A question about : Beware of the redundancy tax trap!
There is a very real danger that many people are falling into a tax trap because of the lack of clear information on how the redundacy pay tax system works and the quirks and side effects the system has.
I've just saved myself a whopping Ј13k by spotting the tax trap, so I guess it's a good time to share ... I mean the advice, not the money!
The trap is set when you are paid PILON (Pay In Lieu Of Notice) and you are in grave danger of becoming a 40% tax rate payer in the same tax year. Remember that if you were a 40-percenter last year, you might not be this year - conversely, if you weren't last year, you could be this year. In fact both scenarios can arise from redundancy. Tread carefully. Do the math.
The danger of not discovering the jagged mandibles of this trap come from the wording relating to this PILON. Namely (a) it is TAXABLE INCOME if it was specified as an option in your contract, or (b) it is COMPENSTATION if it was not specified and your employer is paying it in compensation for not giving you notice - i.e. they are saying: go right now, and don't come back. In fact, most of them say you are terminated in a suprisingly bad Austrian accent.
The theory is that (b) is actually a preferred and more generous option. Even though it rather oddly represents a breech of contract by the employer! The truth is that it is merely the thick grass concealing the tax trap for the unwary who then, overjoyed, go merrily dancing through that long grass on the way to the bank and then the nearest employment agency without looking. Seriously, guys and gals, some of us really do have a positive attitude to life's mishaps.
However, the PILON payment will be ambiguous to the tax office, and by default they will assume it is TAXABLE PAY. It is unlikely that your employer will tell the tax office up front that it is COMPENSATION. You then have to persuade the tax office that it is - and their job is to not believe you until you prove it. For this you need a WRITTEN STATEMENT from your employer with the magic trap-opening words compensation in lieu of notice. Get it from them now! Do not delay!
...but that's just the grass - it is not the trap. In fact the trap exists whether or not PILON is part of your redundancy pay. The PILON just makes it wider, or makes your foot bigger, depending on the wording.
Let me explain: if the PILON is considered to be income, then your tax footprint gets bigger. Bigger feet make it more likely to step into the trap. If it is compensation, then it is likely to make the trap bigger - but more about that one later.
Also, the closer your termination date is to the end of the tax year, then the closer you are to the tax trap. If it is at the start of the tax year, the trap is so far away, you are unlikely to step into it. If it is at the end of the tax year, the trap is so close, you have probably already got your foot in it and it is too late. Anywhere in between ... well, tread carefully.
So what does the trap consist of?
TAX DUE = ( REDUNDANCY PAY + PILON - Ј30k ) x Highest Tax Rate
where Highest Tax Rate depends on what you earned that year. In other words, if you pay 40% tax on JUST ONE POUND in the year, you will have a Highest Tax Rate of 40%. And the tax on your redundancy package has just DOUBLED! This is the hair-trigger mechasnism of the trap. SNAP!
...did your eyes water when you read that? No? Well read it again. This time I will catch your jaw, eyebrows, whatever.
In my case, it meant that if (in the remaining four months of this tax year) I accidentally earned Ј3.5k - the kind of money the government hands out to jobseekers - the goverment would then demand Ј13k back from me! ...presumably to pay four other job seekers I'm in competion with - ooh, I've just become a conservative.
Indeed, if I found a job that paid me an astonishing Ј13k for that four months, I would not be the lucky man I thought I was going to be. You'd think this would be an ideal situation, wouldn't you! But I would have to hand it ALL to the government (every last darned penny) ...ooh, now I'm an ultra right wing conservative.
So - beware.
Me? 
Well, I'm off on a four-month Ј13k holiday, paid for by Her Majesty's government! ...Will send a postcard. ...hmmm, I wonder if there are any jobs in the States, ...or Australia? ...bye ...now, where were those rose-tinted sun glasses? ... had them a moment ago ...
