The default position
Whether pension contributions are paid on PILON depends on three things in order:
- The pension scheme rules. Occupational pension schemes define what counts as pensionable pay. Most schemes tie pension contributions to basic pay in the notice period; some extend to bonuses and PILON, some do not.
- The employment contract. The PILON clause usually specifies what elements are included in the payment - basic pay only, or basic pay plus a defined pension contribution.
- The termination agreement. A settlement agreement can override the default and specify pension treatment explicitly.
In practice, contractual PILON on basic pay carries pension contributions for auto-enrolled workers; ex gratia PILON as part of a settlement usually does not, unless negotiated in.
Contractual vs non-contractual PILON
Contractual PILON (the employment contract contains a PILON clause the employer chooses to exercise) is treated as earnings from employment. Pension contributions on basic pay usually apply for auto-enrolled workers because PILON on basic pay is a contractual entitlement earned under the contract.
Non-contractual PILON (no PILON clause; the employer pays a lump sum instead of requiring the employee to work notice) is a breach of contract compensated by damages. Damages historically escaped pension contributions because they were not earnings. Since April 2018 the PENP tax treatment aligns non-contractual PILON with contractual PILON for income tax and National Insurance, but pension scheme rules typically still treat it as non-pensionable.
Worked example - contractual PILON with pension
An employee earning £60,000 gross basic pay is on 3 months contractual notice. The employer exercises the PILON clause and pays the notice as a lump sum. Employer pension contribution is 8 per cent, employee auto-enrolment contribution is 5 per cent.
| Item | Amount |
|---|---|
| Basic pay for 3 months | £15,000 |
| Employer pension contribution (8%) | £1,200 (paid into scheme, not to employee) |
| Employee pension contribution (5%) | £750 (deducted, paid into scheme) |
| Gross PILON paid to employee | £15,000 |
| Employee pension deduction | -£750 |
| Taxable pay for PILON | £15,000 (full amount, PENP applies) |
| Income tax (40%) | -£6,000 |
| Employee NI (2%) | -£300 |
| Net cash to employee | £7,950 |
Notice the employer's £1,200 contribution flows straight into the pension scheme, not to the employee - and is not part of the taxable PILON figure. Use the PILON calculator to model your own numbers.
Worked example - non-contractual PILON with no pension
Same employee, same £60,000 salary, same 3 months notice, but no PILON clause. The employer terminates by mutual agreement and pays a settlement of £15,000 for the lost notice period.
| Item | Amount |
|---|---|
| Settlement payment for lost notice | £15,000 |
| Employer pension contribution | £0 (non-pensionable under most schemes) |
| Employee pension contribution | £0 |
| PENP applies - taxed as earnings | £15,000 |
| Income tax (40%) | -£6,000 |
| Employee NI (2%) | -£300 |
| Net cash to employee | £8,700 |
Higher net cash to the employee (£8,700 vs £7,950) because no pension deduction. But zero pension top-up, so the total value (cash + pension) is lower (£8,700 vs £9,900 including the £1,200 employer contribution and £750 employee contribution flowing into the scheme).
Salary sacrifice pensions
Where the employee is in a salary sacrifice pension arrangement, the mechanics differ:
- The employee's salary is contractually reduced by the sacrifice amount.
- The employer pays the sacrificed amount plus its own contribution into the pension.
- PILON on the post-sacrifice salary is smaller (because the base is smaller).
- The employer may agree to pay the sacrifice amount into the scheme as part of PILON, or may pay it as cash.
Salary sacrifice can be very tax-efficient at termination if the employer agrees to route the PILON element into the pension scheme instead of paying it as cash - the pension contribution avoids income tax and NI on that portion. This is one of the most valuable termination-planning levers available. See a specialist tax adviser before agreeing terms.
Boosting pension contributions from a termination package
Employees receiving termination packages often use them to fund extra pension contributions. The mechanics:
- The employee negotiates part of the ex gratia payment to be paid into the pension scheme rather than as cash.
- The pension contribution goes in gross (not subject to income tax or employee NI).
- The Annual Allowance (£60,000 for 2024-25) caps how much can go in tax-efficiently in one tax year.
- Carry-forward of unused Annual Allowance from the previous three tax years can be used.
- The employee saves the income tax and NI they would otherwise pay on that portion.
