Occasionally, we have clients who come to Becketts wishing to explore the financial planning opportunities available to them when they are going through a voluntary or compulsory redundancy process.
These are often extremely difficult times; considering not only the financial implications of the situation, but also the mental side of change. Losing a job can be one of the most stressful periods of a person’s life. As such, we take our work in this area incredibly seriously and aim to alleviate at least the financial burden of the process.
One of the major planning opportunities with redundancies is the use of pension contributions in lieu of some or all of your severance payment. Detailed next are two real-life anonymised case studies to help show the potential benefits available.
Rules of Thumb
Here are some basic rules of thumb to help the process along:
- Always remember that many redundancy packages – including how they are structured – are up for negotiation. Often it’s the employee who is in the better negotiation position, as they are protected by employment rights and companies can be keen to reach an agreed resolution swiftly.
- The first £30,000 of a non-contractual severance payment will usually be tax-free. As such, in 99% of circumstances, it is best to take this as a direct payment to your bank account. Tax and National Insurance will normally be payable on any amount above £30,000 so it makes sense to consider how this will impact you and to explore any potential ways of reducing your liabilities.
- When companies make pension payments on behalf of their employees as salary sacrifice they save National Insurance tax, which is 13.8% and you save it too, which will be 12% or 2% depending on your income level. This is a significant saving and so they are often very happy to make pension contributions. There is no reason why this saving could not be passed onto you in full, or potentially shared, thereby increasing your severance.
The next two case studies show the benefits of high-quality financial planning at two different income levels. It is imperative when considering a redundancy to review the whole structure of a household’s finances and not just the individual severance offer in question. This will often mean looking back over a number of years. The benefits of doing so can be sizeable.
Whilst this article and planning assessments are focused on redundancy, the carry forward and pension calculations can be used at any point time. Please feel free to contact Becketts on 01253 881910 or firstname.lastname@example.org for a free, no obligation assessment of your position.
Case Study 1 – Simple Planning for a Mother of Two
Mrs Smith approached Becketts as she was being made redundant. She had worked for her employer for 7 years and due to the sale of a unit of the business – that she helped build – her role was no longer needed. She was not unhappy about this, as she had two young children that she was caring for and she had been considering reducing her hours anyway.
Mrs Smith was on a salary of £50,000 and was being made redundant in March with a redundancy severance offer of £40,000. This was an exceptional payment, which was based on her huge contribution to the area of the business that was being sold. Her statutory payment would have been closer to £4,000.
Mrs Smith approached Becketts initially to consider how she should invest the proceeds of her severance.
We reviewed Mrs Smith’s wider financial position, as well as the specifics of the severance payment. Mrs Smith was in an unusual situation whereby the effective rate of tax on the taxable severance payment was going to be extremely high.
The £10,000 severance when added to her other taxable income of £50,000 was going to get hit with 40% higher-rate tax and in this circumstance it was going to erode Mrs Smith’s child benefit payments entirely.
The result was that of the £10,000 Mrs Smith was only going to receive £4,012; an effective tax rate of nearly 60%.
Becketts advised Mrs Smith to go back to her employer and request that the £10,000 excess above the £30,000 tax-free severance payment be made as a salary sacrifice contribution to her pension as well as asking for the employer national insurance saving to be passed on. Her company agreed to this due to the exceptional work that she had done, also, it did not cause them any additional costs. Through our support, Mrs Smith received a £30,000 tax-free severance and a pension contribution of £11,380.
As such, Mrs Smith received an increase in her estate value of £7,368.
Case Study 2 – Carry Forward planning for a man planning on Carrying On
Mr Jones was a senior executive at a local Plc. He had worked in the project management division of his company for over 35 years, arriving as a graduate back in the 80’s. He had been working with an adviser for a number of years and was positioning towards a slowdown and a more flexible working pattern, rather than sailing off into the sunset never to work again. He loved his job and felt he had a lot to give with regards to bringing through the next generation of management. Nevertheless, his wife was a few years older than him, in her early 60s, and she wanted to travel now, rather than waiting until she felt it may be too late.
