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Case study: Making the most of a redundancy payment

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The problem: Roy was a made redundant from his job as a senior manager in March.

His severance package included a large redundancy payment of £105,000, making £75,000 of it taxable. Additionally, he was given additional pension service in the defined benefit scheme which saw his annual allowance usage spike last year.

He had already secured another well paid position in another company which will pay an income of £150,000 this tax year. His new employer does not have its own pension scheme but will make a contribution of £25,000 per year to his personal pension.

As he did not need the redundancy payment immediately and and because of the additional rate tax liability on a large part of his redundancy payment he was keen to pay it into a pension.

His previous pension scheme have confirmed his previous pension input period had been aligned to tax years and his inputs were £75,000 for 2012/13, £35,000 for 2011/12 and £30,000 for 2010/11.

From this he concluded that as his annual allowance for this tax year is £50,000, and as new employer is making a £25,000 contribution this year, so this gives an unused allowance this year of £25,000 (£50,000 – £25,000), and carry forward of £10,000 (£150,000 – £75,000 – £35,000 – £30,000) and has started off his new personal pension with a £35,000 gross contribution.

His new provider has advised him that his PIP end date has by default ended on 5 April 2014 so his contribution is tested against the 2013/14 annual allowance.

He comes looking for advice on what to do with the remaining £40,000 of his redundancy payment.

 

The solution: He would like to put the remaining £40,000 of his redundancy into his pension plan but did not think he could.

Roy has relevant earnings of £225,000. This is important as he can only pay 100 per cent of his relevant earnings in a tax year, regardless of how much annual allowance he has available.

For annual allowance purposes, what is measured is the total pension input amounts in a PIP. As Roy’s schemes have both got PIPs that run in tax years that has made things simpler.

Roy has not got his carry forward calculations correct.

Carry forward is used to remove or mitigate any tax liability where a scheme member’s total pension inputs exceed the standard annual allowance in a tax year.

This is done by going back three years and offsetting any excess against the unused allowance from that year and then going on a year if necessary until:

 

– the unused allowances are used up, which leaves a taxable excess, or

– until the excess is removed.

 

Roy only had the last three years information so assumed the £25,000 excess used up most of the £35,000, leaving £10,000 carry forward available for 2013/14.

You go back to Roy’s previous scheme and get the information for 2009/10 and prepare a schedule of inputs for Roy.

 

  2009/10 2010/11 2011/12 2012/13 2013/14 2014/15

Annual Allowance

£50,000

£50,000

£50,000

£50,000

£50,000

£40,000

Pension Inputs

£25,000

£30,000

£35,000

£75,000

£25,000*

£25,000*

Unused (Excess)

£25,000

£20,000

£15,000

(£25,000)

£25,000

£15,000

Used up in 2012/13

£25,000

£0

£0

£0

 

 

Unused for 2013/14

£0

£20,000

£15,000

£0

 

 

* new employer contributions

 

The £25,000 excess in 2012/13 was fully offset against the unused allowance from 2009/10 which was three years before 2012/13, leaving the unused allowances of £35,000 from 2010/11 and 2011/12 fully available for use in 2013/14.

The maximum allowance in 2013/14 is £85,000 and Roy’s new employer and his own contribution comes to £60,000.You advise Roy that he can make a further contribution of £25,000 gross.

You then explain that even though his PIPs run in tax years these can sometimes be manipulated to suit clients’ needs.

His new personal pension provider allows clients to nominate their own PIPs so when he pays his extra £25,000 you get Roy to nominate that his PIP ends the following day.

His nomination means a new PIP starts which must end in the 2014/15 tax year. As the annual allowance is falling to £40,000 next year Roy can pay the final £15,000 into the new PIP. This will be paid in 2013/14 for tax relief purposes but use up the 2014/15 annual allowance as the PIP ends in that tax year.

By having a deeper understanding of the carry forward rules and knowledge of how to make use of PIP flexibility to best suit a clients’ needs, Roy’s adviser has allowed him to achieve his objective of getting all his redundancy payment into his pension plan.

Les Cameron is a technical manager at Prudential 

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