P.S. (to Martin Lewis) If you liked this article enough to want to offer me a job as a journalist, well,... please don't. ...At least, not until April 2010.
Best answers:
- Ohmygod! Someone got out of the wrong side of bed this morning!
First off - a sense of humour in times of stress is strongly advised.
Secondly - who's gloating - if you actually bothered to read between the lines you'll recognise lots of sarcasm and a valid warning. I nearly got caught out and I'm breathing a thankful sigh of relief.
And yes, after nearly getting into a tax trap from redundancy after a quarter century of employment by one company I find myself to be a potential 40-percenter as a result of a redundacy payment. Gosh ain't I lucky.
As for the "prat"? tut tut, takes one to know one.
Should I perhaps add that the same tax trap exists if you are a 10%-er and the redundancy tax trap will apply if you accidentally become a 20%-er. Would you be happier then? (Later edit: as I add later, this is probably not the case, thanks to the Ј30K tax free bit - so you'd probably be safe from the trap)
And for the record... no not every one who uses this web site is poor, just as not everyone with savings is rich. In fact, most "rich" people these days have big mortgages which become abrupt and serious liabilities in a redundancy situation, when suddenly they realise just how "poor" they are - its savings versus liabilities, isn't it? - and a tax trap of any kind will hit hard.
So, I'm sorry you are so easily offended. - Again, I'm sorry you are so easily offended.
Be nice if you had something constructive to add.
Again: Should I perhaps add that the same tax trap exists if you are a 10%-er and the redundancy tax trap will apply if you accidentally become a 20%-er. Would you be happier then?
(Ah hang on - I'm editing here, as I just realised that in this case you would "thankfully" probably fall below the Ј30K tax free part of the redundancy payment, so I guess you would be safe).
Indeed, do you feel that Martin Lewis's evident wealth disqualifies him from contributing to a forum on his own site, perhaps?
Sorry - but you are sinking your own boat here. - Sounds like good advice,well explained..assuming its accurate.
Even HM Queen,the richest woman in this fair land..is a moneysaving expert ! - I'm interested to understand this a little better.
This is going to affect me. I am on a good salary and will be receiving 3 months PiLON when I leave at the end of January. Now I was expecting to be taxed/NI'd etc and have budgeted to lose approx 40% of my PiLON. My redundancy payment alone (excluding PiLON) is just below the tax free threshold
However, what can be done in this instance? Not sure I fully understand? I'll be looking for immediate employment. Is it better to therefore wait until 2010/11 tax year? - Well I'll have to second her - because as far as I am aware she's right... you would get taxed on everything over the thresh hold at 40% so if you earn Ј1 over the limit (as the example used here) then on that Ј1 you will get taxed at 40% - anything below at 20% (apart from the free allowance etc etc etc).
- Ok. a noddy worked example in the manner it was explained to me:
Normal income at point of termination results in you being (say) Ј1000 below the 40% threshold.
Employer has confirmed the PILON is compensation, not income, but it will be paid as part of the redundancy package. Lets say 'x' months notice that results in Ј8,000 PILON. Even though this is for a notice period that lies partially into the next tax year (oh, yeh, I forgot that one) it comes into this years' tax equation through the back door of redundancy package tax.
Redundancy pay (without PILON) is generous because you were there back in 1980 when the company was founded as hence is a whopping Ј32,000.
Taxable redundancy = 8k+32k-30k = 10k
Highest rate of income tax is however at this time in the year still 20%
Therefore redundancy tax is notionally 2k
BUT. in (say the remaining month of the tax year after your termination) you get income - perhaps even jobseeker's allowance, in excess of Ј1K.
As a result, your income tax upper rate for THIS YEAR is now 40%
So now, redundancy tax leaps from Ј2k to Ј4k, just because you earned more than Ј1K of actual additional taxable income.
QED - What a stupid post.
The rules on redundancy payments are very clear and overall PILON shouldnt increase your tax from what it would have been if you had worked the full year.
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