£35,000 Redundancy Payment: How to Split It Between an ISA and a Pension (2026/27)

The Starting Point: How £35,000 of Redundancy Pay Is Taxed

Genuine redundancy payments — the compensation element specifically for loss of employment, not notice pay, holiday pay or other contractual entitlements which are taxed as normal salary — benefit from a tax-free exemption on the first £30,000. Anything above that is added to the employee's income for the year and taxed at their marginal rate.

Case study: Josh, a basic-rate taxpayer earning £34,000/year, is made redundant in July 2026 and receives a £35,000 redundancy payment (confirmed by his employer as the genuine compensation element).

In Josh's case, because his total income for the year remains within the basic rate band even after adding the £5,000, the excess is taxed at 20%, costing him £1,000. If Josh had a higher salary or the redundancy pushed his total income into the higher-rate band, more of that £5,000 could be taxed at 40%.

Option 1: Take the Full £35,000 as Cash

This is the simplest option and gives Josh full access to the money, useful if he needs it for living costs during a job search. But it leaves £1,000 on the table in tax that could potentially have been avoided.

Option 2: Redirect the £5,000 Excess Into a Pension

Many employers, particularly when a redundancy is handled via a settlement agreement, will allow some or all of the payment above £30,000 to be paid directly into the employee's pension as an employer contribution rather than as cash. Because employer pension contributions are not treated as the employee's taxable income, this avoids the income tax charge on that portion entirely.

By having the employer pay the £5,000 excess directly into his pension rather than as salary, Josh avoids the £1,000 tax charge entirely, and the full £5,000 lands in his pension rather than a reduced £4,000 after tax. This route depends on the employer agreeing to structure the payment this way — it's a common negotiating point in settlement agreements and worth raising during redundancy discussions.

Where Should the £30,000 Tax-Free Portion Go?

This is the bigger practical decision for most people, and it comes down to accessibility versus tax efficiency.

Suggested split for Josh (illustrative, not advice): Given he expects to find new work within a few months but wants some resilience, Josh could keep £15,000 as an accessible cash/Cash ISA buffer, put £15,000 into a Stocks & Shares ISA for medium-term goals (using this year's and, if timed around the tax year boundary, part of next year's £20,000 allowance), and make a £5,000 personal pension contribution using money he doesn't expect to need soon.

A £5,000 personal pension contribution from Josh, a basic-rate taxpayer, would attract 20% relief added automatically by the pension provider — turning his £5,000 net contribution into £6,250 in the pension. This is a separate benefit from the employer-contribution route described above and applies when the employee personally chooses to invest already-received (and, on the excess portion, already-taxed) redundancy money into a pension.

Checking the Numbers Fit Within Allowances

Because Josh's numbers are modest relative to both allowances, there's no risk of an Annual Allowance charge or excess ISA subscription. Larger redundancy payments — for senior employees or long-service payouts running into six figures — need more careful sequencing across tax years to stay within the £20,000 ISA and £60,000 pension limits.

Practical Takeaways

1. Confirm with your employer (or former employer) exactly how much of the payment is genuine redundancy compensation versus notice pay or holiday pay, since only the compensation element gets the £30,000 exemption.
2. Ask whether any excess above £30,000 can be paid as an employer pension contribution rather than cash — this is a straightforward way to avoid an unnecessary tax charge.
3. Prioritise an accessible cash or ISA buffer first if reemployment isn't guaranteed, before locking money into a pension.
4. Use the
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   Project ISA savings growth over time with the UK £20,000 annual allowance.

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   and
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   Estimate your pension pot at retirement and projected annual income.

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   together to compare how the same money might grow in each wrapper over your expected timeframe.
5. Check Annual Allowance headroom before making a large pension contribution, especially if you've already had employer contributions earlier in the same tax year.