Settlement agreement tax: what is tax-free and what is taxed

The £30,000 exemption

Genuinely ex-gratia termination payments, money paid as compensation for losing the job rather than for work done, are free of income tax up to £30,000 under section 403 of the Income Tax (Earnings and Pensions) Act 2003. Anything above £30,000 is taxed as income in the year you receive it, though no employee National Insurance is due on the excess (the employer pays Class 1A on it).

Statutory redundancy pay counts toward the same £30,000 limit. It is itself tax-free, but if you receive £10,000 statutory redundancy plus £25,000 ex-gratia, £5,000 of the package is taxable.

Line by line

Ex-gratia compensation

Tax-free up to £30,000 in aggregate with statutory redundancy; excess taxed as income.

Statutory redundancy pay

Tax-free, but uses up part of the £30,000 exemption.

Notice pay and payment in lieu of notice (PILON)

Always taxed as earnings with NI, whatever the agreement calls it. Since 2018 the post-employment notice pay (PENP) rules stop notice being dressed up as ex-gratia.

Accrued holiday, bonuses, commission

Earnings. Taxed with NI in the normal way.

Payment for a confidentiality or restrictive covenant

Taxable as earnings, however small.

Employer contribution to your legal fees

Not taxed as your income, provided it is paid direct to the solicitor under a term of the agreement for advice on the termination.

Payment into your pension

Can usually be made gross, outside the £30,000 limit, within your annual allowance, often the most tax-efficient use of an excess over £30,000.

A worked example

Tax treatment turns on drafting and on your other income in the year. Have the figures checked before you sign, this page is general information, not tax advice. HMRC's rules are at gov.uk.