Can I put my pay-off into my pension?

I am being made redundant and my employer is offering an
ex-gratia payment, part of which I can take as a contribution to my money purchase pension scheme to avoid tax. The payment will take my total earnings above 150,000. Are such redundancy payments – whether coming as income or employer pension contributions – subject to limits on pension savings tax relief?

Laith Khalaf, pensions analyst at financial adviser Hargreaves Lansdown, says restrictions may apply for payments received in this tax year, but things are changing for the better in April.

You might be caught by the current pension contribution limit of up to 30,000 if your “relevant income” for the year exceeds 130,000. This figure includes employment earnings and the taxable element of your redundancy payment (typically, the first 30,000 of a pay-off is tax-free). However, in calculating the income figure, you may deduct personal pension contributions of up to 20,000.

So, for example, if your total earnings (including taxable redundancy pay) are 145,000 but you make a 20,000 pension contribution, HMRC deems your relevant income to be 125,000 and you would not be caught by the new restrictions. In this case, the taxable part of your redundancy payment can be restructured as an employer pension contribution, subject to a limit of 255,000 including any other contributions made in this tax year.

However, if you are caught by the restrictions, the contribution that your employer can make without triggering a tax charge for you is limited. The limit depends on your circumstances and could range from zero to 30,000. For many, the figure will be 20,000 minus their other pension contributions in that year. If total contributions exceed your limit, you will be subject to a tax charge of up to
30 per cent on the excess.

These rules are being scrapped from April and replaced with a flat 50,000 annual pension contribution allowance. This could give you greater scope to use a pension to protect your redundancy payment from tax – assuming you can delay matters until the new tax year. Your employer would then be able to pay up to 50,000 into a pension tax-free, irrespective of how much you earn.

You may also be able to carry forward unused pension allowances from the previous three tax years.