Redundancy payments being used for pension contributions

Can a redundancy payment be used to boost an individual’s pension savings?

Potentially, yes, though only the part of a redundancy payment over the tax exempt threshold of £30,000 counts as relevant UK earnings. Tax relief on individual contributions is restricted to the higher of £3,600 or 100% of relevant UK earnings.

Can an individual pay the whole redundancy payment into their pension plan?

A redundancy payment can be made up of the actual redundancy payment and other payments such as:

• salary
• holiday pay
• bonuses
• payment in lieu of notice

Any part of a lump sum redundancy payment that comes from salary, bonuses, payment in lieu of notice, or holiday pay does count as relevant UK earnings. However, only the part of the actual redundancy payment over the tax-exempt threshold of £30,000 will be classed as employment income and count as relevant UK earnings.

To pay the full redundancy payment into the pension as a personal contribution, the individual needs to have enough relevant UK earnings from a source other the redundancy payment to cover the full payment.

How to calculate how much of the redundancy payment counts as relevant UK earnings

Let's look at an example where an individual receives a lump sum payment on redundancy that's made up as follows:

• one month’s salary - £2,500
• one month’s salary in lieu of notice - £2,500
• holiday pay - £750
• redundancy payment - £31,250
• total - £37,000

The first three items all count as relevant UK earnings. In addition to that, £1,250 of the redundancy payment is also classed as relevant UK earnings. So this redundancy payment will add £7,000 to the individual’s relevant UK earnings for the tax year.

Any salary from before they got made redundant and after, if they get a new job, within the same tax year as the redundancy payment, will also count towards their relevant UK earnings.

What can be done with the first £30,000 of the redundancy payment?

As the first £30,000 is not relevant UK earnings it cannot be used to support a personal contribution.

However, it is important to remember that the individual may have relevant UK earnings from before they get their redundancy payment. For example, the individual earns £20,000 between April and August and then gets made redundant. The redundancy payment is £37,000 of which £7,000 is relevant UK earnings. So, they have total relevant UK earnings of £27,000 meaning they could pay £27,000 of the redundancy payment as a pension contribution.

In addition, if the individual gets another job before the end of the tax year, they will have more relevant UK earnings, those new earnings can be used to support more pension contribution paid from the redundancy payment.

If it isn’t possible to pay any more into the individual’s own pension it can be used to make a third-party contribution for someone else.

It could be used to pay £3,600 gross to a non-taxpayer's pension plan, for example a child or grandchild. If the individual was married or in a civil partnership, depending on their relevant UK earnings some or all of the £30,000 could be paid into their pension plan. Similarly, a payment could be made to an adult child’s pension on the same basis.

Does the annual allowance apply to pension contributions made from redundancy payments?

In the normal way, if total contributions (including any made from the redundancy payment) in a tax year are over the annual allowance, the individual may be subject to an annual allowance tax charge. They may be able to carry forward unused annual allowance from previous tax years in order to avoid this charge. If the redundancy payment is large or the individual was a high earner you should check whether the tapering of annual allowance applies.

Similarly, if the money purchase annual allowance applies this will restrict how much can be paid into a money purchase plan. Remember carry forward is not available if the money purchase annual allowance has been triggered.

Can an individual salary sacrifice a redundancy payment?

Yes. The individual can ask the employer to pay some or all of the redundancy payment as an employer contribution, this is redundancy sacrifice. This doesn’t require a formal exchange of letters as it isn’t a salary or bonus exchange but has the same result.

What about tax relief?

Any tax relief on individual contributions is restricted to the higher of £3,600 or 100% of relevant UK earnings, as normal. Corporation tax relief will be paid on any employer contribution paid as a result of the redundancy subject to the wholly and exclusively for the purpose of trade rules.

Where the redundancy payment pushes the individual’s earnings, for the tax year, over £100,000 they will start to lose their personal allowance. Once their income is over £125,140 their personal allowance is zero.

A personal contribution to a pension will reduce their taxable income. If the contribution can bring their adjusted net income down to below £100,000 they will retain the personal allowance and give them at least 60% tax relief on their pension contributions.

The individual could ask the employer to pay an employer pension contribution instead of paying them the redundancy payment. The pension contribution could be equal to or only part of redundancy payment if they still need some redundancy payment. This will also reduce their adjusted net income.