Losing your job can be a terrible experience, but there is an upside in certain circumstances. Rachel Lacey explains how to best exploit the situation.
Redundancy can be a real kick in the teeth. From tense meetings with HR and awkward parting conversations with colleagues, to worries about what you’ll do next and how you’ll manage financially. It’s a horrible process to go through.
But, when the ‘grieving’ is over, there’s often an upside to redundancy, in the form of a generous redundancy payment.
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Depending on your age and circumstances, that lump sum could give your retirement an incredibly tax-effective boost, or help you retire earlier than planned.
What am I entitled to?
Statutory redundancy pay is currently a full week’s pay for each complete year of service if you are aged between 22 and 40 and have been continuously employed for more than two years. This rises to a week and half if you’re over 41.
Payments are capped though at a maximum of £643 a week for 20 years, giving a maximum statutory payment of £19,920.
However, many businesses will offer contractual redundancy pay in excess of these rates.
You may also get pay in lieu of notice to boost your payment further, as well as pay for any holiday that you did not get the opportunity to take.
Redundancy pay is tax-free up to £30,000, but this doesn’t extend to pay in lieu of notice or holiday pay.
Can I pay my redundancy payment into my pension?
It may be that you need your redundancy payment to pay the bills. But if you have other sources of liquid cash to tide you over or manage to find a new job quickly, you could potentially put some of your final pay-off into your pension.
Tax relief equivalent to the rate of income tax that you pay, can give your contribution an instant boost.
This is particularly beneficial if you are paying a higher rate of income tax now than you’ll pay when you’re retired.
The catch is that paying a redundancy cheque into your pension isn’t as straightforward as contributing earnings.
“Like most tax rules, the rules on redundancy payments are complicated,” says Alice Guy, head of pensions and savings, at interactive investor.
“The first £30,000 of any redundancy payment is tax-free and won't count as earnings for income tax or tax-relief purposes, but redundancy pay over £30,000 is taxable and also qualifies for pension tax relief.”
This means that while contributing holiday pay or pay in lieu of salary is relatively straightforward, you might only be able to get tax relief on any portion of redundancy pay over the £30,000 threshold.
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However, you might be able to get around this, if you have sufficient taxable earnings and aren’t likely to breach the annual allowance, which is currently 100% of your earnings up to a maximum of £60,000.
Guy explains: “Let’s say you earn £80,000 and pay £10,000 into your pension. You could still potentially pay in £30,000 redundancy pay and receive tax relief as you have spare annual allowance and enough taxable pay.
“However, if you earned £35,000 and paid £10,000 into your pension, you couldn't then pay £30,000 redundancy pay as you only have £25,000 left of taxable pay. You could however, pay in £25,000.”
Confusingly though, whether this is an option for you, could come down to the timing of your redundancy. Steve Webb, partner at consultant LCP explains: “You can get tax relief on private pension contributions worth up to 100% of your annual earnings. This means that for those who are made redundant late in a financial year there may be a much higher level of earnings for that year than for someone made redundant early in the year.”
In some cases there may also be instances where you can pay in more than £60,000. If, for example, you didn’t pay in the maximum permitted during the last three tax years, you can then carry forward that unused allowance, so long as you aren’t paying in more than 100% of your earnings this year.
This would mean that if you wanted to pay £70,000 into your pension, you would need to have earned at least £70,000 in the current tax year.
Webb adds: “If you are a higher-rate taxpayer in the current year, but unlikely to be so again in future, this makes it particularly attractive to try to max out on pension saving this year so that you can get higher-rate relief on the contributions but only pay basic rate tax on the money that you draw out.”
It is also important to note that if you are over 55 and have already taken some taxable withdrawals from your pension, you’ll no longer be bound by the annual allowance, and the lower money purchase annual allowance will now apply. This will mean that your overall contributions for the year will be limited to £10,000, irrespective of your overall earnings, with no ability to use carry forward rules.
The amount you can pay into your pension may also be lower if you earn more than £200,000 and are subject to the tapered annual allowance.
If you have a defined benefit pension, or final salary pension – rather than a defined contribution one – you can’t normally pay any redundancy payment into your pension. However, some schemes may allow you to buy ‘added years’. You might also be able to top up via an additional voluntary contributions (AVC) scheme, if you have one.
Max out your ISA
If paying a redundancy payment into your pension is proving less straightforward than you’d hoped, it’s worth bearing in mind that it’s not the only tax-effective way to save for retirement.
Contributions into ISAs don’t enjoy tax relief as they do with pensions, but all withdrawals are paid tax-free. This can be hugely helpful in retirement and enable you to boost your income without increasing the amount of tax you need to pay.
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The ISA allowance is currently £20,000 a year, but couples can consider combining allowances to collectively shelter £40,000 a year from tax.
An ISA also gives you a bit more flexibility and means that even if you have the money earmarked for retirement you can access it whenever you wish.
Any redundancy money that you pay into your pension will be tied up until you are 55 (rising to 57 in 2028).
What about retiring early?
Of course, if you are getting closer to the age at which you had planned to retire, a redundancy payment might also give you the opportunity to wind down earlier than you had planned.
Guy says: “Depending on the level of your redundancy payout, it can be a great time to step back and have a rethink. Having extra time and money could allow you to go travelling, move to your dream location or even embark on a new career. For many, it allows them to consider early retirement, especially if they are already close to their pension goals.”
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