Redundancy payments being used for pension contributions

Only part of a redundancy payment counts as relevant UK earnings.

A redundancy payment can be made up of the actual redundancy payment and other payments such as salary, holiday pay or payment in lieu of notice or PILON as it is also known. Any part of a lump sum redundancy payment that comes from salary, 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 therefore count as relevant UK earnings.

Let's look at an example where a member 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.

Remember the relevant earnings will only be for the part of the year worked before redundancy.

In the normal way, if the maximum contribution is paid and that’s over the annual allowance, carry forward of unused AA from previous years will be required to avoid an AA charge.

Alternatively, the member can ask the employer to pay some or all the payment as an employer contribution. This doesn’t require a formal exchange of letters as it isn’t a salary or bonus exchange but has the same result.

Pension contributions can bring your taxable income down to below £100,000 and retain the personal allowance giving 60% tax relief on pension contributions, or 61.5% tax relief if paying tax in Scotland.

You can reduce taxable income significantly through pension contributions as the pension contribution will extend the basic rate band.

Note

The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.

All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.