Geopolitical issues, a floundering employment market and the impact of generative AI has created fears of job losses across many sectors, leading to some workers facing the risk of redundancy.

Those affected by redundancy may be concerned what their tax liability will be on any redundancy settlement received. They may also be considering whether they should use all or part of any payment to help fund pension contributions in a tax efficient manner.

The tax position on redundancy

Employees who’ve been made redundant only pay tax on redundancy payments above £30,000. In addition, employees do not pay any National Insurance on the redundancy payment, regardless of the amount.

A change introduced on 6 April 2020 means that employers now need to pay Class 1A National Insurance (15%) on amounts above the £30,000 exemption.

However, a redundancy package can be made up of several different components. Tax and National Insurance are deductible from termination payments that are classed as general earnings, such as payment in lieu of holiday or notice.

Since 6 April 2018, where employment is ended before the contractual notice period, the rules have become more complicated. The amount treated as post-employment notice pay needs to be calculated, which is classed as general earnings subject to Tax and National Insurance.

It is therefore important to determine what the package consists of to understand the tax position.

Example

Donald has earned £14,000 already in the tax year but has now been made redundant. He has agreed a redundancy package of £37,000 and is looking to use this to maximise pension contributions. His package is made up as follows:

Donald agrees with his employer that he will sacrifice the first three items of his package and £2,000 of the redundancy payment in exchange for an employer contribution of £7,000 into his pension scheme.

As he has previously earned £14,000 of relevant UK earnings in the tax year, he will then make a member payment of £11,200 net to a Relief at Source scheme. This will qualify for basic rate tax relief, so is topped up to a gross contribution of £14,000 (£11,200/0.8).

Donald will therefore have total pension contributions of £21,000, with £18,800 of his redundancy package left over.

Comment

If looking to use redundancy sacrifice, it will normally be advisable to sacrifice general earnings (subject to income tax and National Insurance) first, followed by the amount of the redundancy payment that exceeds £30,000 (subject to income tax and employer Class 1A National Insurance). It may be worth exploring whether the employer will agree to pass any of their National Insurance saving into the scheme.

Important information

Please note this is for general information only and is based on LV's understanding of the relevant legislation and regulations and may be subject to change.

The tax treatment of benefits depends on individual circumstances and may be subject to change in the future.

The use of this document is at your own risk, and the content should not be used for the provision of professional advice.

LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.