Redundancy.

Being made redundant can be stressful, and tax is often the last thing you want to think about.

But redundancy payments can affect your tax in ways that aren’t always obvious. It’s common to pay too much – or too little – tax at first. That can happen if the tax taken from your redundancy payment isn’t quite right, or if your other income for the year hasn’t been taken into account yet.

This page explains what usually happens, where problems can crop up and what to do.

Do I pay tax on my redundancy payment?

Your redundancy payment may be completely tax free, or you may have to pay tax on parts of it.

• Statutory redundancy pay (compensation for losing your job): you don’t pay Income Tax or National Insurance if this amount is under £30,000
• Unused holiday pay, pay you earn during your notice period, payment in lieu of notice, or bonus: You pay Income Tax and National Insurance on these, as you normally would

 

Here is an example:

• You are given £10,000 redundancy pay. You don’t pay tax on this.
• You have a four-week notice period. You earn £250 a week so this comes to £1,000. You pay tax on this, as you would your normal wages.
• Your total payment comes to £11,000. You only pay Income Tax and National Insurance on £1,000. The rest is tax-free because it’s under £30,000.

 

Why this causes confusion.

Often, everything is paid together in one lump sum. So it can look like tax has been taken from “your redundancy”, even when it’s actually been taken from the taxable parts.

What could go wrong?

The tax taken at the time is unlikely to be exactly right.

Large, one-off payments can push you into a higher tax band for that year. This can lead to problems later on.

You may underpay tax without realising, meaning you may get an unexpected tax bill later on.

If you’re in Self Assessment, you might not get a tax bill until up to 22 months after you received the redundancy payment.

The tax code for redundancy payments.

Redundancy pay is often made after you’ve left your job. Because of that, employers usually use a special tax code.

Most people are paid using a 0T tax code on a Month 1 basis (shown as 0T M1).

That code does two main things:

• 0T means no tax-free personal allowance is given in the calculation. Normally, part of your income each year is tax-free. Under 0T, that allowance isn’t applied to this payment.
• M1 (Month 1) means the tax is worked out just on this payment, on its own. It doesn’t take into account what you earned earlier in the tax year.

 

Because of this, the tax taken off can look higher than you expect. This doesn’t necessarily mean you’ve paid too much tax overall — and you may be due a refund.

Why employers use it.

From the employer’s point of view, this is the safest option because this is what HMRC tells them to do.

It helps avoid a big underpayment straight away. But it also means the tax taken is often not quite right once your full year’s income is considered.

What this means for you.

The effect depends on how much you usually earn.

• If you’re normally a basic rate taxpayer, you’re quite likely to overpay tax at first.
• If you’re normally a higher rate taxpayer, you may underpay tax without realising.

 

Either way, the final position usually isn’t clear until HMRC looks at your income for the whole tax year.

What if an 0T tax code has not been used?

If an 0T tax code hasn’t been used, you will need to get advice to check your what’s happening with your taxes (known as a tax position) for the year.

This is a specialist area and you may need tax adviser to help, especially if there is any dispute about what elements of a redundancy package are taxable.

If the redundancy was recent, you should check your tax position with HMRC or a tax adviser to see if you need to pay more tax or are due a refund.

If you were unaware that there was an underpayment of tax on the redundancy payment, you may need advice on dealing with tax debt.

Where to get help.

Tax and redundancy payments can feel confusing, but help is out there to make sure you pay the right amount of tax.  

There is information on the HMRC website about redundancy and tax.

We have information about how to find a tax adviser or account. If you’re unable to access private tax advice, we provide free, expert advice. Find out more about our helpline.