Redundancy Settlement Agreements: How Much Is Tax-Free in 2026?

The £30,000 exemption: what the law actually says

Under Section 401 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA), payments received in connection with the termination of employment are free of income tax up to £30,000. Since April 2018, this exemption also covers employee National Insurance contributions — so the first £30,000 is genuinely free of both taxes.

This threshold has not changed since 1988, despite wages rising significantly. In real terms, the exemption is worth far less than it once was.

Employer NI caveat: Since April 2020, employers must pay Class 1A employer NI (13.8%) on termination payments exceeding £30,000. This is the employer's cost, not yours — but employers factor it into settlement negotiations, which can reduce what they offer.

What qualifies for the £30,000 exemption?

The exemption applies to payments made because of the termination of your employment — not payments for services rendered. Qualifying payments include:

What does NOT qualify: always fully taxable

These payments are taxable in full as earnings, regardless of how they are labelled in the settlement agreement:

The PILON rule changed significantly in April 2018. Before that date, if your contract was silent on PILON, there was an argument (often used) that the payment was a "damages" payment rather than earnings — and could slip under the £30,000 exemption. HMRC closed that loophole. Since 6 April 2018, all PILON — Post-Employment Notice Pay (PENP) in HMRC terminology — is treated as employment income subject to full PAYE, regardless of contract wording.

Statutory Redundancy Pay: the baseline

Before any enhanced or ex gratia element, your entitlement to Statutory Redundancy Pay (SRP) depends on age and service:

• Under 22: 0.5 weeks' pay per year of service
• 22–40: 1 week's pay per year of service
• 41+: 1.5 weeks' pay per year of service

Weekly pay is capped at £719/week in 2026/27 (up from £643/week in 2024/25). Maximum service counted is 20 years.

Maximum SRP 2026/27: £719 × 1.5 × 20 = £21,570

SRP always falls within the £30,000 exemption. It is also not subject to employer NI.

Worked example: Rachel's settlement agreement

Rachel is 42, a higher-rate taxpayer earning £65,000/year. She has been employed for 8 years and is offered a settlement agreement worth £62,413 in total.

The settlement breakdown:

• Statutory Redundancy Pay: £6,580 (8 years × 1.5 × £548 capped weekly pay)
• Ex gratia payment: £50,000
• PILON (1 month salary): £5,417
• Accrued holiday pay (5 days): £1,250
• Legal costs reimbursement: £500

Step 1 — Identify taxable vs exempt elements:

Step 2 — Calculate taxable income:

• PILON + holiday: £5,417 + £1,250 = £6,667 taxable as earnings
• Excess over £30k exemption: £50,000 + £6,580 = £56,580 - £30,000 = £26,580 taxable

Total taxable from settlement: £33,247

Step 3 — Tax at Rachel's marginal rate (40% HR taxpayer):

• £33,247 × 40% = £13,299 income tax
• Employee NI on PILON and holiday pay only: £6,667 × 2% (above UEL) = £133
• Net settlement received: £62,413 - £13,299 - £133 = £48,981

Employer's additional cost: Employer NI on £26,580 excess = £26,580 × 13.8% = £3,668 (Rachel doesn't pay this, but the employer does — they may reduce ex gratia to offset it).

Timing a settlement: can splitting across tax years help?

If your settlement straddles the 5 April year-end, it may be possible to split the payment:

• One instalment in the current tax year (e.g. March 2026)
• One instalment in the new tax year (e.g. May 2026)

This can push part of the taxable excess into a year where you are a basic-rate taxpayer rather than higher-rate — saving 20% on the split portion.

Practical example: Rachel receives £16,290 taxable (after £30k exempt) in 2025/26 and £16,290 in 2026/27. If she drops to basic-rate in 2026/27 (having left employment), she saves 20% × £16,290 = £3,258.

This requires careful planning and agreement from the employer. The termination date must genuinely be in the relevant year — you cannot backdate it.

Settlement vs employment tribunal: the comparison

Settling avoids the time and cost of tribunal proceedings. But it means signing away your right to bring most employment claims. The key tribunal awards for comparison in 2026/27:

If your case involves discrimination or whistleblowing, a settlement may undervalue your claim. Get specialist employment law advice before signing anything.

Pension contributions within a settlement

One often-overlooked strategy: ask your employer to pay some or all of the settlement directly into your occupational or personal pension scheme.

• Employer pension contributions are not subject to the £30,000 cap
• They are not subject to income tax or NI for you
• They are a tax-deductible expense for the employer
• The contribution counts toward your Annual Allowance (£60,000 in 2026/27)

Example: Instead of receiving a £40,000 ex gratia payment (£10,000 of which would be taxable at 40%), Rachel asks her employer to pay £10,000 into her pension and £30,000 as ex gratia. The pension contribution is completely outside the ITEPA framework — no tax on entry. At 40% marginal rate, this saves Rachel £4,000 in tax, and her employer saves their NI on the £10,000 excess.

This requires careful drafting by both parties' solicitors and should be confirmed with HMRC guidelines. But it is entirely legitimate.

Legal costs in settlement agreements

A settlement agreement is only legally binding if you have received independent legal advice from a qualified solicitor or legal executive. It is standard practice for the employer to contribute to these costs — typically £250–£500 + VAT.

This contribution is tax-free to you under a specific HMRC exemption — provided it genuinely relates to advice on the settlement agreement itself.

National Insurance summary

This is one of the most commonly misunderstood areas of settlement taxation:

Sources

• HMRC: Employment Income Manual EIM13780 — £30,000 exemption
• HMRC: Post-Employment Notice Pay (PENP)
• gov.uk: Statutory Redundancy Pay rates
• ACAS: Settlement agreements
• Employment Tribunal Service: Award limits 2026/27