Redundancy payments: the sneaky tax you'll face if you lose your job

Thousands of people will face significant tax bills on their redundancy payments.

It’s not exactly a secret that the UK is heading into a tricky economic period.

We have all seen the way that our household bills are on the rise, on everything from mortgages and food to fuel, gas and electricity. Finances, for many of us, have never been tighter.

Businesses of all sizes are also struggling. After all, if we have less money to spend each month, then we can’t spend it with retailers and service providers who deliver anything other than the most essential goods and services.

As a result, it seems certain that there will be a recession. In fact, according to the Bank of England itself, the nation is about to head into a recession that will last more than a year.

However, those who fall victim to the incoming recession and lose their job will also suffer a sting in the tail, courtesy of the taxman.

The redundancy payout

Losing your job is never a pleasant experience, though the pain can be eased somewhat through the payout you receive from your former employer.

The rules covering statutory redundancy pay state that you will receive up to one and a half week’s pay for each full year of service, depending on your age when being made redundant, capped at 20 years of service.

This is only the statutory minimum though ‒ plenty of employers will pay above this level, meaning that if you lose your job you could be entitled to a far more generous severance payment, particularly if you’ve worked for them for some time.

That payout can make a huge difference to your financial and mental health, giving you a little breathing space while you find a new job.

The trouble is that you might not end up getting to keep all of it.

The taxman wants a slice

That’s because you can only receive so much in the form of a redundancy payment before you have to pay Income Tax on the money.

The threshold is set at £30,000, which at first glance looks like a huge figure. However, data obtained by AJ Bell shows that a whopping 51,000 people paid Income Tax on their redundancy payout in 2017/18 (the most recent data), coughing up an average of £7,451. 

That’s an enormous sum of money when you’re dealing with the upheaval of having lost your job, and needing to find new employment.

According to data from HM Revenue & Customs around one in five people who receive redundancy payments have to pay tax on that payment, a significant number of people who are unfortunate enough to lose their jobs.

Moving with the times

It’s one thing for the taxman to set a threshold at which point people have to pay tax on redundancy payments.

However, you would hope that over time, as the nation’s finances develop, that threshold would be updated.

Yet that’s not what has happened. The £30,000 threshold was set back in 1988, a massive 34 years ago.

That’s absolutely ridiculous. Analysis from AJ Bell suggests that if the threshold had moved in line with inflation, it would now sit at a whopping £73,000, more than double its current level.

Rising job losses

It is simply not good enough that this threshold has been left untouched for such a long period. By leaving it at its current level, the Treasury is essentially benefiting from a stealth tax, a levy that the vast majority of people have absolutely no idea about.

This would be troubling enough in good times, but we are about to head into an economic storm.

According to Treasury data, around 69,000 people were made redundant back in 2016-17, again the most recent year for accurate figures.

That’s undoubtedly a lot of people, but we are likely to see far more people lose their jobs in the months ahead.

The economy looks set to head into recession, having shrunk in the second quarter of the year, and is on track to shrink for a second straight quarter.

Businesses of all kinds are facing much higher costs, and not just because of their energy bills, which is denting their ability to make profits.

And once that happens, businesses either have to strip back those costs ‒ such as by cutting staff levels ‒ or else face potentially going out of business altogether.

That means the likelihood of thousands more people losing their job, and being hit with the pain of losing a chunk of their payout to the taxman.

Every penny counts

Obviously, it’s not just businesses that face a tough time ‒ it’s going to be an extremely challenging time for all of us too.

Indeed, that’s the whole reason that the Government has now announced a new energy price guarantee, as well as the promise of Liz Truss and team to reduce taxes in order to give people a financial boost.

Yet here is the perfect example of an overlooked tax that could easily be addressed immediately, and make a real difference to people who are about to go through a particularly tough period.