How to use redundancy to boost your pension and retire early

Redundancy normally deals anyone experiencing it a nasty emotional and financial blow, but if you are approaching retirement it can prove a well-timed opportunity.

Any accompanying compensation package can boost your pension, offer handy tax perks and allow you to overhaul your finances in various useful ways like paying off debts.

We look at ways to turn what might at first seem a setback to your advantage, with a checklist compiled with the help of pension experts. Below are their tips on how to put yourself in a better position to retire, perhaps a lot sooner than you planned.

Redundancy: If you are approaching retirement it could prove a well-timed opportunity

Your pension and redundancy

Use your redundancy payout to enhance your pension and improve your financial position going into retirement.

Age rules: ‘Lots of pension schemes contain favourable terms if you’re retiring due to redundancy,’ says Patrick Bloomfield, senior actuary at pension consultancy Hymans Robertson.

‘You’re usually allowed to retire immediately if you’re over age 55, rather than needing your employer’s consent or the consent of the scheme’s trustees.’

Andrew Tully, technical director at pension firm Canada Life, says: ‘From the age of 55, what’s called the minimum pension age, you can flexibly access your private defined contribution or personal pensions, subject to the tax rules.

But he cautions: ‘It’s worth keeping in mind from April 2028, the minimum pension age will move to 57, which means most people will need to be 57 or older from that point before they can access their pension.’

Maxing out contributions and matching benefits: Once you know you are being made redundant and during your notice period, you should consider maximising your contributions into your work pension scheme, says Tully.

‘Many employers offering workplace schemes will be investing a minimum of 3 per cent contribution with your contribution set as a minimum 5 per cent of salary. However, some schemes will offer scope to match contributions if the employee contributes more.’

There is more below about the tax advantages of putting extra cash into your pension if you are made redundant and want to retire.

Retiring now: Taking early retirement may be more achievable than you thought if you are made redundant at an older age, according to Jonathan Watts-Lay, director of workplace financial education specialist Wealth at Work.

‘An individual could use their redundancy payment or pension tax free cash to pay off any outstanding loans and mortgages, and as a result, they may be able to maintain their standard of living.

‘For example, someone earning £30,000 per year, once they have paid income tax (£3,006), National Insurance (£1,804), pension contributions via salary sacrifice (£2,400), mortgage (£6,000) and loans (£2,400), may end up with a disposable annual income of around £14,390.’

Tax advantages:  Make the most of any redundancy package

Tax advantages:  Make the most of any redundancy package

He adds: ‘Realising that you may only need a retirement income of less than half of your salary to maintain your standard of living can be an eye opener, and make retirement a more realistic option.’

Tax strategies to max out redundancy and pension benefits

Here’s what you need to know about tax if you are made redundant, especially if you want to retire.

Your redundancy payout: ‘Redundancy packages are not set in stone, they vary according to the company but are also based on age, length of employment, and job role,’ says Watts-Lay.

‘For those who have been in the same job for at least two years, your employer is usually legally required to pay you. The legal minimum is called ‘statutory redundancy pay’. However it is vital that you check your employment contract as you may be entitled to more.’

Watts-Lay says usually the first £30,000 of a redundancy payment is tax free, with anything over this being added to your income and charged at your marginal income tax rate.

He notes that employee National Insurance will not be deducted from a redundancy payment.

‘For example, someone who has an annual salary of £36,000, has earned £15,000 so far this tax year and is offered £50,000 redundancy would owe £4,000 in tax on their redundancy pay.

‘This is because the first £30,000 of their redundancy pay is tax free but the remaining £20,000 is taxable. As they have earned £15,000 so far this year, even with the £20,000 added to this, they are still within the basic rate tax band, so tax of £4,000 is due on the redundancy pay (20 per cent of £20,000).

‘Individuals could end up in a higher rate tax bracket, depending on their income and redundancy pay.’

Income tax advantage: ‘Most people’s pension income will be lower than their working income was, so you’ll pay a lower average rate of tax in retirement than in work,’ says Bloomfield.

Got a tax question? 

Heather Rogers, founder and owner of Aston Accountancy, is This is Money’s tax columnist.

She can answer your questions on any tax topic – tax codes, inheritance tax, income tax, capital gains tax, and much more.

You can write to Heather at taxquestions@thisismoney.co.uk.

‘That means it makes sense to pay additional pension contributions before retirement (contributions these are tax free) and take the money back out as income from your pension the other side of retirement.’

He says this is especially valuable if you’re a higher-rate tax payer due to the extra tax relief that goes into your pot when you make pension contributions, but it’s still worth considering if you pay basic rate tax.

