Voluntary Severance payment into pension fund?

J._Jones · 7 April 2018 at 4:26PM

I'm currently discussing leaving my employer which offers a Voluntary Severance/Early Retirement scheme whereby I'd get a decent cash sum to go. As I'm nearly 55, have a wife in a well-paid job she really enjoys and we also have investment income, I'm intending that this will effectively be me stopping work. So, as I'll shortly be legally entitled, I'm going to start drawing a reduced pension from the occupational scheme of around £15,000 p.a. as things currently stand.

Uncertainty has arisen, however, about what to do with the VS/ER payment which in my case is likely to be in the region of £43,000. Now I'd been assuming that most of this could be paid straight by my employer into the occupational scheme so as to off-set the actuarial reductions that will be applied because I'm starting to draw the pension from 55. This would, I hope, raise the current £15,000 annual pension by perhaps another couple of thousand. But a conversation with the employer's pensions officer has sowed serious doubt in my mind. She confirmed that such a payment to the scheme was possible but advised me strongly against asking for the severance payout to be made in this form. She told me that such a payment would be fully taxed at my marginal rate if it went to the pension fund whereas if I received it personally the first £30,000 of the £43,000 would be taxed at my marginal (40%) rate. I already knew about this £30,000 tax-free allowance for severance payments taken by departing employees, of course, but the idea that there would be 40% tax on any of the £43,000 if it went instead into my pension fund was news to me and very unsettling.

Are there any experts out there, or people who've been through this situation of deciding what to do with a significant lump sum on severance or early retirement, who have any thoughts about whether my employer's pensions officer (not the most impressive individual if I'm honest) was correct and was giving me accurate information? (I did ask her to repeat what she said, and she willingly did, so this wasn't just me mis-hearing or getting the wrong end of the stick.)

As you'll gather, I've got my doubts. I can find nothing online that suggests all of a severance payment would be taxed at 40% if it went straight to the pension fund. In fact all I can see is information about a £40,000 annual contributions limit before any tax becomes payable. This suggests that, contrary to what she told me, I ought to be able to take £3,000 in cash personally and leave the rest of my severance payment to be paid by the employer tax-free into the occupational scheme.

Thanks in advance.

Linton · 7 April 2018 at 4:54PM

For Redundancy, voluntary or otherwise....

The first £30K is tax free and isnt earned income. Anything beyond that is taxable in the current tax year so could put you into a higher tax band. It is counted as earned income in the current tax year for the purposes of pension contributions. You could pay the pension contribution either (probably) before tax through the employers scheme or after tax as a private pension contribution. The advantage of the latter is that you can contribute all your gross income (-20% to make it a net payment) and get tax relief on the amount covered by your tax allowance even though you didnt pay tax on it.

So in general it makes sense not to contribute the first £30K but contribute as much of the rest as you can. You will be limited by the £40K with carry forward total annual contribution limit.

If its not classed as redundancy the rules are probably different, I dont know.

ermine · 7 April 2018 at 5:02PM

the first £30k of a redundancy payment is tax free. As for paying the rest into your pension - that worked fine for me. I saved 40% tax and got it out tax free (by spreading the payment out under the personal allowance over time).

Do you earn more than £100k? Have you paid more than £40k into your pension in the year the redundancy payment is due? If the latter, do you have unused pension contributions from the last three years to carry forward?

Taking the £30k tax free rather than putting it through your pension seems a good way because you don't put tax-free money into a potentially taxable wrapper, but the excess into the pension looks a good way to go, and I can't see why the pensions officer say you'll be taxed at 40%, unless when you take the pension it will be more than the annual higher-rate tax threshold, in which case yes, they are right.

Brynsam · 7 April 2018 at 6:28PM

J._Jones wrote: »

Uncertainty has arisen, however, about what to do with the VS/ER payment which in my case is likely to be in the region of £43,000. Now I'd been assuming that most of this could be paid straight by my employer into the occupational scheme so as to off-set the actuarial reductions that will be applied because I'm starting to draw the pension from 55. This would, I hope, raise the current £15,000 annual pension by perhaps another couple of thousand.

You're being very optimistic if you are only 55 and think 'most of £43,000' would raise your annual pension by another couple of thousand. Get a quote from the scheme before deciding anything - less than half that is likely to be nearer the mark.

J._Jones · 7 April 2018 at 8:30PM

1) Thank you Linton. Very helpful.
2) Ermine: I earn £55k so am in no danger of already getting anywhere close to the £40K annual tax-free pension contribution limit.
3) Brynsam: You raise a key question I've been pondering but didn't ask here. My scheme's online pension modellers unfortunately offer no clues on this matter so I simply took "perhaps another couple of thousand" as a very rough ball-park figure because that's what I know I can get if I decided to take the payment personally and add it to our existing private investments. About 4% is my annualised return over two decades and more. So if you're correct and my scheme's quote on what they can give me for (say) £43,000 is, as you reckon, not even a grand, then this will end my quandary straightaway and I'll simply take the severance payment and invest it myself.

greenglide · 7 April 2018 at 11:02PM

and I'll simply take the severance payment and invest it myself

Surely you do what most others do and take the £30,000 tax free and have the rest paid into the pension.

