Effects of taxation on redundancy packages
Q: I am finalising arrangements to accept a voluntary severance package from my employer. I have been told that the first £30,000 of my lump sum is tax free. Is this the case?
A: You are correct in what you say, the first £30,000 of redundancy pay is tax free and anything over and above that will be taxed.
If you have a liability to tax then the payment counts against your tax bill in the year you receive the money and not the year you were made redundant, this fact is particularly relevant as we are approaching the end of the current tax year.
So if for example you received an amount over £30,000, but this wasn’t payable to you until after April 5, then you could potentially save some tax depending upon how much you earn in the next tax year.
Confusion around the tax free amount of up to £30,000 can arise if, built within your contract of employment, you have a notice period and as part of your severance, your employer states that you can leave immediately.
Normally they will pay you your salary for that notice period but may include this as part of your redundancy entitlement. If this is the case then that amount should suffer tax and national insurance in the normal way.
Take for example Gavin, who as part of his redundancy entitlement is not required to work his one month’s notice.
His normal rate of pay is £5,000 per month. If his employer agreed an overall package of £30,000 then £25,000 of this would be tax free and £5,000 is taxed in the normal manner. Mark however, who has no notice period but earns the same as Gavin, can receive his £30,000 completely tax free.
Anything else you receive that is not money, for example if your employer allows you to keep the company car as part of your redundancy package, this would be converted into a cash value for tax and National Insurance purposes.
So again providing that any such gifts, together with any cash you have been given, do not exceed £30,000 then all of this is given tax free. If your overall redundancy payment exceeds the threshold then it is, as mentioned earlier, advantageous to consider having this amount paid into a pension scheme.
If in the example given above, Mark is a higher rate tax payer and is due to receive an overall sum of £50,000, then £20,000 will be taxed at 40% giving him a net overall payment of £42,000.
If his employer is willing, it may be possible to ask them to contribute the excess i.e. £20,000 into a pension scheme which will mean he receives £30,000 as cash and has £20,000 invested in a pension scheme.
Other things to consider with regards redundancy is the reclamation of any overpaid tax or National Insurance.
When you leave employment you will be given a P45 which will reflect your overall income and tax deducted in the tax year you were employed.
If you are claiming Jobseeker’s allowance you should give your P45 to the Jobcentre office and if appropriate you will be given a refund when you stop claiming or in the new tax year.
If you are not claiming Jobseeker’s allowance ask for form P50 and return it to any Inland Revenue office. Again they will calculate if you have paid too much tax.
As ever, in all matters relating to tax and finance you should consider seeking out professional help to offer you guidance.
Raymond Mulligan is managing director of Johnston Campbell, a company of independent financial advisers regulated by the Financial Services Authority. For further information, please contact email@example.com or (028) 9022 1010