When his company offered an impending voluntary redundancy scheme, he was referred to Becketts and brought his offer and options to us to see how it would fit in with his retirement plans.
Mr Jones was earnings £175,000 per annum with all benefits included. His company had moved from a final salary scheme 5 years ago to a defined contribution one, however, they were making minimal payments in.
The company were offering a severance payment of £115,000.
Becketts reviewed the taxation position of this payment detailing the following to Mr Jones:
– £30,000 Will be tax-free
– £85,000 Will be taxable and liable to both National Insurance at 2% and Income Tax at 45%,
The net payment received by Mr Jones would have been £75,050 from the gross £115,000 payment.
As Mr Jones had been saving for a number of years, he had already built up solid assets across his and his wife’s ISAs alongside a strong cash balance. These funds were not required at the moment, so he could consider making pension payments in lieu of the severance payment.
Mr Jones did not think this was possible because when he was discussing it at work with his colleagues, he had been told that he could only make a maximum payment of £10,000 due to his high income.
Becketts ran through how the tapering of annual allowance worked and the rule changes that had been implemented over the years. Mr Jones believed that with higher earnings, the maximum he could put into his pension was £10,000, so he thought he was maximising his contributions already.
He was not aware that he could look back and mop up any unused allowance for the past three years via contributions now. Nor was he aware that the rules had changed for the 2020/21 tax year and there was now a higher threshold of £240,000 before tapering began.
Consequently, we calculated the maximum that Mr Jones could pay into his pension and receive tax relief on the premiums. The basics of this calculation looked as follows…
Prior to 2016/17 Mr Jones had maximised his annual pension contributions:
Unfortunately, Mr Jones had been basing his planning on a number of rules that were not accurate.
- The annual allowance reduction is not a cliff edge change, but as the name suggests it tapers down as earnings increase. Mr Jones believed as soon as he earned over £150,000 he would drop from £40,000 to £10,000 as a maximum contribution level
- What can be seen is that in 2018/19 and 2019/20, the annual allowance was only reduced to £27,500 from £40,000 as he only lost £1 of allowance for every £2 he earned over £150,000
- Also in 2020/21, the threshold for assessing annual allowance increased to £240,000. As such, even with the severance payment there is a sizeable contribution that can be made.
- Finally, as he was not aware of the carry forward rule, there would have been a sizeable contribution that could have been missed.
After assessing Mr Jones’s full financial planning position, it was clear that his estate would be liable to inheritance tax. Furthermore, given that he was planning on doing consultancy work moving forward on a flexible basis plus other solid savings, we suggested £84,500 of his severance be paid into his defined contribution pension.
We suggested his employer also provide a national insurance payment on top of the severance and in this instance they agreed to a 50% cost saving payment so that both parties benefitted. This resulted in Mr Jones receiving an extra £5,865 in taxable severance pay.
Overall, through our support, Mr Jones received:
– A post-tax lump sum of £33,373.45 and a pension contribution of £84,500. A total severance in asset value of £117,873.45.
– An increase of £42,823 from his starting position. He also has protected £84,500 from inheritance tax – potentially saving his estate another £30,020 in inheritance tax.
Mr Jones received a number of consulting positions very soon after his employment ceased. A number of those were taken up, after he had spent three months travelling Southern Europe with his wife. He now works nine months of the year consulting and spends the other three months of the year travelling with his wife. She now plans on negotiating this to a six-on six-off situation.
Hopefully, the above two case studies help show the benefits of really going into detail with regards to any style of redundancy. With these specific instances, the outcome was a positive one, with both clients looking forward to the next phase of their working life.
As mentioned earlier, there are many situations whereby this is not the case. For those considering a new working pattern, but who are less sure about it, we would recommend a book by Pauline Johnson-Zielonka PhD, Retirement Life Plan: Navigating the transition from a rewarding career available on Amazon here.
Becketts FS Ltd has over 20 years’ experience working with business owners and high net worth individuals assisting with the wealth management, tax planning and financial forecasting of theirs and their families’ futures. As a Chartered Firm, we operate to the highest of standards and would be happy to have an initial discussion with anyone looking for assistance in structuring, managing and administering their finances. Feel free to get in touch via email to email@example.com.