The economic fallout from COVID-19 has resulted in totally unexpected and unplanned redundancies for a lot of businesses. If you’ve been made redundant, this guide’s for you. The way you use your redundancy payout can substantially reduce your tax bill. Make sure you get all the information and run all the numbers before you make any decisions.
I’ve just been told I’m being made redundant, what should I do?
When you’re hit with the news, it’s a shock. And you’ll need to deal with the emotional repercussions in the best way for you.
Practically speaking you need to:
- Find out what outstanding commission, bonuses and holiday pay you are owed
- Work out what sort of redundancy package you’re going to get
- See if any benefits are available to you, just to tide you over
- Set yourself up ready to begin your search for a new job
In this guide, we’re going to define the redundancy process and how it relates to the tax system. We’re not going to sugar coat it, redundancy is a massive blow. But we can help you make the best decisions for you and your tax position as you make your way through it.
Am I eligible for a redundancy payment?
To be eligible for a redundancy payment you must have been with your employer for at least two years prior to the redundancy notice.
You may have a redundancy package laid out in your contract of employment, in which case you need to scrutinise those terms and conditions. Or you may be reliant on the statutory redundancy pay policy.
Often employees have some idea that redundancies are on the way, but for others it’s a total bolt from the blue.
What if I’m laid off?
If you are laid off from your job, being made redundant seems a likely outcome. Our earlier article goes into your rights if you are laid off or put on short-time working. You might want to trigger redundancy yourself if your employer has laid you off, as it may put you in a better financial position.
You are eligible to apply for redundancy yourself if you’ve been on either no pay or less than half pay for either four consecutive weeks, or six weeks of a 13 week block. The timeline to do this is tight. You need to work out when your last non working day was during that four consecutive weeks or 13 week period. Then you must make sure you’ve written to your employer about redundancy before four weeks have passed from that date.
How is the amount of statutory redundancy pay calculated?
The formula for calculating statutory redundancy pay is:
- Half a week’s pay for every full year you’ve worked under 22 years old
- One week’s pay for every year you’ve worked between the ages of 22 and 41
- One and a half week’s pay for every year you’ve worked after the age of 41, up to a length of service maximum of 20 years
Other benefits included in your redundancy package – like a company laptop or car – are given a monetary value by HMRC and included in the redundancy payment total. In other words, HMRC considers it, puts a figure on it and it all gets added together in your final redundancy amount for tax purposes.
If you’ve been made redundant on or after 6th April this year, the maximum weekly amount you can receive is £538. This takes the maximum statutory redundancy payment £16,140.
Remember, this is the statutory amount that an employer is legally obliged to pay you. Redundancy clauses in your employment contract may allow for higher payments.
You are not entitled to any redundancy pay if you are fired for misconduct.
But the company I worked for went bust, does that mean I get nothing?
No, you’re still entitled to your statutory amount. If your company has folded, then you apply to the Redundancy Payment Office instead. You need Form RP1 from GOV.UK for this application.
Do I pay tax on my redundancy payment?
You do not pay any tax on redundancy payments that are up to £30,000. So if you are getting a payment based solely on the statutory amount, which ceilings at £16,140, you will not have to pay any tax. This is the case for the majority of people who are made redundant. You also don’t have to pay National Insurance Contributions.
For the minority who get more than £30,000 in their redundancy payout, expect to pay tax on everything else. This is usually sorted out by your employer if you get your money before your P45. Otherwise you’ll be issued an OT tax code if the tax has not already been taken. Whichever situation you are in, you must check the numbers yourself to make sure you’ve paid the right amount of tax.
Other taxable issues:
- Outstanding holiday pay: This is considered in the same bracket as wages, so you pay tax and NICs
- Payments in Lieu of Notice (PILON): if you don’t have to work your notice period after you’ve been made redundant, your employer might give you payments in lieu of notice. Tax and NICs are payable on any PILON. These exist because your employment contract has been ended early and this is your compensation for that breach.
- Overtime, wages owed, bonuses: all liable for tax and NICs
- Bonuses and Commission: if these are a usual part of your pay, then they can be included in the calculation of your redundancy payment amount. If you only get an odd one-off payment of this nature, they will be excluded.
Redundancy tax refunds
Your tax bill is worked out by HMRC every year, based on your entire year’s earnings and you’re issued your tax code. Being made redundant part way through the year means that this calculation of twelve months at a certain income, is no longer correct. And there’s every chance you are owed a tax refund. It is not a separate redundancy tax refund thing. Because you’ve lost your job, you’ve now overpaid income tax. And so it becomes a simple income tax refund.
