Settlement Agreement Tax in 2026: The GBP 30,000 Rule Explained
How settlement agreement payments are taxed in 2026/27: the GBP 30,000 exemption, what counts as taxable pay, PILON, NI rules and how to check your take-home.
Quick answer
In 2026/27 the first GBP 30,000 of a genuine compensation payment for loss of employment is usually free of Income Tax and National Insurance. Everything you have earned -- salary, holiday pay, bonuses and notice pay -- is taxed in full and does not count towards the GBP 30,000. Anything above GBP 30,000 is added to your income and taxed at your marginal rate.
How a settlement agreement is split for tax
A settlement agreement (the modern name for a compromise agreement) is a legally binding contract that ends your employment on agreed terms, usually in exchange for a payment. For tax, the single headline figure is split into parts that are treated very differently.
The tax outcome depends entirely on what each part of the money actually represents, not on the label your employer gives it. HMRC looks at the substance. A payment called "compensation" that is really your notice pay will still be taxed as notice pay.
The three broad categories are:
- Earnings you have already worked for. Outstanding salary up to your leaving date, accrued holiday pay, and any contractual bonus or commission. These are pay, taxed in full.
- Notice pay. Whether you work your notice or are paid in lieu of it, this is treated as earnings (see PILON below).
- Genuine termination compensation. A true ex gratia payment for the loss of your job -- statutory and enhanced redundancy, or compensation for unfair or wrongful dismissal. This is the part that can use the GBP 30,000 exemption.
The GBP 30,000 exemption in detail
The first GBP 30,000 of qualifying termination compensation is free of both Income Tax and National Insurance. This is a single GBP 30,000 limit covering all such payments connected with the termination, not GBP 30,000 per payment.
Statutory redundancy pay counts towards the GBP 30,000. So if your statutory redundancy is, say, several thousand pounds and your employer adds enhanced redundancy on top, you add them together and only the total above GBP 30,000 is taxed.
Here is a simplified worked example showing the principle (figures are illustrative):
| Component | Amount (GBP) | Tax treatment |
|---|---|---|
| Salary to leaving date | 3,000 | Taxed in full (Income Tax + NI) |
| Accrued holiday pay | 1,200 | Taxed in full (Income Tax + NI) |
| Notice pay (PILON) | 6,000 | Taxed in full (Income Tax + NI) |
| Statutory + enhanced redundancy | 38,000 | First 30,000 tax-free; 8,000 taxed |
In this example, GBP 30,000 of the redundancy is tax-free, while the GBP 8,000 excess plus all the earnings and notice pay are taxable. Your actual figures will differ, so model your own position with the calculator below.
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Open Take-Home Pay calculatorPay in lieu of notice (PILON) is always taxed
This trips up a lot of people. Since April 2018, all notice pay is taxable as earnings, whether or not your contract contains a PILON clause. Employers must work out the post-employment notice pay (PENP) -- broadly the basic salary you would have earned during any unworked notice -- and tax that amount in full.
PENP cannot use the GBP 30,000 exemption. If an employer tries to dress up notice pay as tax-free compensation, HMRC will recharacterise it. So when you read a settlement offer, identify how much of it is really your notice period; that part will be taxed at your marginal rate with National Insurance on top.
What happens above GBP 30,000
Anything above the GBP 30,000 exemption is added to your taxable income for the year and taxed at your marginal Income Tax rate.
For England, Wales and Northern Ireland in 2026/27 the bands (on gross income) are:
| Band | Rate | Gross income |
|---|---|---|
| Personal Allowance | 0% | Up to 12,570 |
| Basic rate | 20% | 12,571 to 50,270 |
| Higher rate | 40% | 50,271 to 125,140 |
| Additional rate | 45% | Above 125,140 |
The Personal Allowance is GBP 12,570 and is frozen until April 2028. It is tapered away by GBP 1 for every GBP 2 of income above GBP 100,000, vanishing at GBP 125,140. That creates a 60% effective tax rate on income between GBP 100,000 and GBP 125,140 -- a real risk when a large lump sum lands in one tax year.
In Scotland the band structure is different, with rates of 19%, 20%, 21%, 42%, 45% and 48%. Scottish taxpayers should expect their settlement to be taxed across those bands, so the take-home on amounts above GBP 30,000 can differ from the rest of the UK.
