Redundancy payments are payments compensating an individual for the loss of their job. They can be made in cash or benefits in kind.
The payment will either be fully taxable, partially taxable, or fully exempt depending on the nature and the amount of the payment. Planning is important as a significant sum can take your income above £100,000. This is where you start losing your tax-free allowance and suffer an effective tax rate of 60%. Furthermore, you will need to register for self-assessment with HMRC and file a tax return.
How could a termination payment be taxed?
Apart from earnings which are always taxable, the first £30,000 of your redundancy package is likely to be exempt.
But it is your employer’s responsibility to tax your termination payment correctly and therefore the employer bears the risk of tax and penalties if the treatment is wrong. However, it is important to be aware of these points.
How does my employer deal with any income tax and NIC due on the payment?
As with your wages, your employer should deal with the tax and National Insurance Contributions (NIC) due on any taxable parts of your redundancy package, but the exact treatment and any action you need to take will depend on the timing of the payment.
When you are made redundant, your employer should issue you with form P45.
Payments in lieu of notice -applicable from 6th April 2018
Up until 5th April 2018, contractual payments in lieu of notice (PILONs) were taxed as earnings, whereas non-contractual PILONs were often treated as termination payments and could fall under the £30,000 exemption.
From 6th April 2018, any element of the termination payment that relates to a PILON is taxed as general earnings and are subject to income tax and national insurance
Payment made before your employment ends
If your redundancy payment is made before you leave your job and before your employer issues you with form P45, any taxable amounts, such as unpaid wages and any part of a redundancy payment over £30,000, should be included in your final pay and you will be taxed using your normal tax code.
Payment after your employment ends
If your taxable redundancy payment is made after you leave your job and your employer has already issued form P45, your employer will use an 0T tax code against any taxable amounts. This means you will be treated as having no personal allowance. The employer will take off tax at the appropriate rates before paying you the balance.
Remember, this will only affect you to the extent that your package contains taxable elements, such as, unpaid wages, or if your redundancy payment is over £30,000.
In this situation, you may overpay tax on the redundancy payment, but you will be able to reclaim any overpaid tax.
Will the tax my former employer deducts be correct?
If your redundancy payment is made before your employment ends and you do not gain employment again within that tax year, you may have overpaid tax. It will also depend on things like how much of your termination package was taxable, how accurate the tax code your former employer used was and your other tax affairs. The scale of the refund will also depend on how far through the tax year you were made redundant.
If your redundancy payment is made after your P45 has been issued and your employer applies the tax code 0T, you are at high risk of overpaying tax. It will depend on how taxable your termination payment is and the level of your other taxable income in that tax year.
If I get another job or become self-employed, how do I claim a tax refund?
If you gain employment within the same tax year soon after you’ve been made redundant, make sure you give your new employer your P45 as quickly as possible. Any tax under or overpayment should then be corrected through the PAYE system and adjusted through your payslips. If you’re on an emergency tax code, any under or overpayment may not be fully settled until the tax year has ended and HMRC are able to process all of your information.
Alternatively, if you have started your own business or you're completing a tax return for another reason (rental income for example), you can include the taxable elements on your tax return.
If I remain unemployed after my redundancy, how do I claim a tax refund?
Claiming Jobseeker's Allowance (JSA) or Universal Credit (UC)
If you are claiming jobseeker's allowance (JSA) or universal credit (UC) – you must give your form P45 to the Jobcentre as soon as you claim the allowance.
They will use this to work out whether you will be entitled to a repayment when you stop claiming or once the tax year ends on 5th April, whichever comes first.
Please note, JSA is taxable; UC is not taxable.
If you are not claiming Jobseeker's Allowance or Universal Credit
If you are not claiming JSA or UC and will be unemployed for over four weeks, you will need to fill in ‘form P50 – claim for repayment of tax when you have stopped working’ and send it to HMRC with parts 2 and 3 of your form P45 (or your P45 and details of any post P45 payment) or complete the online version of the form, using the Government Gateway
What if I do not receive the redundancy payment immediately?
You will be taxed on the redundancy payment in the tax year that you receive it, even if you were made redundant in an earlier tax year.
The £30,000 limit applies to one job and can be carried forward to be used against any later redundancy payments from the same job.
Any National Insurance that is payable on any part of a redundancy package paid later will be charged at whatever the rates are when you receive the payment.
A payment into a registered pension scheme or an employer-financed retirement benefits scheme (EFRBS) as part of arrangements for the termination of employment is fully exempt from tax subject to your annual allowance. Making a termination payment to such pension schemes, rather than to the employee directly, is very effective tax planning and is commonly used.
Failing that, you could make personal pension contributions in the same tax year, subject to the level of your UK earnings, annual and lifetime allowances. The annual allowance is presently £40,000 but this could reduce to £10,000 depending on your level of income. In addition, you may have unused allowances brought forward from previous years.
If you would like to explore what options are available to you regarding pension contributions, you should speak with an independent financial adviser. Your local TaxAssist Accountant may be able to recommend some to you.
How we can help
If you’ve been made redundant, we can check your tax calculations and help you get back any tax you have overpaid. We can also prepare your tax return, if it turns out you need one.
If you’ve since gone into business, we can also help get the business registered, help you with your bookkeeping and VAT returns, prepare the year end accounts and tax returns.
By Samantha Skyring FCCA
Last updated September 2019
Disclaimer: The information provided is based on current guidance (at date of publication) from HMRC and may be subject to change. Any advice shared here is intended to inform rather than advise. Taxpayer's circumstances do vary and if you feel that the information provided is beneficial it is important that you contact us before implementation. If you take, or do not take action as a result of reading this information, before receiving our written endorsement, we will accept no responsibility for any financial loss incurred.