I’m being made redundant – can I include my pay in my pension to reduce taxes?

I am going to be made redundant and will receive severance pay of around £80,000.

I know that the first £30,000 is tax-free. Can I put the rest into a pension to save the amount of tax I pay?

If so, could I also receive a lump sum of 25 percent of this amount when I turn 55? I am currently 52 years old and a taxpayer at the 40 percent rate. DM by email

SCROLL DOWN TO LEARN HOW TO ASK HIS FINANCIAL PLANNING QUESTION

This is Money’s Harvey Dorset responds: The answer to both questions is simply yes.

If you can afford it, especially if you can find a new job without much delay, then saving your severance pay instead of spending it is a smart move.

Putting it into your pension will allow you to feel the benefits of the Government’s tax cuts, as well as benefit from the growth of your pension pot for years to come.

However, if you’re hoping to withdraw a lump sum in three years, choosing an alternative savings product for some of that money could be a better option and earn you higher returns. Financial adviser Andrew Smith explains in more detail below.

However, if you think you’re likely to find it difficult to find a new job, it’s important to make sure you can use some of your severance package as a buffer during the time you’re out of work.

This is Money spoke to two financial advisers to find out what you need to consider before committing your redundancy package to your pension.

Dominic Tryczynski, Private Client Advisor at HFMC Wealth, answers: Being made redundant can be a stressful life event or a golden opportunity depending on your circumstances. The payment you receive is designed to soften the blow and help you cover expenses while you look for work.

Don’t rush: Dominic Tryczynski recommends taking the time to work out how much money you need before committing it to your pension

The first £30,000 is usually tax-free, but any part of a lump sum severance payment that comes from salary, notice pay or holiday pay is taxed as employment income. Your employer should be able to confirm how this is broken down in your redundancy offer.

Your questions about pensions are easy to answer in isolation.

• Yes, you could put the taxable part of the payment into a pension to save tax, if you have enough annual allowance left.

This may include unused allowance from the previous three tax years. It may also be possible for your employer to make the contribution for you through salary sacrifice, which could also save you money on National Insurance.

• Yes, you could withdraw 25 per cent of this as a tax-free pension lump sum at age 55. The remainder would be taxed at your marginal income tax rate when you choose to withdraw it.

But there are other things to consider and you need to weigh the tax benefits against your immediate needs.

To do this, it is necessary to ask some questions:

• What are my current expenses and who depends on my income?

• Am I going to continue working after this?

• What is the job market like in my industry right now?

• Are you likely to get a job with the same salary or could you end up earning more or much less?

• Do I have enough cash to cover my expenses for the next 12 months (or longer depending on some of the answers above)?

This should give you a good idea of ​​whether you might need this money before you turn 55. If so, putting it into a pension might not be a good idea as you won’t be able to access it before then.

However, if the taxable funds are not needed elsewhere, contributing to a pension could be a great way to save tax and plan for your long-term future.

A pension contribution would receive 20 per cent tax relief up front, meaning a £50,000 payment would increase to £62,500 with tax relief.

You could also potentially claim back some of the tax at a higher rate, as well as getting back your personal allowance and child benefit payments if you had lost them due to your high income.

There is no need to rush into making this decision.

It may take a while before you can determine whether these funds are needed in the short or medium term, and putting the money into a pension fund will reduce your options as you won’t be able to withdraw it until you reach age 55.

You have until 5 April 2025 to make pension contributions (and receive tax relief) for the current tax year, and you can currently carry over any unused annual allowance into the following three tax years.

However, it is worth noting that you will lose the ability to make salary sacrifices on the initial payment if you delay the decision, as this must be done at the time you receive the redundancy payment.

If you made a contribution in a future tax year, you will need to have a sufficient annual allowance and “relevant income” – that is, earned and taxed income – in that tax year. If you don’t work again, you will be limited to contributing £3,600 per year.

Pensions are a great long-term planning tool that can reduce the taxes you pay and leave you better off in the long run. But when you’re in the middle of a big life change, such as a redundancy, you need to weigh the immediate tax advantages against the flexibility that cash gives you.

Sometimes, doing nothing (at least for now) is a perfectly legitimate strategy.

Long term: Andrew Smith says a fixed-rate savings account could provide better returns in five years

Andrew Smith, Independent Financial Advisor at Flying Colours, answers: First of all, I am sorry to hear that you are being made redundant. It is certainly a stressful time, but I hope that it can offer new and exciting opportunities for the future.

You are right to recognise that the first £30,000 of a severance pay is tax-free. Anything above that amount is taxed at the marginal rate of income tax, whether 20%, 40% or 45%.

To reduce the tax burden on this, as you say, one could potentially put some or all of this into a personal or defined contribution pension system.

However, you should check that the pension fund can accept additional contributions and that it has the necessary subsidies to do so.

Annual pensions are capped each year at the maximum of an individual’s earnings or up to £60,000 if annual gross earnings are higher than this.

There are some circumstances where “carrying over” can increase your annual allowance. “Carrying over” involves using unused allowances from the previous three tax years, once the maximum has been reached within the current tax year.

There are also some circumstances where you may have a reduced annual allowance. Perhaps you have a particularly high income or have activated what is called a ‘money purchase annual allowance’, but this would only apply if you have already started using your pensions.

You will also need to consider what gross pension contributions have been made during the current tax year, as these will need to be included in any calculations.

As you can see, your annual allowance depends on a number of factors. It’s important that you can accurately estimate what your allowance will be, so as not to create a tax liability and undo all the effort you’ve put into saving for your retirement.

By doing the proper research yourself or seeking advice in this area, you will be able to determine whether you can contribute the full £50,000 into a pension to benefit from the tax relief it could bring.

You’re also right about accessing 25 per cent of your pension as tax-free cash, although in some cases it can be more, so it’s worth checking.

You should be able to take it at age 55 (until age 57 on April 6, 2028) depending on the details of the pension plan.

However, before you withdraw the tax-free money, keep in mind that it is advisable to invest for the long term (at least five years). If you know you will need the funds in the next three years, investing them in your pension may not be the best option.

This is due to market movements, which could mean that your funds do not increase in value over this short period of time. Instead, you may want to consider placing the funds in a fixed-rate savings account.

It’s also worth noting that immediately withdrawing 25 percent of your tax-free cash is often not the best way to ensure the longevity of your pension.

Once that money has been used, it is gone forever. In the long term, it may be better to keep the funds within your pension, where they can grow and have a better chance of lasting throughout your retirement.