Are pension payments and settlement agreements tax free?
Pension payments in settlement agreements can be tax free and therefore worth considering if you are getting over £30,000 from your employer. In this article we explore how to pay a lump sum of money into your pension scheme as part of your settlement agreement deal, and the types of practical issues you need to consider.
If you want to find out how much you should get for your settlement agreement, try our Settlement Agreement Calculator.
You are probably already aware that the first £30,000 ‘ex gratia‘ payment is normally tax free, above which the balance will be subjected to income tax and NI deductions just like a salary. You may also find that you can’t pay more than a £50,000 lump sum into the pension scheme in total for this tax break to be applicable so check how much you’ve paid in already.
Every pension scheme is different, and we would advise that you contact your specific pension provider to ask them what their rules are on paying in tax free lump sums. One common feature across all providers is that if you have a settlement agreement in place, you are normally allowed to pay in a lump sum tax free. You can then draw this money down during your retirement in instalments in the usual way. This is particularly useful if you are nearing retirement age (and your settlement agreement settlement amount is over £30,000 in the first place).
Top 3 tips
- Payments into your pension under a settlement agreement are not taxable
- This will be locked in to your pension until you’re older
- You can only draw it down in instalments
Pension settlement agreement case study
One complex case which we did involved negotiating a settlement agreement for a client who was nearing retirement age and was part of a government backed pension scheme. He was receiving over £30,000 from his (soon to be ex) employer, and wanted as much of it to be tax free as possible. Could we help him pay a lump sum of money into his pension scheme tax free?
Firstly we contacted the scheme and it transpired that they had a calculator to tell you exactly how much you could put in and how much you could get out. Our client was able to pay in around £20,000 in return for a monthly payout increase of £1,250. The next highest increment was more than our client was to receive, so he paid in the most he possibly could.
In the end he received around £32,000 ex gratia as well as £21,000 into his pension, and around £1,500 was paid directly to Monaco Solicitors as his representatives, based on a small percentage of the deal which we negotiated for him, so that £1,500 was tax free for him. Thus he only paid tax on the £2,000 of the ex gratia payment above the £30k tax free limit.
The pension scheme required a letter or a form to be filled out by the employer confirming that our client was still in pensionable employment. This means that it was crucial to ensure that the ‘EDT’, or ‘effective date of termination’ of employment, was after the date when the lump sum would be paid to the pension scheme. Given that in settlement agreement situations, the EDT is normally prior to the payout of lump sums, this point required some negotiating and working closely with the employer.
In the end we agreed to extend the EDT to around 21 days after the last day of being salaried, by changing the employment contract to a zero hours contract.
In other cases the employer organises the payment direct to the pension provider and there is no need to go through complicated application forms or worry about date of termination of employment.