Bloomfield warns that you should bear in mind that your state pension will be taxed as income too when you start drawing it, pushing more of your income into basic or higher-rate tax brackets.

Topping up your pension: ‘If you can afford to do so, it may be worth considering paying some of your redundancy payment into your pension to boost your retirement savings,’ says Watts-Lay.

‘For those approaching retirement, this may be a particularly attractive way of providing a final boost to the value of their pension pot.’

Tully says: ‘If you have enough emergency funds set aside, the redundancy payment could be a windfall.

‘Using an element of the redundancy payment to top up your pension is an excellent way to increase the size of your pot.

‘For example, a £15,000 tax-free redundancy payment, grossed up with 20 per cent tax relief is worth £18,750 into your pension. If you are a higher rate taxpayer, you can claim a further £3,750 in tax relief’. Find out more about pension tax relief benefits for higher earners here.

Special payment arrangements: It is worth checking with your employer and pension scheme whether they offer any extra benefits for paying redundancy cash into your pension.

Tully says: ‘Where you might have a long period of service and a redundancy payment over £30,000, your employer might consider making a payment into your pension as part of a negotiated settlement.

‘Care would be required in these circumstances practically relating to your annual allowance limit and any income tax consequences.’

Bloomfield says: ‘Most employers will allow you to “waive” some or all of your redundancy payment into your pension scheme as a special contribution.

What is the annual allowance? 

The annual allowance is the standard amount you can put in your pension every year and qualify for tax relief on what you saved.

It is £60,000 or up to 100 per cent of your annual earnings if they are lower than this.

The annual allowance includes your own and your employer’s contributions into a pension, and the tax relief itself.

> Read a This is Money guide to the annual allowance

‘It’s worth speaking to your scheme’s administrators to find out how much annual allowance you have available (how much you can pay in each year and qualify for full tax relief).

‘The annual allowance has just been increased from £40,000 each tax year to £60,000; which could be really helpful if you’re being made redundant.’

Carry forward annual allowance from previous year: One very important perk of the annual allowance is that you can still benefit from any of it left unused over the three previous tax years, under certain conditions.

You need to have been a member of a pension scheme during the years you intend to ‘carry forward’ annual allowance from, although you don’t need to have paid anything into it.

You must also use up your entire annual allowance first for the year in which you want to do carry forward, and you have to go back to the earliest of the three years and use up the allowance from then first.

‘You can pay up to 100 per cent of your annual income or £60,000 if you earn more than that, into your pension every year, but there are tapering rules for higher earners earning “adjusted income” over £260,000 a year,’ says Tully.

Tax year end: ‘One area that requires particular care is where a large redundancy payment is spread over a tax year end,’ cautions Tully.

‘The key issue here is concerning anti-avoidance legislation, especially if the action would be to reduce the impact of the tapered annual allowance.

‘You should seek specialist financial advice to ensure the overall impact of the action is not seen as avoiding income tax.’

Taking your tax free cash: ‘The benefit of this is that these payments are not subject to income tax and can be phased to meet your monthly income needs,’ says Tully.

‘The advantage is that these payments can be stopped or amended as required.’

He notes that the tax-free payments will make up 25 per cent of the value of your pot to a cap of £268,275, irrespective of the size of your pension, though this cap may be higher if you had previously applied for lifetime allowance protections. (See the link in the box above for more on this).

Dipping into your pension beyond tax-free cash: ‘Drawdown is where you can take as much as you want each year, which gives you a chance to manage how much income you take to avoid paying more tax than you need to in any one tax year,’ says Bloomfield.

‘Be very careful about taking out big lump sums and pushing yourself into a higher rate tax.’

STEVE WEBB ANSWERS YOUR PENSION QUESTIONS

       

Tully warns: ‘Any income taken in addition to the tax-free cash from your personal pension will impact the future opportunity to make pension contributions and should be carefully considered if you decide to look for another job.

‘As soon as a single £1 of income is taken, the Money Purchase Annual Allowance (MPAA) reduces the potential of making further contributions (including yours and any employer contributions) and benefiting from tax relief from £60,000 to £10,000.’

No longer earning an income: ‘Even if you have no relevant earnings in a tax year, you are able to make a contribution of £3,600 to help build or replace some of the withdrawals made,’ says Tully.

Redundancy and final salary pensions 

Most modern pensions are what is known as ‘defined contribution’. This is where contributions are taken from both employer and employee and invested to provide a pot of money at retirement.

However, many existing public sector, and many legacy private sector pension schemes – now typically closed to new contributions – run what are known as final salary or ‘defined benefit’ pensions.

