TL;DR: A UK redundancy payment is taxed under sections 401 to 416 of the Income Tax (Earnings and Pensions) Act 2003. The first 30,000 pounds of a genuine termination payment is exempt from income tax and from both employee and employer National Insurance. The excess above 30,000 pounds is taxed as employment income at the recipient's marginal rate, with employer Class 1A NICs due on the excess from 6 April 2020. Pay in lieu of notice (PILON), holiday pay, contractual bonuses and pay during garden leave do not benefit from the exemption. Statutory redundancy pay calculated under the Employment Rights Act 1996 is always within the 30,000 pound exemption. A payment from a termination into a registered pension can be made tax-efficiently subject to the annual allowance.
Last reviewed May 2026
When a UK employee is made redundant, the termination package they receive is rarely a single payment. It is typically several distinct payments combined on the final payslip: outstanding salary, accrued holiday pay, pay in lieu of notice (PILON) or pay during garden leave, a contractual or enhanced redundancy payment, and possibly an ex gratia element on top of the legal minimum. Each component is taxed under its own rule, and the rules changed in 2018, 2019 and 2020.
This guide sets out the tax treatment component by component, explains the Post-Employment Notice Pay (PENP) calculation that catches disguised PILON, covers the National Insurance position, and shows the practical effect on the leaver's take-home pay.
The legislative framework
The starting point is sections 401 to 416 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003). These provisions create a separate income category for "payments and other benefits on termination of employment" and exempt the first 30,000 pounds. The 30,000 pound figure has been unchanged since the rule was first set; it is not indexed to inflation.
HMRC's Employment Income Manual sets out the detailed administrative position, with separate chapters on the 30,000 pound exemption, the Post-Employment Notice Pay calculation, the treatment of restrictive covenants under section 225 ITEPA, and the relationship between redundancy and other termination categories. The Court of Appeal has ruled on several edge cases involving the boundary between earnings and termination payments, and the manual cites those cases.
The breakdown of a typical redundancy package
A standard redundancy package contains: final salary up to the leaving date (taxed as earnings via PAYE), accrued but unused holiday pay (taxed as earnings via PAYE), PILON or salary during garden leave (taxed as earnings via PAYE; from 2018, all PILON is taxable regardless of contract wording), statutory redundancy pay (within the 30,000 pound exemption), and any enhanced or ex gratia redundancy element (also within the 30,000 pound exemption to the extent the total redundancy element does not exceed 30,000 pounds).
Some packages also include a contribution to outplacement support, legal fees for taking advice on a settlement agreement (where the employer pays the leaver's legal fees directly, this is generally not taxed as the leaver's income under ESC A81), and benefits in kind continuing into the post-termination period. Each of these has its own rule and the payslip should ideally split them by category so the PAYE treatment is transparent.
The 2018 PENP rules: how PILON is now taxed
Before 6 April 2018, the tax treatment of PILON depended on whether the employment contract contained a PILON clause. Contractual PILON was always taxed as earnings; non-contractual PILON could in principle sit within the 30,000 pound exemption if structured as a damages payment. This created a strong incentive to draft packages in a particular way and was a regular area of HMRC challenge.
From 6 April 2018, the Post-Employment Notice Pay rules force the basic salary equivalent of the unworked notice period to be taxed as earnings regardless of contract wording. The PENP calculation is mechanical: it takes the basic pay for the unworked notice period and treats that amount as taxable earnings. Any termination payment in excess of PENP is then tested against the 30,000 pound exemption in the normal way. The effect is that genuine compensation can still benefit from the exemption, but a payment disguised as such cannot.
The 2020 employer NIC change
From 6 April 2020, the portion of any termination payment in excess of 30,000 pounds became subject to employer Class 1A National Insurance contributions at the standard employer NI rate. The change was originally legislated for an earlier date and deferred. Employee NICs are not due on the excess.
The Class 1A liability is reported in real-time through PAYE rather than through the year-end P11D. Employers should account for this when costing a settlement: a 60,000 pound termination package includes a 30,000 pound taxable excess and an additional employer NIC charge on that excess. The total employer cost is higher than the headline package amount. From the employee's perspective, the NIC change has no direct effect because the excess was already taxed as income.
Statutory redundancy pay calculation
Statutory redundancy pay is the legal minimum payable under sections 162 to 166 of the Employment Rights Act 1996. The calculation is: 1.5 weeks of pay per year of continuous service for years where the employee was aged 41 or over, 1 week per year for years aged 22 to 40, and 0.5 weeks per year for years under 22. Weekly pay is capped at a figure reviewed each April by the Department for Business and Trade. The maximum service counted is 20 years.
The current weekly cap and the resulting maximum statutory redundancy payment are on GOV.UK. Even at the cap, the statutory figure is comfortably below 30,000 pounds, so statutory redundancy pay is always fully within the tax exemption. Enhanced redundancy pay paid by the employer above the statutory minimum is also within the exemption (subject to the 30,000 pound overall cap on the redundancy element).
