Redundancy will not be what it was under the new pension contribution rules, says Teresa Hunter
Tax period drama
He may be a smug wimp, but it’s not hard to sympathise with Matthew Crawley, romantic hero of the latest posh- frocks and lace- bonnet hit drama Downturn, sorry, Downton Abbey.
The poor chump can’t do right for doing wrong. One minute, his future is all mapped out, as a Manchester solicitor, solid and secure. Next, he is heir to a dukedom, with palace attached, and potential bride to boot. He gives up his legal practice and moves with Ma to … well…we don’t quite know where. The staff speak Yorkshire, yet Downton is filmed at Highclere Castle in Berkshire, and both family and staff have more than a tinge of tartan about them.
Then, in barely a twinkle of his lordship’s eye, her ladyship is with child, and Matthew’s expectations are far from great. Effectively he is out on his ear. Imagine planning a pension while riding that roller-coaster.
The ever-changing tax and pension scenes may have led some to take life-changing decisions, which they now regret
Over the last few years, the world of pensions has been like a mini soap opera of its own, with endless cliffhangers, twists and turns. Indeed, the ever-changing tax and pension scenes may have led some to take life-changing decisions, which they now regret. I have particularly in mind the new £163;50,000 annual pension contribution limit, welcomed by many. But it will be like salt in the wound to anyone who took redundancy or early retirement before last April to avoid being taxed at 50 per cent on their severance compensation.
You don’t have to go back to Edwardian times to find a golden era with regard to redundancy lump sums, just to the last tax year. A miserly £163;30,000 is all that is tax-free, set in 1988 and unchanged since.
However, there have been ways of sheltering more from tax. Historically, when an employer was arranging a redundancy, relocation or early retirement programme, his advisers would recommend staff consider making a pension contribution with any amount over £163;30,000 or ask the employer to make a contribution via salary sacrifice, on their behalf.
Once they hit 50, now over 55, which is the age group most likely to be receiving massive payouts, they could effectively withdraw it again by taking cash. But when the Government introduced a top-rate of tax of 50 per cent, last April, it launched new restrictive measures to prevent large salaries escaping via salary sacrifice. Unfortunately, this caught long-standing employees looking at the end of their career with a decent lump sum to cushion the blow before the state pension kicks in.
A few acquaintances of mine, one married to an accountant, decided to call it a day early when recession triggered restructuring at their companies. They saw this as the very last opportunity to give up work, safe in the knowledge that their redundancy equated to two or more years salary.
In their minds, they otherwise ran the risk of a prolonged recession and compulsory redundancy six months down the line, without a safety net on which to live for a few years, because payouts over the £163;130,000 income threshold, would have been subject to a 30 per cent tax charge.
How wrong they were. From next April, employees can make pension contributions of up to £163;50,000 annually, back dated for three years. This will enable them to shelter £163;200,000 in a pension, including other contributions, on top of £163;30,000 tax free allowance.
As such, most lump sums can be protected from an onerous tax charge. Like cousin Violet, my lips are sealed as to whether the Treasury had fully conceived of this aspect of the new rules. Certainly, when I called them shortly after the various announcements, they were less than ready with an answer regarding severance pay.
But it all ended happily. After officials contemplated further, I was emailed with the news that no special arrangements were to be introduced for redundancy lump sums or similar payments.
Well, we have to wait until February for the beginning of the next episode of Downton Abbey. Let’s hope we’ve finally tied up all the loose ends over the future of pensions.
Teresa Hunter is personal finance editor of Scotland on Sunday