Being made redundant can be a challenging time, but one advantage could be using some of your redundancy pay to tax-efficiently boost your pension.
In 2023, nearly one in ten people (9.54%) over 50 but not yet at pensionable age left work involuntarily, according to the International Longevity Centre (ILC). Provided you’ve worked for a company for at least two years, you should receive a payout if you’re made redundant.
You could invest some of this money in your pension, but you need to ensure you aren’t breaching your Annual Allowance, and that this is the right decision for you. Make sure you won’t need it to cover rising living expenses, too, as once it’s in your pension it will be tied up at least until you reach the age of 55 (rising to 57 by 2028).
Here, we explain how to use some of your redundancy payout to increase your pension savings, and what you need to consider before paying this money into your retirement pot.
How much can you pay into your pension?
If you pay into a defined contribution pension, sometimes known as a money purchase pension, you can pay in up to 100% of your earnings into your pension each tax year, up to a maximum Annual Allowance of £60,000 in the 2023/24 tax year.
You can also ‘carry forward’ any unused Annual Allowance from the last three years as long as you were enrolled in a pension scheme during that time. This can be helpful if you have a big lump sum such as a redundancy payout that you want to invest in one year. For example, if you receive a redundancy payout of £80,000 and you’ve paid £20,000 into your pension the previous tax year (less than your Annual Allowance), you can pay the full lump sum into your pension if you wish. Read more in our articles How do pension allowances work? and Pension carry forward explained.
Bear in mind you do not need to report additional contributions under carry forward to HMRC, provided you qualify to use this rule, and haven’t exceeded your allowance. If you do contribute more than your overall allowance into your pension, you will pay a tax charge which will claw back any tax relief you received that you were not entitled to. So it’s important to ensure you’re sticking within the rules.
What difference could a redundancy payout make to your pension?
A £10,000 redundancy payment made into your pension at age 50 could boost the average £105,000 pot by £14,669 by the time you reach the age of 67 (to £257,894), according to calculations by PensionBee, the pension provider. If someone were to pay in a £20,000 lump sum at age 50 to the same pot, it could be worth £29,337 more by the age 67. That’s an increase of 47% in your retirement savings.
Impact of adding a redundancy payment to a pension
Pension at age 67 without redundancy payment
Pension at age 67 with £10,000 redundancy payment added at age 50
Pension at age 67 with £20,000 redundancy payment added at age 50
Gain on contribution £
Gain on contribution %
Source: PensionBee, October 2023. Assumptions: £105,000 pot size by age 50, 1% salary growth a year, 3% investment growth (after inflation), 0.7% fee, 8% overall contributions.
Becky O’Connor, director of public affairs at PensionBee, said: “While you might need to use redundancy money to tide you over until you find more work, or to retirement, depending on your age, if you’re lucky enough to get another job quite quickly, this cash is tantamount to a windfall.
“One of the most tax-efficient and generally financially beneficial things you can do with it is add it to your pension. If you are approaching 55, the age at which you can first access your pension, this can make even more sense, as you’re very close to being able to use that money again, but with the benefit of tax relief and hopefully some investment growth on top, too.”
What you need to know about redundancy payments
There are some facts that you should be aware of if you lose your job and receive redundancy pay. After two years of employment, employers must pay at least the statutory redundancy payment, amounting to one week’s pay per year of service. However, you may be able to negotiate a higher payment, particularly if you don’t consider the payment to be fair. The first £30,000 of a statutory redundancy payment is paid tax-free
Your employer may pay some or all of your payment directly into your pension. This is known as ‘redundancy sacrifice’, whereby some or all of the portion of your payment that is liable to tax is paid into your pension on your behalf. This way, you benefit from tax relief, and you don’t have to pay National Insurance on this money.
You have plenty to consider and perhaps worry about without considering pension planning when you go through redundancy, so don’t make any rushed decisions. Only when you’re ready should you think about what to do with your pension, and it’s also a good idea to ask your provider for an up-to-date forecast so you know where you stand first.
What happens to your workplace (defined contribution) pension when you’re made redundant?
If you’re made redundant, your workplace pension remains your pension. If you want to continue paying into your pension after you’ve left your job, contact your employer to see if this is possible. If, for example, you have been paying into the National Employment Savings Trust (NEST) pension, you can continue paying into it if you wish. However, if it’s a scheme linked to that employer you will have to stop contributing.
Alternatively, you may choose in the future to move your pension to a new employer’s pension scheme, or a personal pension. If you are out of work for some time, you can still pay into a personal/private pension such as a self-invested personal pension (SIPP). Read more in our article How private pensions work and Everything you need to know about SIPPs.
If you were paying into a final salary, also known as a defined contribution pension, you will stop paying into the scheme. In this case, it’s best to leave your pension in the scheme rather than move it to a defined contribution pension. You then wait until you reach the scheme’s retirement age before you take your pension benefits.
Find out more in our article What happens to my pension if I’m made redundant?
Get expert help
If you’re wondering whether it makes sense to use some of your redundancy pay to boost your pension, you might want to get advice from a qualified financial advisor. If you’re 50 or over and have a defined contribution pension, you can get free guidance on the options available to you from the Government’s Pension Wise service.
If you’re considering getting professional financial advice, Aviva is offering Rest Less members a free initial consultation with an expert to chat about your financial situation and goals. There’s no obligation, but if they feel you’d benefit from paid financial advice, they’ll go over how that works and the charges involved.
Rest Less Money is on Instagram! Check out our account and give us a follow @rest_less_uk_money for all the latest Money News, updated daily.