They provide a guaranteed income after retirement until you die, and after that continue paying out to a spouse who survives you.

Hymans Robertson advises defined benefit schemes, and below Patrick Bloomfield runs through some pension tips for members if they are made redundant.

Retire earlier with lower or no reduction to income: ‘Defined benefit pension schemes often have more generous reduction factors if you’re taking your pension early because of redundancy,’ says Bloomfield.

‘Sometime reduction factors are waived altogether on redundancy, which could be extremely valuable.

‘If you can retire without any reduction to your pension then it might make financial sense to start your pension immediately, even if you didn’t plan to start your pension so early.’

Put your redundancy payout in your pension: As explained above, some employers and pension schemes will pay your redundancy money straight into your pension.

‘It can be especially worth waiving your redundancy payment as a contribution to your defined benefit scheme, then using this money to fund your tax-free cash,’ says Bloomfield.

‘It will slightly increase the amount of tax-free cash you’re allowed can take. But more importantly, it has the effect of buying more defined benefit pension on the terms that the scheme uses to convert pension into cash (known as commutation terms).’

Managing income over time: ‘Some defined benefit schemes offer something called a “level pension option” where you can choose to take a higher pension initially, which steps down when your state pension starts being paid, so that your overall income stays constant through retirement.’ says Bloomfield.

He says this option is not directly related to redundancy, but worth looking into if you’re retiring sooner than you planned.

Volunteering for redundancy: ‘If you have a defined benefit pension and the redundancy terms are generous, there’s a decent chance that any additional costs could be covered from the scheme’s assets rather than being a one-off contribution from your employer,’ says Bloomfield.

‘From your employer’s perspective that may make you a more appealing candidate for voluntary redundancy than another colleague.’

Further financial tips if you are made redundant

Review your finances: ‘Work out what assets you have, pensions, savings, Isas, property and investments, and what liabilities you have, mortgage, debt, childcare, insurance and utility bills,’ says Jonathan Watts-Lay of Wealth at Work.

‘Then look at any other household income and expenses. If the amount of money you need each month is more than the amount you have coming in, you can then work out what action you need to take to cover your costs.’

Consider paying off debts: It might be worth using some of your redundancy payment to pay off expensive debts if you can afford this, says Watts-Lay.

‘Credit cards and overdrafts can have rates of 18–40 per cent, with some payday loans having rates of 1,500 per cent and more.’

He offers the example of a debt of £3,000 with a rate of 18 per cent, which could take 10 years and 10 months to pay off if paying £50 a month, with total interest of £3,495.

‘If that monthly payment was increased to £100 a month, the debt would be paid off in three years and four months, and interest paid would be only £908. If this was increased to £300 a month, the debt would be paid in 10 months, with total interest of £252 paid.’

Look at your mortgage: ‘Mortgage interest rates tend to be significantly lower than other debts, and can include payment holidays for those who are made redundant,’ says Watts-Lay.

But if you don’t have other debts, you might want to consider using your redundancy cash to overpay on your mortgage.

He gives the example of a £200,000 mortgage which has a 3 per cent rate of interest over 25 years, which would cost you £84,527 in interest over that time.

‘If this is overpaid by £200 a month, the interest reduces to £62,905 over 19 years. If this is overpaid by £400 a month, the interest reduces to £50,209, over 15 years and 6 months, and if this is overpaid by £600 a month, the interest reduces to £41,825 over 13 years.’

Help with financial advice: ‘Some employers will pay for you to speak to an independent financial adviser or provide access to an IFA at a cheaper rate than if you chose one yourself,’ says Bloomfield.

Check your state pension: Work out how much you are going to get with a state pension forecast, and at what age you will be able to draw your state pension.

Read a This is Money guide to buying top-ups to boost your state pension here.

Moving and merging your pensions: ‘If you’ve got a few pensions from different employers then it’s worth thinking about whether to consolidate them into one place to save on costs and make it easier to manage,’ says Bloomfield.

‘Alternatively, you can keep your pensions separate and take each of them at different times, to spread out your lump sums and can leave more of your money invested for longer.’

He says this could help you fit the pension relating to your redundancy around your other pensions, including your state pension.

Tully says: ‘It is fine to keep your pension with your previous employer and it will remain invested and safe until you retire.

‘Some people prefer to move their pension to their new workplace pension scheme, or a private pension. There are benefits to this in that all pensions are kept together in one place.

‘However, there can be a cost to transferring a pension. Investment charges are not all the same and may not be lower, and the range of investment options vary between schemes. Make sure you check these things before moving your pension.’

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