What happens to it in the pension scheme depends on whether it is a DC or a DB scheme and the pension scheme rules.

Kynthia · 8 April 2018 at 8:47AM

J._Jones wrote: »

1) Thank you Linton. Very helpful.
2) Ermine: I earn £55k so am in no danger of already getting anywhere close to the £40K annual tax-free pension contribution limit.
3) Brynsam: You raise a key question I've been pondering but didn't ask here. My scheme's online pension modellers unfortunately offer no clues on this matter so I simply took "perhaps another couple of thousand" as a very rough ball-park figure because that's what I know I can get if I decided to take the payment personally and add it to our existing private investments. About 4% is my annualised return over two decades and more. So if you're correct and my scheme's quote on what they can give me for (say) £43,000 is, as you reckon, not even a grand, then this will end my quandary straightaway and I'll simply take the severance payment and invest it myself.

You say you earn £55k but how much will you earn this year if you stop working part-way through the year? Plus I believe only the redundancy exceeding £30k will count as earned income towards the max amount you can contribute to a pension with tax relief. So if you are made redundant very early in the year it's possible putting the whole redundancy payment in could mean you exceed the earned income limit.

J._Jones · 8 April 2018 at 12:09PM

greenglide: Thanks. Yes, if the return on capital added to the pension fund is as low as Brynsam suggests, then there's no serious decision to take.

Kynthia: Thanks. I should be at around £20k in salary by the point in this new tax year when I'll probably stop work.

I'm reluctantly coming to the conclusion that I'm going to need to pay for some professional advice. There are too many variables in play and too many parts of the taxation and pension regimes that interact with each other for me (especially with my scheme's impenetrable rulebook seemingly designed to stop members understanding their options clearly) to feel I'm fully in command of all of the significant details.

There's an argument that when someone with a Ph.D. in a numerate subject plus part-qualification as an accountant (in the distant past!) isn't confident of working his retirement finances all out for himself the system has become a tad too complex and the official sources of information are in serious need of a re-write to improve clarity.

Brynsam · 8 April 2018 at 1:18PM

J._Jones wrote: »

There's an argument that when someone with a Ph.D. in a numerate subject plus part-qualification as an accountant (in the distant past!) isn't confident of working his retirement finances all out for himself the system has become a tad too complex and the official sources of information are in serious need of a re-write to improve clarity.

That happened in 2006 when we had pensions simplification - since when the morass which is pensions has become complex beyond belief!

Brynsam · 8 April 2018 at 1:21PM

Kynthia wrote: »

You say you earn £55k but how much will you earn this year if you stop working part-way through the year? Plus I believe only the redundancy exceeding £30k will count as earned income towards the max amount you can contribute to a pension with tax relief. So if you are made redundant very early in the year it's possible putting the whole redundancy payment in could mean you exceed the earned income limit.

This is a DB scheme (the reference by OP to 'actuarial reduction' tells us that). If part of the severance payment is paid direct by the employer to the pension scheme it counts as an employer contribution, so OP's earnings are not relevant in this case.

J._Jones · 8 April 2018 at 2:52PM

Erm, yes, Brynsam. But again it's more complicated than that, hence my weary feeling that a professional advisor may be my only way forward with real confidence.

My pension scheme, like some others, has been on a journey during my time as a contributor from traditional DB based on final salary to DB based on career average and in the last few years on to DC (though with two different strands either side of a salary cap, in both of which I'm now involved, and with yet another change to the DC element currently in the offing which, thank you God, yours truly should miss). The result is that my eventual pension is going to be made of up multiple tranches operating under completely different rules. And so while you're correct that "actuarial reduction" refers to a DB entitlement the exact mechanism by which a lump sum paid in at the point of severance would boost my pension is actually unclear: whether it would be used directly to ameliorate the reduction in the DB element or simply buy me additional DC benefits to off-set the DB reduction is anybody's guess (and the totally-opaque literature provided by the scheme sheds no light at all on this as on so much else).

Worse, I've already shared with you my grave doubts about the elementary competence of the advice coming from my employer's pensions officer. But I've also just had to get a second initial benefits quote from the scheme because the first one contained a substantial arithmetical error which I spotted immediately but which neither the scheme's professional team nor our own pensions officer noticed!

This is why, with a heavy heart, I think I'm going to have to pay someone with more day-to-day experience of this complex area to bring together all the relevant information and lay out my options more clearly.

Voluntary Severance payment into pension fund?

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