With the increasing impact of Covid-19 on the economy, as a society we’re witnessing a paralleled effect on people relating to both their social and financial situations, in particular in the over 50s.
Since March 2020 we’ve seen many people put on furlough and in some circumstances, this has led to the increasing spectra of redundancy for many in this age group.
For the over 50s, this further complicates their financial situation. On one hand, they’re already looking to the horizon and planning for retirement, while on the other juggling helping their grown-up children gain a foothold on the property ladder with potentially having to care for parents.
So, what should be the approach if one day a client contacts you asking about options for their existing pension arrangements because they are at risk of redundancy?
The most important aspects are to understand their current and projected cashflow to meet the needs and objectives for the period while they are not working. In most circumstances the employer will provide a set of terms to their employees which you would hope is better than the statutory redundancy pay permitted under legislation. However, that is not always the case.
To understand this fully, as an adviser you need to know the terms that the legislation sets out. The minimum statutory redundancy pay if your client was an employee and they had been working for their current employer for two years or more is calculated as follows:
- half a week’s pay for each full year your client was under 22
- one week’s pay for each full year your client was 22 or older, but under 41
- one and half week’s pay for each full year your client was 41 or older
Length of service is capped at 20 years.
The weekly pay is the average your client earned per week over the 12 weeks before the day they got their redundancy notice.
If your client were paid less than usual because they were on furlough as a direct result of coronavirus, the redundancy pay is based on what they would have earned normally.
If your client was made redundant on or after 6 April 2020, their weekly pay is capped at £538 and the maximum statutory redundancy pay they can get is £16,140.
An important point to remember is that redundancy pay (including any severance pay) under £30,000 is not taxable and this does pose some opportunities for pension planning which we’ll look at later.
A quick example using the official government website for a client age 55, with 3 years’ employment, earning £40,000 p.a. illustrates that they would receive a statutory redundancy pay based on 4.5 weeks, capped at £538 p.w. totalling £2,421. Hopefully, any employer terms would be more generous than these!
In an ideal world, a client would have set aside savings for expenditure in case of emergencies amounting to 6 months (or longer), so what could a client do from a pension planning perspective?
Before redundancy and/or during notice period
- Your client should be looking to maximise their contributions into their employer sponsored scheme. Many employers offering workplace schemes will be investing a minimum of 3% contribution with your client paying 5% of their salary. However, some schemes will offer scope to match contributions if the employee contributes more. It would not be unusual to see a maximum of up to 5% matching available. In simple terms, an employee can increase the pension contribution from 8% to 18% of salary.
- For clients who are 55 plus and in a defined benefit pension arrangement, it would be worth exploring the discount factors that might be applied if their pension entitlement were taken before the scheme’s normal retirement date. In some cases, a scheme will reduce the discounting factors that would be applied to members pension due to redundancy and when they are close to retirement.
- In a small number of situations, where a client might have a long period of service and a redundancy payment is in excess of £30,000, the employer might consider making a payment into the client’s pension as part of a negotiated settlement. Care would be required in these circumstances practically relating to a client’s annual allowance limit and any income tax consequences. Remember that there may be an opportunity to use the client’s carry forward allowances if available.
- One area that requires particular care is where a large redundancy payment is spread over a tax year end. The key issue here is concerning anti-avoidance legislation, especially if the action would be to reduce the impact of tapered annual allowance. While there have been recent changes to these limits, care is still required to ensure the overall impact of the action is not seen as avoiding income tax.
Pension planning post redundancy
For clients who have enough emergency funds set aside, the redundancy payment could be a windfall. Using an element of the redundancy payment to top up their pension is an excellent way to increase their pot. E.g. £15,000.
There will be circumstances where the client will need to supplement their income and would look to potentially draw upon their pension, so what are the options and implications of these actions?
- Firstly, the obvious point is that any withdrawals today will impact potential income in the future and there is only a limited period to make up any shortfalls in the pot.
- The first element to consider is the utilisation of tax-free cash. The benefit of this is that these payments are not subject to income tax and can be phased to meet the monthly income needs of the client. The advantage is that these can be stopped or amended as required. hHowever, there is the limitation that the tax-free payments are subject to the lower of 25% of the pot or 25% of the member lifetime allowance.
- Any income taken in addition to the tax-free cash from the pension will impact the future opportunity to make pension contributions and should be carefully considered if the client is looking for continued employment. As soon as a single £1 of income is taken, the Money Purchase Annual Allowance (MPAA) reduces the potential of making further contributions and benefiting from tax relief from £40,000 to £4,000.
- An option to be considered if income is required would be to look at using an Annuity to provide an income stream, perhaps to support the core needs. The advantage of this approach is that the client would not trigger the MPAA and therefore not restrict future pension contributions. On the other side, the rates are sensitive to both age, health and location and therefore due consideration of these factors need to be balanced against drawing income from other assets available to the client.
- Transfers from defined benefit schemes, either full or partial, might appear an attractive consideration from a client’s viewpoint. However, these must be treated in the same light and consideration as if the client had not been made redundant. While there is an obvious short-term change in client circumstances any action and recommendation still needs to meet the tests associated with this type of transfer. Recent changes to guidance issued by the FCA around transfers from safe-guarded benefits is noticeably clear on this point. Within the new guidance issued, it might be argued that due to redundancy, the client is suffering financial hardship and therefore an adviser could charge on a contingency basis. I would caution against this. A client who has received a redundancy payment which is tax free might be expected to use this to support any fees that might be charged for the advice and therefore not seen as suffering financial hardship. Finally remember, the FCA may well see this type of client as vulnerable and as such would test the approach adopted by the adviser and firm against the firm’s vulnerable client policy in place.
Redundancy introduces for client’s uncertainty and increased levels of anxiety around their personal circumstances. While as advisers you will not be able solve all the challenges your clients will face, you will be able to assist them through the options and opportunities that they can adopt to either maximise their pension or to look at the best options to draw income, whichever is required.
John Chew is pensions, tax and estate planning consultant at Canada Life