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    TaxKilnUK tax guidance
    TaxKilnUK tax guidance

    Redundancy + termination → Pension contribution alternative

    Employer Pension Contribution in Lieu of Cash — Termination Tax Efficiency

    Where part of a termination package is paid as an employer pension contribution rather than cash, the contribution is exempt from employment income on the employee under ITEPA 2003 s.308. This sits outside the s.401 / £30,000 termination payment regime entirely. The contribution must respect the employee's Annual Allowance (£60,000 for 2023/24 onwards) and any carry-forward of unused AA from the prior three tax years. If the employee has already triggered flexible DC drawdown, the Money Purchase Annual Allowance (MPAA) caps the relevant allowance at £10,000. For higher-rate or additional-rate taxpayers, redirecting £20-£30k of a termination package into employer pension contribution typically saves 40% or 45% on the cash-equivalent — significantly better than the only-marginal-rate-saved-by-£30k-exemption on the equivalent cash slice above the cap.

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    Guidance, not advice. We explain the rules, we don't assess your situation. Always seek financial or tax advice from your accountant, or contact HMRC. Read our editorial scope →

    In plain English

    When a settlement package would push you above the £30,000 s.401 cap, you can ask your employer to pay part of the package straight into your pension instead of as cash. The employer pension contribution is not treated as employment income on you — no income tax, no NIC, no s.401 charge. The practical headline: if you'd otherwise receive £20,000 cash above the £30k cap and you're a higher-rate taxpayer, you net roughly £12,000 from that cash slice. If instead the employer pays that £20,000 into your pension, you get £20,000 in the pension. When you eventually draw the pension, the first 25% is tax-free (PCLS) and the rest is taxed at your then-marginal rate. For someone with a long retirement runway, the deferred-tax advantage is substantial. Four traps to check before agreeing to a pension-routed structure: 1. Annual Allowance: £60,000 for 2023/24 onwards. Total pension input across all schemes in the relevant pension input period cannot exceed AA without triggering an AA charge. Carry-forward of unused AA from the prior 3 years can lift the effective ceiling much higher. 2. MPAA: if you've ever drawn flexibly from a DC pension (UFPLS, flexi-access drawdown), your DC AA is capped at £10,000. The employer contribution counts against this. 3. Tapered AA: if your adjusted income exceeds £260,000 (2023/24+), AA tapers by £1 for every £2 above the threshold, down to a £10,000 floor. 4. Scheme rules: the receiving pension scheme must accept the employer contribution. Most modern workplace and personal pensions will; some legacy schemes won't.

    How it works

    Mechanics — payment direct to pension scheme

    The employer pays the contribution directly to the registered pension scheme (workplace or personal). The contribution is NOT routed through the employee's bank account first. PAYE is not operated on it. Employer NIC does not apply to employer pension contributions.

    Annual Allowance and carry-forward

    Standard AA is £60,000 (2023/24 onwards). If you have not used full AA in any of the prior 3 tax years — and were a pension scheme member in those years — you can carry forward the unused portion. Total contribution allowed in the current year = current AA + carried-forward unused AA. A £40k + £15k carry-forward + £20k carry-forward + £25k carry-forward gives £140k of headroom in the right circumstances.

    MPAA — the £10k trap

    Once you have triggered flexible DC drawdown (UFPLS, flexi-access drawdown beyond PCLS only), the MPAA caps DC contributions at £10,000 across all DC schemes per year — and removes carry-forward for DC contributions. A redundancy package routed to a DC pension can easily breach this. Defined-benefit accrual has its own alternative AA but is not usually relevant to a redundancy contribution.

    Tapered AA — high earners

    For tax years 2023/24 onwards: if threshold income (broadly all taxable income less personal pension contributions) > £200,000 AND adjusted income (broadly all taxable income + employer pension contributions) > £260,000, AA tapers down by £1 for every £2 of adjusted income above the threshold, to a £10,000 floor at £360,000 adjusted income. A redundancy bump to taxable income can push high earners into the taper.

    Comparison with cash above £30k

    £20k extra cash at 40% marginal rate: net ≈ £12,000. £20k as employer pension contribution: £20,000 in pension; if drawn at the same marginal rate later, net of 25% tax-free PCLS = £5,000 PCLS + £15,000 taxed at 40% = £5,000 + £9,000 = £14,000. Plus any investment growth in the pension over the deferral period.

    Who this applies to + key conditions

    Statute + manual references

    Primary: ITEPA 2003 s.308 — exemption for employer pension contributions to a registered pension scheme.

    Related: Finance Act 2004 Part 4 — registered pension schemes regime (Annual Allowance + MPAA + tapered AA); FA 2004 s.227-s.238A — Annual Allowance + carry-forward + tapering; FA 2004 s.227B-s.227F — Money Purchase Annual Allowance (MPAA); ITEPA 2003 s.401-416 — termination regime that does NOT capture properly-structured employer pension contributions

    HMRC manual: PTM (Pensions Tax Manual) — PTM050000 (Annual Allowance); PTM056500 (MPAA); EIM21080 (employer contributions)

    Common mistakes + traps

    Worked example

    Daniel, age 56, £120,000 salary, redundancy package £80,000 total, planning to retire at 60

    Daniel's employer offers: £20,000 statutory + enhanced redundancy ex-gratia; £15,000 PILON / PENP; £45,000 ex-gratia compensation for loss of office.