Settlement agreements and ex gratia payments
A settlement agreement (formerly compromise agreement) is the legal document under which an employee waives their potential tribunal claims in exchange for a termination package. The agreement has to be in writing, identify the specific claims being settled, and the employee has to have taken advice from a "relevant independent adviser" (typically a solicitor) whose fee the employer usually pays.
The tax treatment of a settlement agreement payment depends on what the payment is for. A genuine compensation element for loss of office sits within section 401 ITEPA and the 30,000 pound exemption. A discrimination compensation element under the Equality Act 2010 is in principle fully tax-free if it relates to a non-economic loss (injury to feelings), though the boundaries are case-specific. Restrictive covenant payments are taxed as earnings under section 225 ITEPA. The settlement agreement should split the payment into named heads so the employer's payroll treatment is correct.
Paying the termination payment into a pension
Where the employee and employer agree, part of the termination payment can be paid directly from the employer to a registered pension scheme. The contribution is not taxed as the employee's income (subject to the annual allowance) and the employer benefits from a corporation tax deduction. The contribution must go from the employer to the pension provider; if the employee receives the money and pays it in themselves, it is taxed first and then the employee uses personal pension tax relief, which is normally more limited.
The annual allowance for pension contributions is 60,000 pounds for most people in 2026-27, with three years of carry-forward of unused allowance. A large redundancy payment can absorb several years of unused allowance. The tapered annual allowance reduces the limit for very high earners. HMRC's Pension Tax Manual covers the calculation; an employee considering this route normally takes advice from an FCA-authorised pension adviser.
The leaver's practical position
From a leaver's perspective, the practical implications are these. First, the tax-free 30,000 pounds is real and worth substantially more than a 30,000 pound gross salary increase (the leaver pays no NI on the exempt portion and no income tax). Second, the PILON element is fully taxed at marginal rate, so a leaver in higher-rate tax will see a smaller net amount than the headline figure suggests. Third, the PAYE deduction in the leaving month is often higher than the eventual annual tax position requires, and a refund can be reclaimed in-year via form P50 or P53, or by self-assessment.
Where a large termination payment has tipped the leaver into a higher tax band for the year, careful timing of the leaving date across tax years can sometimes reduce the headline marginal rate, although this depends on circumstances and on whether the employer will agree to a date shift. Pension contribution from the termination is the most-effective standard route to reduce the tax bill on a large package.
How we verified this
The legislative basis described here is drawn from the Income Tax (Earnings and Pensions) Act 2003 (sections 401 to 416 and section 225), the Employment Rights Act 1996 (sections 162 to 166), the Finance Act 2018 (introduction of PENP), the Finance Act 2019 (Class 1A on excess termination payments), and HMRC's Employment Income Manual at EIM13000 onwards. Statutory redundancy pay rates and weekly pay caps change at the start of each tax year and are published on GOV.UK. No statutory figure or section reference has been fabricated.
Disclaimer: This article is general information about the UK tax treatment of redundancy and termination payments. It is not personal tax or legal advice. The treatment of a specific termination package depends on the contract, the form of payment, and the leaver's circumstances. Anyone with a significant termination payment should check the position with HMRC, an accountant, or a settlement agreement solicitor.
Frequently asked questions
What is the tax-free limit on redundancy pay in the UK?
The first 30,000 pounds of a genuine redundancy or termination payment is exempt from UK income tax and from both employee and employer National Insurance contributions under section 401 ITEPA 2003. The limit has been unchanged since the rule was first introduced and is not indexed. Any redundancy payment above 30,000 pounds is taxed as employment income at the recipient's marginal rate, with employer Class 1A NICs also due on the excess from 6 April 2020.
Is statutory redundancy pay taxable?
Statutory redundancy pay is the legal minimum under the Employment Rights Act 1996 and is always within the 30,000 pound exemption. Even at the cap on weekly pay times the maximum 20 years of service times the age-banded multiplier, the statutory figure is comfortably below 30,000 pounds. So statutory redundancy pay is always tax-free in practice.
What is PENP and how does it affect my redundancy package?
Post-Employment Notice Pay (PENP) is the basic salary equivalent of the unworked notice period. From 6 April 2018, PENP is forced to be taxed as employment income regardless of how the payment is described in the settlement. PENP comes off the headline termination payment before the 30,000 pound exemption is applied to whatever remains. The mechanism prevents disguised pay in lieu of notice from sheltering inside the exemption.
Are restrictive covenants in a settlement taxable?
Yes. A payment for the employee agreeing to a restrictive covenant (a non-compete, non-solicit or confidentiality undertaking) is taxed as earnings under section 225 ITEPA 2003. It does not benefit from the 30,000 pound termination exemption. A settlement agreement should ideally split the consideration so the restrictive covenant element is identified separately and taxed correctly.
Can I pay redundancy money into my pension to save tax?
Yes, by agreement with the employer. The employer pays part of the termination payment directly into a registered pension scheme; the contribution is not taxed as the employee's income, subject to the annual allowance (60,000 pounds for most people in 2026-27, with three years of carry-forward of unused allowance). The payment has to go from the employer to the pension provider, not through the employee's bank account.
