three children, the relief increases to 65% and for four children the effective tax relief is over 72%.
For those caught by the Personal Allowance trap, the effective tax relief is 60%, meaning for someone with taxable earnings of £125,000, the cost to invest £25,000 into their pension is only £10,000.
Of course, you can also invest any of the £30,000 tax free element into a pension and you will receive tax relief at your highest marginal rate despite the fact that you have not paid tax on the money.
The main drawback of pension contributions is that if you are under age 55, you are unable to access the money until you reach this age and pension contributions are limited by your annual allowances. Lack of access could be an issue at this difficult time when many people need to retain access to as much money as they can. The tax free element is still taxable in your hands (for example if you keep it on deposit then the interest will be taxable if in excess of the savings allowance) so for those under 55 that need to retain access we would recommend using other allowances such as ISAs.