Is redundancy pay pensionable?

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If you’re making redundancies in your business, you might be wondering what to do about your employees’ final redundancy payments regarding their pension.

Do employers have to take pension contributions from redundancy pay? Can employees choose to add more into their pension pot? We go through the process below.

Taking pension contributions

If you make an employee redundant, do you have to take pension contributions from their redundancy pay?

When an employee gets made redundant, they’re usually entitled to a redundancy payment, separate to their salary, holiday pay, and pay in lieu of notice (PILON). This is tax-free lump sum which doesn’t qualify as pensionable earnings for Income Tax or tax-relief purposes up to £30,000. So, there are no pension deductions if your payout is under £30,000. Simple!

There are no pension deductions if the payout is under £30,000.

If the payment is over £30,000, anything above that will qualify for taxable earnings, and the employee can choose to add some or all of it into their pension – under certain conditions, which we’ll share below.

You should note that what the employee receives in their final period of employment as their usual, taxable pay (i.e. their salary payment) will be subject to the usual automatic enrolment deductions. So you’ll need to take pensionable earnings out of their final salary payment.

In conclusion

Salary – yes take pension contributions
Redundancy payment up to £30,000 – no don’t take contributions
Redundancy payment over £30,000 – maybe take contributions, depending on the employee’s wishes

Combining redundancy pay and pensions

What happens if an employee wants to put their redundancy payment into their pensions account?

Employees might want to use their redundancy pay lump sum to top up their pensions pot. If the employee is getting a redundancy payment over £30,000, they can ask their employer to put pay some or all of the amount over £30k into their pension as an employer contribution.

So if they got £32,000, the extra £2,000 is pensionable.

(By the way, this doesn’t require a formal exchange of letters as it isn’t a salary or bonus exchange, but has pretty much of the same result.)

But whether or not they can do that depends on the type of pension the employee has.

Defined benefit scheme pension / final salary pension

These schemes pay a retirement income based on the employee’s salary and how long they’ve worked for their employer for. Generally, these schemes are out of date and are mainly used by the public sector or older pension schemes.

If your staff have a defined benefit scheme, they will usually not be able to put their redundancy payment into their pension. This is because how much you get is based on your salary and how long you’ve been employed, not how much money you put in.

Defined contribution pension schemes / money purchase pension

These are the more common pension schemes, where the pension pot grows the more the employee and employer puts in.

If an employee has this, even if it’s alongside a benefit scheme, they will usually be allowed to put their redundancy payment into it as an employee contribution, up to their usual Annual Allowance, which is up to £40,000 per annum.

Annual Allowance

How does Annual Allowance come into it?

An Annual Allowance is the maximum amount of tax-free money that an employee can build in their pension pot in any one tax year, whilst still benefitting from tax relief.

Annual Allowance is based on employee and employer contributions, plus any other contributions made on the employee’s behalf. The annual allowance is currently £60,000 for most people, or 100% of the person’s earnings if lower.

An employees’ annual allowance will be reduced if their adjusted income for the tax year is more than the adjusted income limit of £260,000.

What happens if an employee exceeds their Annual Allowance?

If an employee wants to add more than their Annual Allowance into their pension, and still wants to benefit from tax relief, they may be able to do this by using any unused Annual Allowance from the last three tax years. It effectively carries over from the last three years.
Usually, if someone exceeds their Annual Allowance, a tax charge is made which takes back any tax relief that was given at source.

Making the payment

How will the payment be put into the pension?

Employers can agree to pay some or all of the taxable part of their employee’s redundancy payment into their pension on the employee’s behalf, as an employer contribution. This will help your employee avoid paying tax and National Insurance on the money.

Alternatively, you can let the employee pay the money into a pension themselves, as an employee contribution. If they do this, they may have to claim the tax relief themselves. They can seek advice about how tax relief will be handled from their pension provider.

What happens to the pension

What happens to an employee’s pension with the company when they are made redundant?

You can reassure your employee that their pension savings will not disappear when they leave the company! It will of course be kept safely for when they need it, separate to your business. When they can use their money depends on your pension scheme’s Ts & Cs – but often when the person reaches 55, if not before.

It might be helpful to remind your staff before they leave how they can manage their pension and ensure they have their account information to hand. This will save them contacting you in the future when they want to review their pension.

An employee may wish to move their pension provider into a new scheme, for example if their next employer has a different scheme, or into a personal pension. To do this, they will simply have to get in touch with the pension provider to transfer their pension savings over into a new account, if applicable.

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