With the increasing impact of Covid-19 on the economy, it seems inevitable we will see a rise in redundancies in 2021.
Clients may need help in figuring out the best approach to the financial aspects of redundancy, especially those who are closer to retirement.
Hopefully an employer will offer more than the statutory redundancy pay set out in legislation, but that’s not always the case.
The minimum statutory redundancy pay for employees who have been working for their current employer for two or more years is half a week’s pay for each full year under age 22, plus one week’s pay for each full year your client was between ages 22 and 41, plus one and half weeks’ pay for each full year your client was 41 or older. Length of service is capped at 20 years.
The weekly pay is the average earned over the 12 weeks before the day your client got their redundancy notice. If they were being paid less than usual because they were on furlough, the redundancy pay is based on normal earnings.
For the current tax year, pay is capped at £538 per week, and therefore the maximum statutory redundancy pay is £16,140. But many employers will offer more generous terms. Redundancy payments under £30,000 are not taxable, with amounts above taxed as earned income.
Clients over age 50 may well be planning for retirement but also juggling other responsibilities. These could include paying for school or university fees, or helping older children gain a foothold on the property ladder. Alongside this they may be having to help elderly parents with care needs. It is this group that is most likely to need help from advisers to guide them in making prudent financial decisions.
Understanding your client’s current and projected income and outgoings can help you plan to meet their needs for the period they are not working. In an ideal world, the redundancy payment could be a windfall, and that may allow some planning opportunities.
Before the redundancy, clients may want to maximise pension contributions if their employer offers to match those higher payments. Where the redundancy payment is in excess of £30,000, the employer may agree to making a payment into the client’s pension as part of a negotiated settlement.
Any pension payment should fall within the available annual allowance, including any carry forward. Redundancy payments are treated as received when the employee becomes entitled to the payment so it’s not possible to spread the payment over multiple tax years.
Even where an employer doesn’t offer a sacrifice arrangement, an individual can use their redundancy payment to top up their pension pot. For example, a higher rate taxpayer receiving a £15,000 tax-free redundancy payment could end up with £18,750 in their pension when basic rate tax relief is added, plus being able to claim a further £3,750 in higher rate relief through their self-assessment return.
The tax-free redundancy payment doesn’t count as net relevant earnings when working out how much someone can personally pay to their pension in a tax-efficient way, so they would need sufficient other taxable income to justify the contribution. Other clients could be caught by the tapered annual allowance due to the size of their redundancy package, limiting the amount they can pay.
Clients who are age 55 or over when they are made redundant may need to access their pension or other savings to tide them through until they can get a new job. One route would be to phase tax-free cash. Obviously, that means the withdrawals are not taxed but, crucially, it will not trigger the money purchase annual allowance, allowing the client the opportunity to make full future pension contributions and take advantage of employer pension payments in any future job.
If income above that level is needed, then taxable drawdown income is one option although it comes with the downside of significantly limiting future provision due to the MPAA. Another option is a partial annuity purchase, which doesn’t trigger the MPAA, but the suitability of this will depend on the client’s future income needs as well as rate on offer considering age, health and so on.
For those in a defined benefit scheme it’s worth exploring the discount factors that might apply if their pension were taken before the scheme’s normal retirement date. In some cases, a scheme will reduce the discount factors due to redundancy.
Redundancy is rarely a pleasant experience due to uncertainty and anxiety around personal circumstances. Whilst you will not be able solve all the challenges your clients will face, you will be able to assist them through the options and opportunities which they can adopt to maximise their pension provision or take income from their pension and savings in the most tax-efficient way possible.
Andrew Tully is technical director at Canada Life