How do I get my tax refund?
If you get a new job very quickly, this can be sorted out through the PAYE system by your new employer. HMRC will also automatically deal with any income tax refund for you if you claim any taxable benefits. If you’ve had a good few months without work, then you can apply for your tax refund using form P50. You’ll need things like your P45 as supporting evidence.
There can be a downside to claiming your tax refund. If you’ve already made a claim and then you land a job out of the blue, you could end up paying tax on your entire salary without the tax free personal allowance cushion.
There are no straightforward guarantees here. As you know, your tax position comprises a whole host of factors. So you’ll have to really dig into your own situation to make the best decision for you.
Can I reduce the tax bill on my redundancy payment by putting it into my pension?
Investing your redundancy payout into your pension means that you can reclaim the income tax at the rate you paid it. This all refers to any amount over £30,000.
On a £90,000 redundancy package, £30,000 is tax free, leaving £60,000 taxable. If you put that into your pension, you get 20% automatic tax relief and then a further 20% when you declare it on your self assessment tax return. This makes the 40% tax relief that you pay as a higher rate taxpayer.
But isn’t there a maximum pension contribution amount?
Yes, there is a maximum annual amount of pension contributions you can make. At the moment this £40,000 or the amount you earn, whichever is the lowest figure. But there is an option to carry forward to other tax years.
You can share the rest of your payout between the previous three tax years, up to the maximum pension contribution amount.
You must do this in the correct order:
- Use the full 2020 – 2021 allowance
- Up to the 2017-18 allowance – three years ago
- Up to the 2018-19 allowance – two years ago
- Up to the 2019 -20 allowance – last year
You’ll need to look at how much you paid into your pension in those years, then you can use up the rest of your annual pension allowance with your redundancy money.
It’s quite fiddly to do because you have to consider: actual earnings for those years, input periods, changes in the current year when you get a new job and start to make pension payments again (amongst other things).
What is immediate vesting?
You have to be at least 55 years old to take advantage of the immediate vesting rule. Quite an unknown term and, unfortunately, nothing to do with Bruce Willis’s preferred action hero uniform. In this situation vesting is the opposite of investing. It means taking money out, rather than putting it in.
It means that you can put your redundancy payment into your pension, then withdraw (vest) 25% of your pension pot immediately and tax free.
Subsequently, you can set up an annuity income, which would then become part of your taxable income. Otherwise you can leave your income in the policy and wait until you’re older to take payments, possibly meaning you’ll get a lower tax rate.
None of this pension business is simple. Each pension provider has its own set of rules, within HMRC regulations. Let’s just say that there are a lot of moving parts that are best handled by a professional. If you would like to learn more about how your pension and tax interconnect, have a look at our Pensions and Tax Guide here.
How do I make the most of my redundancy payout?
This is a question everyone in your position asks themselves. Right from the start, consult an expert. Your position is unique to you. Even if you’re one of 200 made redundant from the same company, your financial and tax circumstances are not the same as your colleagues’.
Once you’ve sorted yourself out for the basics, you’ve got several main options:
- Pay off any debts
- Invest
- Put it into your pension
- Save it
- Start your own business
But whatever you do, get yourself tax efficient first. Err on the side of caution. Don’t assume that HMRC or your employer are 100% correct, mistakes happen, check the figures. Then check them again. Assume that you owe a higher tax bill than you think. Nobody wants a surprise extra tax bill. Get tax facts sorted, at the top of your list, and then see what you can do with the rest.
How we can help you be tax efficient with your redundancy payment
We are tax experts. And we know that you want to make the most of this windfall while you’ve got it. These are just some of the ways we can help:
- Check what tax refund you are owed and make the application on your behalf.
- Complete your self assessment tax return, including your pension contributions.
- Talk you through the whole self assessment process if you decide to start a self employed business.
- If you’re setting up in the construction industry, we’ll get you on the CIS scheme and do your CIS tax return for you.
- Optimise your whole tax position. This includes things like finding any work expenses and allowances that you haven’t claimed for. Yes, you’ve lost your job, but these tax reliefs can be backdated for four tax years, whether you still work there or not.
- Make sure you don’t waste a penny of your redundancy payment on tax you don’t have to pay.
We treat all of our clients as individuals, no two are the same. So we’re not here making generalised promises of definite tax refund figures. But we are saying that you don’t have to work out all this complicated, important stuff on your own. Give us a call on 01228 520477.
