Navigating redundancy can be a stressful experience, but what if a large part of your payout was tax-free? For many, the first £30,000 of a redundancy payment is exempt from tax, providing a significant financial buffer when you need it most.
Redundancy happens when a role is no longer needed, and employers provide a payment to support you during your job search. But how is this payment taxed, and what do you need to report to HMRC?
This guide explains everything you need to know about the tax on redundancy pay, so you can plan your next steps with confidence.
What Is Redundancy Pay?
Redundancy pay is a safety net for when your role is no longer needed, giving you financial support as you transition to a new job.
In the UK, there are two types:
- Statutory redundancy pay: The legal minimum for employees with 2+ years of service, calculated based on your age, service length, and weekly pay.
- Enhanced redundancy pay: Extra support offered by some employers through contracts or policies.
To qualify, you need 2+ years with your employer, be classified as an employee, and face redundancy (not dismissal).
Is Redundancy Pay Taxable?
Good news: redundancy pay up to £30,000 is completely tax-free! For many, this means no income tax on their entire package. Any amount above £30,000 is taxed at your usual income tax rate—but no National Insurance is ever deducted. Why? Because redundancy pay is compensation for job loss, not regular earnings, and gets special tax treatment. Simple as that!
What Are Employer Responsibilities?
Employer Responsibilities in Redundancy Situations
Handling redundancy comes with several key responsibilities for employers, including ensuring fairness, following legal procedures, and addressing tax implications. Here's what employers need to know:
1. Follow a Fair and Legal Redundancy Process
- Fair Selection: Employers must use fair and transparent criteria to select staff for redundancy. Discrimination or bias must be avoided.
- Consultation: Conduct meaningful consultations with affected employees and explore alternatives to redundancy where possible.
2. Manage Redundancy Payments Correctly
- Tax and National Insurance: Any taxable portions of redundancy payments should be processed through the Pay As You Earn (PAYE) system.
- Tax-Free Threshold: Redundancy payments up to £30,000 are usually tax-free. For amounts above £30,000, employers must deduct the appropriate tax before making the payment.
3. Provide the Right Documentation
- P45 Form: Employers are required to issue a P45 form when someone is made redundant. This ensures the employee has the necessary documents for their tax records and future employment.
By following these steps, employers can handle redundancy situations fairly, legally, and efficiently, while also ensuring compliance with tax regulations.
How Much Redundancy Pay Is Tax Free?
The £30,000 tax-free allowance isn't a one-size-fits-all rule; it depends on who's paying you. This allowance applies per employer or per group of connected employers. What does this mean for you?
Working for Unconnected Employers
Imagine you've worked for two entirely separate companies during your career. If you're made redundant by one, and then later by another completely unconnected employer, each redundancy package could qualify for its own £30,000 tax-free allowance.
- Example: You receive £25,000 redundancy from Company A (tax-free). Years later, you're made redundant from Company B (not linked to Company A) and receive £20,000. Both payments are likely tax-free.
Redundancy from Connected Companies
What if your employers are linked? If you're made redundant from companies that are "connected" (like a parent company and its subsidiary, or a group of companies under common control), you generally only get one £30,000 exemption to cover all payments from that entire group of connected employers.
- Example: You work for "Tech Solutions Ltd," which is a subsidiary of "Global Innovations PLC." If you're made redundant, the £30,000 allowance covers your total redundancy pay from both Tech Solutions and Global Innovations, as they are connected.
Multiple Redundancies from the Same Employer
What if you're made redundant by the same employer more than once? Whether this happens months or years apart, the rule remains the same: you typically only receive one £30,000 tax-free allowance for all redundancy payments from that specific employer.
- Key takeaway: The £30,000 limit resets for new, unconnected employers, but not for repeat redundancies from the same employer or from connected employers.
Understanding these distinctions helps you grasp how your redundancy pay might be taxed. Do you know if your previous employers were connected?
Do You Have to Report Redundancy Pay to HMRC?
Whether you need to report your redundancy pay to HMRC depends on a few key factors, primarily whether your employer has handled the tax correctly.
Let's break down what you need to do.
Payments Under the £30,000 Threshold
If your total redundancy payment is under £30,000, it is tax-free.
- What does this mean for you? You typically don’t need to report this payment to HMRC.
