Redundancy need not be taxing

Fortunately, in the UK we have redundancy rights which can help to cushion the financial blow. The first £30,000 of redundancy payment is completely free from income tax. This applies to both voluntary and compulsory redundancies and is tax-free even for higher-rate taxpayers.

Any redundancy payment over this amount is added to all other income for the year and taxed at the individual’s marginal tax rate. his will mean that some people will end up paying up to 60 per cent tax on part of their redundancy payment if it takes them over £100,000 of income for the year, or 40 per cent tax if the redundancy takes them above £42,385.

This may sound a little unfair, especially as the tax is effectively paid on the day you leave work. It doesn’t have to be this way, as it is possible for most people to claim back the tax paid on redundancy payments. The easiest way to do this is to make a payment to a qualifying personal pension scheme. There are several restrictions on what can be paid into a pension. Firstly, contributions cannot exceed 100 per cent of tax-year earnings. Taxable redundancy payments count as earnings for pension purposes. Secondly, there is an annual contribution allowance of £40,000 and, in most cases, any unused allowance from the last three years can be carried forward into this tax year.

It is very important to find out what unused allowance is available to be carried forward.

In the case of final salary schemes, this can be difficult to calculate and the pension administrators will provide the required information.

The July 8 Budget added an extra complication with this calculation and we have seen that some pension administrators have not yet amended their systems to take the recent change into account, so advice should be sought before paying in large amounts.

If the contribution limits are breached, then a tax charge applies. So, a pension contribution that is within the limits can be used to claim back tax at up to 60 per cent. Part of the tax is added to the pension scheme and part is refunded by HMRC.

Full access to the pension pot is now available at any time after age 55 and with careful planning, tax on withdrawals should average 15 per cent or less for most people.

David Hill is a Chartered Financial Planner and Independent Investment Adviser at Hills Financial Planning, 15 Agnew Street, Larne. He can be contacted on 028 28276814, email [email protected] or see www.hillsfinancialplanning.co.uk