Tax on redundancy payment

ELM_Herts

Hi All.  I'm going to be made redundant next month. I will receive about £70k. I know the first £30k is tax-free but wondered at what the remainder will be taxed at. I am a higher rate tax payer but wondered if, as we are only a month into the tax year and therefore the total payment plus salary received to date would put me just under the 40% annual threshold, if it might be taxed entirely at the lower rate? And then if I find new employment, that will be fully taxed at the higher rate for the rest of the tax year? 

Or do they tax the whole lot at 40% and then it would be up to me to claim it back from HMRC if I don't find new employment in this tax year? 

Thank you in advance for your expertise! 

FatherTireseus

The remainder over £30k will be taxed at your 'marginal rate' but the way that income tax works is that it is calculated on a cumulative basis (unless you have a 'month 1' code) against the cumulative personal allowance.

So (unfortunately for you) if you are made redundant in May, the second month of the tax year, you will only have two months worth of personal allowance to offset against the redundancy payment.  The personal allowance this year is £12,570 and the higher rate threshold is £50,270 - so you can earn an additional £37,700 before you start paying higher rate tax.

But if your annual income is over £150,000 (£12,500 per month) you start paying tax at 45%.

Those allowances equate to £1047.50 personal allowance per month tax free, the next £3141.61 per month is taxed at 20%, the next £8,310.83 at 40% and anything over £12,500 per month at 45%.

You say you're a higher rate taxpayer so let's assume your salary is £55k.  That's £4583.33 per month.

Month 1 of the tax year - total income £4583.33, personal allowance £1047.50.  Taxable amount is therefore (4583.33-1047.50) = £3535.83, of which the first £3141.61 is taxed at 20% and the rest at 40%.  I make that £786.00 total tax.  (May be out by pennies here and there due to rounding).

Month 2 of the tax year - let's assume that you get made redundant at the end of the month and so get a full month's pay.

Total income is £4583.33 + £70,000, of which £30,000 is tax free. .

But what the payroll will work out is actually total income in the year to date which is two months of £4583.33 + £70,000 less £30,000 tax free redundancy.  Therefore the total amount subject to tax in two months is £49,166.66.

To calculate tax, they will take off two months worth of personal allowance: 2 x £1047.50 = £2,095.

So the tax calculation becomes:

Month 2: total income = £49,166.66 less personal allowance of £2095 = £47071.66.

The first tranche taxed at 20% is 2 months worth of £3141.61 = £6283.22 x 20% = £1256.64.

The tranche taxed at 40% is 2 months worth of £8310.83 = £16,621.66 x 40% = £6648.66.

BUT pro-rata, your income in two months pushes you into the additional rate band so the remaining £24,166.67 is taxed at 45% = £10,875.

Total tax due after two months is (1256.64 + 6648.66 + 10875.00 ) = £18,780.30.

You've already paid tax of £786 in month 1, so the tax due in May month is £18,780.30 - £786 = £17,994.30.

Now, as you say, if you don't find any other employment in the tax year, on those figures you would actually still be a basic rate taxpayer at the year end and would have overpaid tax to the tune of over £10,000.

So yes, if you didn't earn anything else, you would have to reclaim it from HMRC.

If you did get another job, you should get a P45 from your first employer showing the amount earned and the tax paid; when you give it to a new employer, unless you're earning mega-bucks, they will keep calculating tax on a cumulative basis adding on an extra month's personal allowance in each payroll period.  You may find you don't pay any tax at all for a while as you've overpaid so much, but the overpayment gradually unwinds month by month.  You may still have overpaid tax by the end of the tax year in which case you're back to reclaiming it from HMRC.

ELM_Herts

Thank you so much for that detailed reply, I really appreciate it! Since the entire amount over £30k will be taxed at the higher rate, I will see if it can all be paid into my company pension (I have lots of unused annual allowance from the past three years). 

FatherTireseus

Hope it all made sense, it would be easier in tabular form.....

Putting it into a pension if you have the unused allowance and don’t need the money until retirement age is a tax efficient strategy.

chrisbur

FatherTireseus said:

 You may still have overpaid tax by the end of the tax year in which case you're back to reclaiming it from HMRC.

Provided that the OP is on the correct tax code then the correct tax should be deducted by month 12 at the latest with no need to make a reclaim.  When you get to month 12 you are given your full year's allowances and the tax calculated then is the tax you are due to pay for the full year.

getmore4less

If not going down the pension route to use most of the taxable

The strategy some take is don't claim JSA and plan a gap in employment.

do a P50 to get the tax sorted,


then change your mind and start job hunting with/without  JSA


Not clear if your ~£70k is just redundancy or includes other taxable elements like PILON or holiday pay.

FatherTireseus

chrisbur said:

FatherTireseus said:

 You may still have overpaid tax by the end of the tax year in which case you're back to reclaiming it from HMRC.

Provided that the OP is on the correct tax code then the correct tax should be deducted by month 12 at the latest with no need to make a reclaim.  When you get to month 12 you are given your full year's allowances and the tax calculated then is the tax you are due to pay for the full year.

You are indeed correct and I was having a bit of a brain fade moment.  Thanks for pointing it out.

ELM_Herts

getmore4less said:

If not going down the pension route to use most of the taxable

The strategy some take is don't claim JSA and plan a gap in employment.

do a P50 to get the tax sorted,


then change your mind and start job hunting with/without  JSA


Not clear if your ~£70k is just redundancy or includes other taxable elements like PILON or holiday pay.

That's an interesting perspective!  My employer has actually told me I can't put the PILON element (around £22k) into my pension and have to take it as taxable income.  So perhaps I will do this - would be good to know what happens if I do then get a job quite soon after doing the P50 thing!