- What should your employer do? They should not deduct any Income Tax or National Insurance from this amount.
Payments Over the £30,000 Threshold
Any amount you receive over the £30,000 tax-free allowance is considered taxable income.
- What should your employer do? Your employer is responsible for deducting the correct amount of Income Tax and National Insurance from the portion of the payment that exceeds £30,000.
- What should you do? Always double-check your payslip and the final payment breakdown. Do the figures look right? If you suspect your employer has deducted too much or too little tax, you should contact HMRC directly to clarify the situation.
When Might You Need to File a Self Assessment Tax Return?
You may need to complete a Self Assessment tax return if:
- Additional tax is owed: If not enough tax was deducted from your redundancy payment.
- You are due a refund: If too much tax was deducted and you need to claim it back.
By understanding these rules, you can ensure your tax affairs are in order after receiving a redundancy payment.
What Is the 70/30 Rule in Redundancy?
You might hear discussions about a "70/30 rule" concerning redundancy pay, but it's important to clarify that this is not an official tax rule for redundancy payments.
Where does the idea of percentages come from then?
This concept often arises when employers offer enhanced redundancy packages. These are additional, non-statutory payments, where employers might calculate your payout based on:
- Percentages of your salary
- Formulas tied to your length of service.
What you do need to focus on for tax purposes:
When you receive a redundancy offer, the most important thing is to understand which parts of your payment:
- Qualify for the £30,000 tax-free allowance. This amount can be paid to you without any tax deductions.
- Will be taxed as regular income. Any portion of your redundancy payment that exceeds the £30,000 threshold, or certain specific payments like outstanding holiday pay, will be subject to Income Tax and National Insurance.
How Is Redundancy Pay Calculated?
Your statutory redundancy pay depends on three things:
- Your age during employment
- How long you’ve worked for your employer
- Your weekly pay (up to a legal limit)
Here’s how the calculation breaks down:
- Under 22 years old: Half a week’s pay for each full year worked
- Between 22 and 40 years old: One week’s pay for each full year worked
- 41 years old and over: One and a half weeks’ pay for each full year worked
You can estimate your payment using the UK Government's redundancy calculator.
What About Enhanced Redundancy Pay?
Some employers offer enhanced redundancy packages that go beyond the legal minimum. These can:
- Remove the weekly pay cap for higher payouts
- Use bigger multipliers for more generous redundancy pay
Check with your employer to see if enhanced redundancy terms apply to you.
Understanding Different Types of Payments
When you leave your job, not all payments are treated equally for tax purposes. Some payments are tax-free up to £30,000, while others are taxed like regular income. Understanding this is key to avoiding unexpected tax bills.
Which Payments Are Taxed Like Normal Income?
Several types of payments you receive when leaving employment are subject to standard tax and National Insurance deductions, just like your regular salary. These include:
- Holiday Pay: Any unused holiday pay you receive is taxed as normal wages. This applies even if it's included in your redundancy package.
- Payments in Lieu of Notice (PILON): If your employer pays you instead of having you work your notice period, this payment is generally subject to income tax and National Insurance. Your employer should calculate what you would have earned in basic pay during this period and tax it accordingly.
- Unpaid Wages, Bonuses, or Overtime: Any outstanding earnings, such as bonuses or overtime, are also taxed and have National Insurance contributions deducted, even if you receive them after your employment has ended.
What Payments Might Be Tax-Free (Up to £30,000)?
However, genuine compensation for the loss of your job – payments that are not tied to your employment contract – can often qualify for the £30,000 tax-free allowance. This means you won't pay tax on the first £30,000 of these specific types of payments.
Why is this distinction important? It helps you accurately plan for your tax liability and understand what money you'll actually receive. Always check with your employer or a tax professional if you're unsure about the tax treatment of your specific redundancy package.
How Debitam Can Help Small Business Owners
Struggling with the complexities of redundancy pay? For small business owners, getting the tax implications wrong can lead to costly penalties and unhappy former employees.
Debitam is here to help. We specialise in employment tax obligations, ensuring your redundancy calculations and HMRC reporting are accurate and compliant. Protect your business and support your employees by getting it right the first time.
Need expert guidance on redundancy pay? Contact Debitam today to ensure a smooth, compliant process.