Example: an employee at the 45 per cent additional rate receiving a £50,000 ex gratia payment could instead take £30,000 as cash and £20,000 as employer pension contribution. Tax saved: £9,000 (45 per cent of £20,000) plus employee NI. The pension grows tax-free until drawdown.
Auto-enrolment during notice
Auto-enrolment continues throughout the notice period on a working-notice basis. Pension contributions on basic salary are deducted from each monthly payslip in the normal way. On PILON, the position depends on the contract:
- Contractual PILON on basic pay: contributions typically continue on the PILON amount.
- Non-contractual PILON: contributions typically do not apply.
- Garden leave: contributions continue on basic pay in the normal way (garden leave is still employment).
Employees who want to boost pension contributions at termination should do so via a settlement agreement rather than relying on default auto-enrolment behaviour.
Employer NI on pension contributions
Employer pension contributions do not attract Employer National Insurance (currently 15 per cent). This is one of the key reasons employers are often willing to route termination sums into pension: it saves the employer 15 per cent on top of what the employee saves on income tax and employee NI. The commercial gain to both sides is real - always raise pension routing as an option in exit negotiations, especially for higher-earners.
Common mistakes
- Assuming pension contributions carry through automatically. They often do not on PILON, especially non-contractual PILON. Check the scheme rules and the contract, and specify treatment in any settlement agreement.
- Missing the Annual Allowance limit. Contributions above £60,000 (2024-25) plus carry-forward attract an annual allowance charge.
- Ignoring salary sacrifice. Salary sacrifice arrangements can be very valuable at termination but need active negotiation because the default is to unwind them.
- Not aligning with the £30,000 s.401 allowance. Pension routing works alongside (not instead of) the £30,000 tax-free termination allowance. Both can be used.
- Not taking specialist advice. Pension and termination tax interact in complex ways. Specialist advice usually pays for itself several times over on senior exits.
Useful calculators
- PILON calculator
- Notice period calculator
- Final pay estimator
- Redundancy pay calculator
- Redundancy tax estimator
Related guides
- PILON tax
- PILON and holiday pay
- PILON and bonus payments
- PILON examples
- PILON explained
- PILON vs garden leave
Authority pages
Frequently asked questions
- Are pension contributions paid on PILON?
- It depends on the contract and scheme rules. Contractual PILON on basic pay usually carries pension contributions for auto-enrolled workers. Non-contractual PILON usually does not. Salary sacrifice arrangements need active negotiation. Always check the pension scheme rules and specify treatment in any settlement agreement.
- Can I direct part of a termination payment into my pension?
- Yes, and it is often very tax-efficient. Employer pension contributions avoid both income tax and NI (employee and employer). Subject to the Annual Allowance (£60,000 for 2024-25) plus any carry-forward from previous years. Route as much as makes sense given the Annual Allowance and your overall tax position.
- Does the PENP tax rule affect pension contributions?
- PENP determines how much of the payment is taxed as earnings. It does not change whether pension contributions are due; that is a scheme and contract question. Since 2018 all PILON is fully taxable under PENP, making pension contributions an increasingly valuable planning lever.
- Does salary sacrifice pension apply during PILON?
- Only if the employer agrees to continue routing the sacrifice amount into the pension scheme. The default at termination is to unwind salary sacrifice, so specify treatment in the settlement agreement if you want the pension contribution to continue. Very valuable for higher-earners.
- What is the tax saving from pension routing?
- For a 40% higher-rate taxpayer, routing £10,000 to pension instead of taking as cash saves £4,000 income tax plus 2% NI. Employer also saves 15% employer NI. Total saving to both sides can be over 55% of the amount routed - a very compelling reason to negotiate pension routing in exit packages.
Sources and further reading
- HMRC EIM13874 - PILON and termination payments — HMRC guidance on PILON tax treatment.
- The Pensions Regulator: Auto-enrolment — Auto-enrolment employer duties.
- GOV.UK: Tax on your pension contributions — Annual allowance and pension tax relief.
- GOV.UK: Salary sacrifice — Salary sacrifice tax treatment.
- Income Tax (Earnings and Pensions) Act 2003, section 402D — PENP - post-employment notice pay - the primary PILON tax rule.
General information about UK PILON and termination pay, not personal tax or legal advice. For your situation take advice from HMRC, ACAS or an employment-law solicitor.