Talk yourself into a good retirement deal

Sir Fred Goodwin, the former head of Royal Bank of Scotland, has been criticised for walking away from his struggling company with a £16.9m pension pot that will pay him close to £700,000 a year for the rest of his life.

But the payout was achieved as part of a legal severance package agreed between Sir Fred and his company and highlights how many people can negotiate such agreements for themselves – albeit at considerably lower levels.

As businesses seek to cut costs, anyone thinking about taking voluntary redundancy should be aware that they can often negotiate a good pension deal with their employer, experts say.

Often, this can actually increase the size of the redundancy payout. If some of the severance payment is paid into the pension, higher rate taxpayers can get a further 40 per cent tax relief.

“If you’re being made redundant, it’s quite common for a batch of your redundancy money to be diverted into a pension scheme to secure you some additional benefits,” says Alan Smith, an actuary at First Actuarial.

However, it often only makes sense to divert redundancy money into a pension scheme for larger sums.

The first £30,000 of any redundancy payout is paid free of tax, meaning it would not benefit from tax relief if it were paid into the pension.

How an employer pays into a pension scheme for its departing employees depends on the type of scheme.

Defined benefit – also called final salary – schemes pay a pension based on a proportion of a person’s final salary upon leaving the company.

The pension for those who retire before the normal retirement age is usually based on a lower percentage of final salary, to reflect the fact that they will be making fewer contributions and that the income will be paid to them for a longer period.

But employers can offer not to make this reduction in income, as a sweetener for people taking voluntary redundancy. “It’s not atypical that you might have a provision that says under certain types of early retirement, say redundancy, you may waive that reduction,” says Raj Mody, a partner at PricewaterhouseCoopers.

This was common in the 1980s and early 1990s, say actuaries, but is not as common now as schemes have fallen into deficit. Sir Fred managed to secure this deal, but most people will have to check first with their scheme.

Because a pension is based on a legal contract, every scheme will differ in exactly how it treats its employees.

Senior executives may also have individualised non-standard employment contracts, with details of extra pension benefits included.

Some defined benefit schemes have it contractually written in that a “good leaver” – someone departing voluntarily – should receive better terms than a “bad leaver”, according to Mick Calvert at Watson Wyatt.

Such differences in rules explain why Sir Fred is to receive a pension of £703,000, rather than the £416,000 a year he would have received if he had been fired.

But often, pension scheme rules on redundancy payouts are not set in stone – so there is room for negotiation.

Mody says many schemes have not updated their rules to reflect shifts in the way people work, such as flexible working or phased retirement.

“Many rules have been around for decades and don’t pin down what happens under every single event. There’s a whole host of modern day working practices that may not be reflected,” he explains.

“In individual cases, there is scope to negotiate if there were circumstances that weren’t envisaged.”

Such a negotiation could also include how much money would be paid to one’s spouse on death – typically this is 50 per cent of a defined benefit pension, but it could be higher.

Employers using a defined benefit scheme may even find it is more cost-efficient for them to pay into a person’s pension rather than give them a lump sum as severance.

The employer would only have to pay back the pension scheme over a number of years, rather than all at once, meaning it could defer payments until the economy improves.

There are also ways to pay more into a defined contribution scheme. While annual contributions into a pension are capped at £235,000, this cap is removed in the year a person retires. So those on very high earnings could ask their employers to put more into their pensions. “The employer could make a one- off top-up contribution into your pension if they’re feeling benign,” says Tom McPhail at Hargreaves Lansdown. This would make sense for those likely to receive large bonuses when they leave a company.

“If they wanted to give you a bonus to pay you off, they could put it in your pension fund if it’s the year you’re retiring – and you could take 25 per cent out as a tax-free sum,” he adds.

Except for those deemed to be in “special occupations” – such as footballers or wrestlers – people cannot withdraw pension benefits until they are 50.

And from next year, this will go up to 55, so those under 55 should be aware that if they take redundancy, they might not be able to access their pension until later than they had realised.

Savers should also bear in mind that if they are retiring this year, it is their last chance to claim tax relief on pension contributions. The maximum contribution with tax relief for people who are not working is just £3,600.

Employers can also pay into a self-invested personal pension (Sipp) when an employee leaves, though Calvert says this is easier if the employer already operates a Sipp. Otherwise, the money is paid to the employee net of tax, then the employee pays it into the Sipp and claims the tax relief – which is tax- neutral, but more time-consuming.