    1. Step 1 — Without restructuring: £15,000 PILON taxed as ordinary income; £65,000 within s.401 → £30k tax-free, £35k taxed at 40% (or partly 45% given his £120k salary already used basic + higher band). Roughly £35,000 × 40% = £14,000 tax. Net from s.401 slice ≈ £30,000 + £21,000 = £51,000.
    2. Step 2 — With pension restructure: Daniel asks employer to redirect £35,000 of the ex-gratia into his SIPP. Settlement: £15,000 PILON (PAYE), £30,000 ex-gratia (within s.401 £30k cap — tax-free), £35,000 employer pension contribution.
    3. Step 3 — AA check: Daniel's AA is £60,000 for 2025/26. He used £8,000 employee + £4,000 employer (workplace match) in 2025/26 = £12,000 used. He has £48,000 of current-year AA headroom + significant carry-forward from years before he was salary-sacrificing aggressively. £35,000 is well inside.
    4. Step 4 — MPAA check: Daniel has not drawn any DC pension yet. MPAA does not apply.
    5. Step 5 — Tapered AA: Daniel's adjusted income (£120k salary + £35k employer contribution + £15k PILON + £30k ex-gratia) = £200k. Below £260k threshold — no taper.
    6. Step 6 — Net result: £30,000 ex-gratia tax-free + £35,000 in pension (drawable from age 57 minimum pension age, 25% PCLS tax-free). PILON £15k taxed normally.
    7. Step 7 — Compared to step 1, Daniel has converted ~£14,000 of income tax into a £35,000 pension pot (vs £21,000 net cash). Significant tax efficiency given his 4-year horizon to draw.

    Outcome: Daniel's pension-routed structure saves ~£14,000 of immediate income tax and adds £35,000 to retirement savings (drawable shortly with 25% PCLS tax-free). Materially better than the all-cash structure.

    How this connects to the rest of the framework

    Settlement agreements →

    Settlement agreement should include a specific pension contribution line item with the receiving scheme identified.

    £30k exemption mechanics →

    Employer pension contribution sits OUTSIDE the s.401 regime entirely — preserves the full £30k exemption for the residual ex-gratia.

    Scenarios — 8 cases →

    Senior-nearing-retirement scenario shows full pension-routed structure.

    Frequently asked questions

    What happens if I miss the Self Assessment deadline?+
    The Self Assessment deadline is 31 January (online filing) for the previous tax year. Miss it and HMRC apply an automatic £100 penalty. Beyond that: £10 per day from 3 months late (capped at £900), 5% of tax due at 6 months late, and another 5% at 12 months late, under Schedule 55 of the Taxes Management Act 1970. If you have a genuine reason (serious illness, bereavement, technical issue with HMRC's systems) you can appeal with evidence; HMRC accepts reasonable excuse appeals in most genuine cases.
    Do I need an accountant or can I file Self Assessment myself?+
    Legally you can file Self Assessment yourself via gov.uk for free, most simple sole-trader returns (single income source, basic expenses) are realistic to self-file. An accountant adds real value when: your trading profit is above £40,000 (extraction-strategy decisions matter), you have multiple income streams (PAYE + self-employment + property + dividends), you've crossed the £90,000 VAT threshold, you're considering incorporation, or you have an HMRC enquiry. Expect to pay £400-£1,500/year for a typical sole-trader accountant; the cost is itself a deductible expense.
    How do payments on account work?+
    When your Self Assessment tax bill exceeds £1,000 for the first time, HMRC requires payments on account toward NEXT year's tax. Half the current bill is due 31 January (alongside the current bill); the other half is due 31 July. So your first January after crossing the threshold can hit with a double-bill: last year's balance + first payment on account. Adjust via Form SA303 if you expect next year's income to drop substantially. Payments on account don't apply if more than 80% of your tax is collected via PAYE.
    Does the employer save NIC?+
    Yes — employer NIC does not apply to employer pension contributions, in contrast to cash above the £30k cap which attracts Class 1A NIC. Employers often share part of the saving with the employee in the structure.
    Can I route into a SIPP rather than my workplace pension?+
    Yes, provided the SIPP is a UK registered pension scheme and the trust deed accepts third-party contributions. Most modern SIPPs do.
    What if I exceed AA?+
    An AA charge arises on the excess at your marginal rate — wiping out the tax saving. Always run AA + carry-forward + MPAA before agreeing the structure.
    Can the employer just give me cash and I contribute?+
    You can, but the outcome differs — your personal contribution gives you basic-rate relief at source plus higher-rate relief via SA, but the employer NIC and Class 1A position is worse. Routing as employer contribution direct is usually better.

    Free + regulated-body resources

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