Paying Redundancy Payments into Pension: Managing Change Responsibly

Workforce reductions are never easy. And employee redundancy can be an emotional and financial turning point for employees and employers have a duty to manage the process with care. One way to support employees during this transition is by helping them make the most of their redundancy entitlements. 

A key question many employers face is: can employees redirect their redundancy payments into pensions and if so, how can this process be managed?

Download the guide to discover:

• Benefits of paying redundancy payments into a pension
• A checklist for managing redundancy and pension contributions
• Compliance and legal considerations
• Important deadlines
• Sample payroll instruction sheet
• Glossary of key terms

Can redundancy payments be used to boost an employee’s pension savings?

Yes, severance payments can often be paid into a pension as a way of helping employees maximise their savings and reduce tax liabilities. The opportunity exists because severance pay is treated differently for tax purposes compared to regular salary.

• Tax-free portion: The first £30,000 of a genuine redundancy payment is free of income tax. This creates a chance to contribute more into pensions without immediate tax charges.
• Above £30,000: Any redundancy amount above this threshold is subject to income tax and National Insurance in the normal way. Employees may still choose to contribute some or all of this taxed portion into their pension if they wish.

Employers can play an active role in making the process smooth by liaising with payroll and pension providers, ensuring contributions are handled compliantly.

How much of a redundancy payment counts towards pension contributions?

When considering how much of statutory redundancy payments into pension contributions, there are several rules to keep in mind:

• The £30,000 exemption: Only the first £30,000 of redundancy pay is exempt from income tax. Employees may contribute this exempt portion into their pension, but pension contribution limits still apply.
• Annual allowance: The standard annual allowance for pension contributions is £60,000 (2025/26). Contributions above this may trigger tax charges unless unused allowances from the previous three tax years are carried forward.
• Relevant earnings: Normally, pension contributions cannot exceed 100% of an employee’s “relevant earnings” for the year. However, redundancy pay does not count as relevant earnings for personal contributions. This makes employer contributions, or salary sacrifice arrangements, particularly important in this context.

For employers, understanding the interaction between severance pay, pensions and tax allowances ensures employees do not miss valuable opportunities.

Calculating relevant earnings from redundancy payments

To clarify the rules, here are two practical examples:

• Example 1 – Employee with salary and redundancy pay
  Emma earns £40,000 per year and is made redundant with a £50,000 package. Only her salary (£40,000) counts as relevant earnings for personal contributions. This means she could personally contribute up to £40,000 into her pension, even though her redundancy package is larger.

• Example 2 – Employer contributions
  James earns £25,000 and receives £35,000 redundancy pay. His relevant earnings for personal contributions are £25,000. However, his employer can contribute some or all of his redundancy package directly into his pension, subject to the annual allowance of £60,000. This allows James to shelter more of his redundancy payment from tax.

This distinction, between personal and employer contributions, is critical for managing redundancy payments effectively.

How to process redundancy payments into pension savings

From an employer’s perspective, processing redundancy payments into pensions requires coordination between payroll and pension providers. The steps generally include:

1. Employee election – The employee confirms in writing how much of their redundancy payment they wish to direct into their pension.
2. Payroll processing – Payroll must classify whether the contribution is employer-funded, employee (personal) or via salary sacrifice.
3. Tax treatment – Ensure that only contributions within the £30,000 tax-free limit are exempt. Any excess should be taxed correctly before being paid into a pension.
4. Pension provider notification – Notify the pension provider of the contribution type (regular, additional, or employer one-off).
5. Record keeping – Maintain detailed records of the redundancy calculation, pension contribution amounts and tax treatment for HMRC compliance.

Employers who clearly communicate these steps help employees make informed financial decisions while maintaining compliance.

Can employees’ salary sacrifice their redundancy payment?

In certain cases, employees may use salary sacrifice arrangements to redirect redundancy payments into pensions. This can be advantageous because:

• Tax and (National Insurance) NI savings – Contributions via salary sacrifice reduce taxable income and National Insurance liabilities.
• Employer flexibility – Employers can agree to enhance the pension contribution in lieu of cash payments, maximising the employee’s financial benefit.
• Compliance caveats – HMRC has restrictions on salary sacrifice for termination payments. Employers should seek professional advice before offering this option.

In practice, not all redundancy elements are eligible for salary sacrifice and arrangements must be set up before termination is finalised. Clear communication with employees and proper payroll processing is essential.

What compliance issues should employers watch out for?

Managing redundancy responsibly means paying close attention to compliance requirements. Key issues include:

Understanding tax compliance – Clarify tax treatment and reporting obligations.

• Reporting obligations – Redundancy payments over £30,000 must be reported via payroll and taxed accordingly.
• National Insurance – Employer NI contributions are due on termination payments above £30,000.
• Pension reporting – Pension submission contributions must be recorded accurately, with clear separation between employee and employer contributions.

Mistakes in reporting can lead to penalties, backdated liabilities and reputational risks.

Supporting employees through redundancy responsibly

Redundancy is more than a financial transaction, it’s a moment of uncertainty for employees. Employers who approach it responsibly can support staff wellbeing while safeguarding their employer brand.

Practical support includes:

• Financial guidance – Offering access to financial education, counselling, or independent financial advice can help employees decide how to use their redundancy package.
• Clear communication – Transparent communication about options, timelines and processes reduces anxiety.
• Wellbeing support – Providing access to mental health resources, employee assistance programmes, or career transition services demonstrates empathy and care.

Ultimately, helping employees understand how redundancy payments can strengthen long-term retirement savings is one of the most responsible steps employers can take.

Download the full guide

Redirecting redundancy payments into pension savings is a valuable opportunity for employees, but only if employers manage the process correctly. From calculating relevant earnings to handling compliance, each step requires careful attention.

By acting responsibly, employers can support employees’ financial security during redundancy while also reducing tax inefficiencies.