Answers · UK 2025/26

How is an ex-gratia redundancy payment taxed?

Ex-gratia (voluntary, over-and-above-statutory) redundancy payments share the same £30,000 tax-free threshold as statutory redundancy pay -- the two are added together, and only the combined total above £30,000 is taxed as income (with no employee National Insurance on the termination payment itself, though employer NI applies above £30,000). Payments in lieu of notice and holiday pay are taxed separately as normal earnings, not under this threshold.

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An ex-gratia payment is an extra, discretionary amount an employer chooses to pay on top of statutory redundancy pay, often as part of a settlement agreement, and it shares the same generous £30,000 tax-free allowance as statutory and contractual redundancy pay -- but only for the genuinely redundancy/termination element of a package. **The combined £30,000 tax-free threshold** Statutory redundancy pay, contractual (enhanced) redundancy pay, and ex-gratia payments are all added together and treated as one single termination payment for tax purposes. The first £30,000 of this COMBINED total is tax-free; only the amount above £30,000 is subject to Income Tax (at your marginal rate) via payroll. **No employee National Insurance on the termination element** Unlike ordinary salary, genuine termination payments (including the amount above £30,000) are NOT subject to employee National Insurance at all. However, since April 2020, employers DO pay employer Class 1A National Insurance (at the standard employer NI rate) on the portion of the termination payment above £30,000. **Worked example** Sarah is made redundant and receives £8,000 statutory redundancy pay plus a £25,000 ex-gratia payment as part of a settlement agreement -- a combined termination payment of £33,000. The first £30,000 is entirely tax-free and NI-free. The remaining £3,000 is subject to Income Tax at Sarah's marginal rate (say 20%, so £600 tax), but NO employee National Insurance is due on any part of it. Her employer, however, pays employer NI on that £3,000 excess. **What does NOT qualify for the £30,000 exemption** Critically, not everything in a redundancy or settlement package benefits from this exemption: - **Payment in Lieu of Notice (PILON)**: taxed as normal earnings in full, subject to both Income Tax AND employee National Insurance, under the Post-Employment Notice Pay (PENP) rules, regardless of how the payment is labelled in the settlement agreement. - **Unpaid salary, bonuses, and holiday pay**: all taxed as normal earnings, in full, exactly as if you were still employed. - **Payments for restrictive covenants** (e.g. agreeing not to work for a competitor): fully taxable as earnings. **Worked example: package including PILON** David's settlement includes £20,000 ex-gratia payment plus 3 months' PILON worth £12,000. Only the £20,000 ex-gratia element benefits from the £30,000 exemption (falling entirely within it, so it is tax-free). The £12,000 PILON is taxed as normal salary in full, with both Income Tax and employee National Insurance deducted, regardless of the overall package being under £30,000 in total. **Why this trips people up** Settlement agreements often bundle several different payment types together under one headline figure, but HMRC looks at the true nature of each component separately -- always ask for (or have a solicitor review) a tax breakdown of exactly which parts of a settlement qualify for the £30,000 exemption and which are taxed as normal earnings.