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Higher tax bracket after redundancy pay? The domino effect on other allowances

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27/11/2020
If you’re facing unemployment or have been given details of your redundancy pay, the sums involved may push you into a higher tax bracket. Here are seven allowances and thresholds which may be impacted.

While the first £30,000 of redundancy pay is free of tax and National Insurance Contributions (NICs), other elements of the package are subject to deductions, such as being paid in lieu of notice (PILON), unpaid wages, bonuses and holiday.

If your annual salary teeters on the edge of the tax brackets, redundancy pay may push you into a higher tax band. This can be a problem particularly later in the tax year when workers have already received a large bulk of their wages.

As such, this payment can also impact other allowances, thresholds and benefits, creating a domino-effect which you need to be aware of.

Below, Stephen Moore, partner and head of employment at Ashfords, and Kay Ingram, public policy director at LEBC Group outline the implications of a lump sum redundancy payment which pushes people above these thresholds:

  • £12,500 tax-free personal allowance
  • Basic rate (20%) taxpayers earning up to £50,000,
  • Higher rate (40%) taxpayers earning up to £150,000
  • Additional rate (45%) taxpayers earning over £150,000.

Ingram says: “A one-off spike in income may mean that tax allowances are lost, and extra tax is due. Making pension savings or gift aid donations reduces income for tax purposes and can restore allowances and save tax.”

1) Personal allowance

The personal allowance is the amount you can earn before having to pay any income tax.

It currently stands at £12,500 and means if you earn below this threshold, you shouldn’t have to pay any income tax.

However, this figure can be reduced. Moore explains: “Every £2 of an employee’s adjusted net income over £100,000 results in £1 being lost from the personal allowance. This means that if an employee’s adjusted net income reached £125,000 when redundancy pay was taken into account, their personal allowance would be removed for that tax year.”

Ingram adds: “Once taxable income is over £125,000, no personal allowance is left, costing the taxpayer up to £5,000 a year.”

2) Personal savings allowance

The personal savings allowance was introduced in 2016 which reduces the amount of tax people pay on their savings income.

The rules vary depending on the amount of tax you pay:

  • Basic rate (20%) taxpayers can earn up to £1,000 of savings income without tax
  • Higher rate (40%) taxpayers can earn up to £500 of savings income without tax
  • Additional rate (45%) taxpayers aren’t eligible for the personal savings allowance.

Ingram says: “Where earned and property income is below £12,500 an additional £5,000 of savings income can be received with no tax to pay. The £5,000 savings income allowance is reduced pro-rata where taxable earned and property income is between £12,500 and £17,500.

“A rise in income could mean more savings income becomes taxable. However, interest earned within an Individual Savings Account (ISA) is tax-free and doesn’t count towards this allowance.”

3) Child benefit

Child benefit is paid to the parents and guardians of children up to age 16, and children aged 16 to 19, if they stay in approved full-time education or training. It is £21.05 per week for the eldest child and £13.95 per week for subsequent children.

Where one parent earns more than £50,000 a year, they are required to pay 1% income tax on the child benefit for each £100 of income above this. Under the high-income child benefit tax charge, this means the value of child benefit is eroded to nil once the taxable income of one of the adults exceeds £60,000.

Moore says: “For adjusted net income in excess of £60,000, all child benefit will have to be paid back as income tax. If adjusted net income is between £50,000 and £60,000, some child benefit will have to be paid back as income tax.”

Ingram says the introduction of the high-income child benefit charge has led many families to waive the benefit rather than pay tax on it.

She adds: “Where the income is increased by a one-off payment, the child benefit is taxed on the higher earner and they will need to report it HMRC by 5 October the following tax year if they want the extra tax to be collected via PAYE.

“While child benefit could be waived, this is only worthwhile if the increase in income is likely to be permanent as a drop in income thereafter will mean it becomes tax-free once more. Making a one-off pension saving or gift aid donation could restore some or all of the tax-free benefit.”

4) Tax-free childcare

Where both parents are working a minimum of 16 hours per week and earning at least the National Living Wage/ Minimum Wage, help with paying for childcare for under 12s is available from HMRC, Ingram explains.

However, the government has temporarily removed the minimum income requirement for those receiving furlough pay or the Self-Employment Income Support Scheme (SEISS).

“Parents may save up to £8,000 per year per child in a tax-free account with a 25% subsidy of up to £2,000 per year per child added to their savings. This is then used to pay for childcare with a registered provider.

“If one adult has taxable income of more than £100,000, they are ineligible. As a temporary measure, key workers who earn above £100,000 remain eligible. Others may need to suspend payment to their tax-free childcare account until earnings drop or reduce their income with pension savings or gift aid donations,” Ingram adds.

5) Marriage allowance

The Marriage allowance lets a non-taxpaying partner give up a portion of their unused personal allowance to the higher income-earning partner, which results in a lower tax bill for the couple.

The partner earning less than the £12,500 personal allowance gives up 10% of their allowance to their taxpaying partner. The taxpaying recipient must be a basic rate (20%) taxpayer. This year, couples can save £250 on tax bills under this allowance.

Ingram says: “A one-off payment pushing income over £50,000 would make them ineligible for marriage allowance and the higher earner would be taxed on the additional allowance transferred to them.”

6) Annual pension allowance

The annual pension allowance is the total amount of money you can pay into your pension pot every year, including contributions from your employer into a defined benefit or defined contribution scheme, tax-free. You get tax relief from the government on pension contributions up to this limit – currently £40,000. Any contributions above the threshold are subject to income tax at your marginal rate.

However, in 2016, the tapered annual allowance was introduced, reducing a high earners’ annual pension allowance to as little as £4,000.

Moore says: “For every £2 of adjusted income over £240,000, an individual’s annual allowance is reduced by £1 to a minimum of £4,000.”

Adjusted income is any taxable income minus certain reliefs but includes employer pension contributions and contributions made via salary sacrifice. It’s included to stop people avoiding the annual restriction by exchanging salary for employer contributions.

7) Student loan repayments

Student loan repayments are deducted via PAYE at a rate of 9% of pay above the earnings threshold of £26,575 (£19,390 for pre 2012 loans).

Ingram says: “An increase in pay increases the repayment deducted. Where this represents an overpayment for the year, a reclaim can be made at the end of the tax year by calling the Student Loan Company.”

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