Redundancy and pension contributions
Even as we start to emerge from the recession, many employers are continuing to downsize their workforces, and are often targeting those employees who are the most expensive by offering a ‘package’ of redundancy and retirement options.
As the most expensive employees are likely to be the longest serving, these financial settlements can often be substantial.
Care should be taken to maximise the benefits to anyone considering these options.
Whilst a redundancy payment can be attractive, it should be remembered that any payment in excess of £30,000 is liable to tax. The excess over this amount is added to the individual’s income in the tax year in which the payment is made.
Depending on when the payment is made, in relation to the tax-year end, this could create a liability to higher rate tax, on all, or part of the excess over £30,000.
One way to avoid this extra tax hit is to make a payment into an AVC or personal pension, allowing you to benefit from income tax relief on the ’slice’ of income that would have otherwise been taxed at 40%.
Indeed, a few pension schemes will allow a payment made to an AVC to be taken back as a tax-free lump sum, at retirement, resulting in a rare free handout of tax relief from HM Revenue and Customs!
It is, therefore, imperative that anyone in this position takes advantage of independent financial advice, before making any decisions on such packages, particularly as many pension-based options carry valuable lifetime guarantees.
If , after April 2011, a £180,000 redudancy lump sum is put into a pension fund will it be taxed.
Thanks for your question, Mike.
As things stand, higher rate tax relief on pension contributions will be unavailable to people with earnings over £180,000. The relief will be tapered away for people with earnings between £150,000 and £180,000. This means that you would be paying 40% and 50% income tax on the redundancy lump sum (the amount over the tax-free payment of £30,000, and assuming you have employed earnings for that tax year) but limited to 20% income tax relief on the pension contributions.
With these large sums of money at stake, and the complexity of the pension tax relief rules and transitional anti-avoidance measures in place, you should seek professional independent financial advice to maximise any planning opportunities.