National Insurance on settlement payments
Employee National Insurance applies to the earnings elements -- salary, holiday pay, bonuses and notice pay. In 2026/27 employee Class 1 NI is 8% on earnings between GBP 12,570 and GBP 50,270, and 2% above GBP 50,270.
The genuine compensation within the GBP 30,000 exemption is free of National Insurance for you. There is also an employer National Insurance charge on certain termination amounts above GBP 30,000, but that is the employer's cost, not yours, so it does not reduce your take-home directly.
Legal fees, outplacement and other items
Two common extras are usually tax-free:
- Legal fees. If your employer pays your solicitor directly for advice on the settlement agreement, under the terms of the agreement, this is normally not a taxable benefit. Independent legal advice is a legal requirement for a valid settlement agreement, which is why this treatment exists. Keep the invoice.
- Outplacement support. Counselling and retraining services to help you find new work can often be provided tax-free, subject to conditions.
By contrast, a payment for a restrictive covenant (for example, agreeing not to compete or not to poach clients) is taxable in full -- it is consideration for a promise, not compensation for loss of office.
Will you get a tax refund?
Quite possibly. Settlement payments are frequently taxed at source using emergency or month-12 codes, which can over-deduct, especially if you leave part way through the year and your income for the year ends up lower than the deduction assumed.
After the tax year ends, HMRC usually reconciles your position automatically and refunds any overpayment. If you do not expect to work again soon in that tax year, you can claim earlier using HMRC form P50 (stopped working) or P53 (lump sums). Always check the final figures rather than assuming the amount deducted was correct.
A simple checklist before you sign
- Identify each component and confirm which parts are earnings and which are genuine compensation.
- Check that notice pay (PENP) has been taxed correctly and not hidden inside the tax-free element.
- Confirm the GBP 30,000 exemption is applied only to the compensation element.
- Consider whether a pension contribution (Annual Allowance GBP 60,000 in 2026/27) could shelter the excess above GBP 30,000.
- Ask for legal fees to be paid directly to your solicitor under the agreement.
- Model your full-year income, including the taxable settlement, to see your real take-home and band position.
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The GBP 30,000 rule is genuinely valuable, but only for the right kind of payment. Earned pay and notice pay are always taxed in full, and a large award can push you into the higher, additional or even 60% bands. Get the split documented correctly, consider a pension contribution for the excess, and check whether you are owed a refund after the year ends. Because this is a financial decision that can run to tens of thousands of pounds, take the independent legal advice the law requires -- and run the numbers before you sign.
This article is general information, not personal tax or legal advice. Always confirm current rules at gov.uk and take advice on your own circumstances.
Frequently asked questions
How much of a settlement agreement is tax-free in 2026?
The first GBP 30,000 of a genuine compensation payment for loss of employment can usually be paid tax-free and free of National Insurance. This exemption only applies to true termination payments, such as a redundancy element or compensation for unfair dismissal. It does not cover contractual pay you have earned, such as salary, holiday pay, bonuses or pay in lieu of notice, which are taxed in full. Anything above GBP 30,000 is taxed as income.
Is pay in lieu of notice (PILON) taxable?
Yes. Since 2018 all notice pay is treated as earnings and is fully subject to Income Tax and National Insurance, whether or not your contract mentions a PILON clause. Employers must calculate post-employment notice pay (PENP) to work out the part of any settlement that represents your basic salary for the notice period. That portion is taxed in full and cannot use the GBP 30,000 exemption, even if the payment is labelled compensation.
Do I pay National Insurance on a settlement payment?
You pay employee National Insurance on the parts that count as earnings, such as salary, holiday pay, bonuses and notice pay. In 2026/27 employee Class 1 NI is 8% on earnings between GBP 12,570 and GBP 50,270 and 2% above GBP 50,270. The genuine compensation element within the GBP 30,000 exemption is free of National Insurance. Note that employer NI may apply to part of larger termination awards, but that is the employer's liability, not yours.
How is the amount above GBP 30,000 taxed?
Anything above the GBP 30,000 exemption is added to your taxable income for the year and taxed at your marginal Income Tax rate. In England, Wales and Northern Ireland that is 20%, 40% or 45% depending on your total income. A large lump sum can push you into a higher band or, between GBP 100,000 and GBP 125,140, trigger the 60% effective rate as your Personal Allowance is withdrawn. Use a take-home calculator to model the impact.
Will I get a refund if too much tax is deducted?
Possibly. Settlement payments are often taxed when your normal Personal Allowance and lower bands have already been partly used, so the deduction can be higher than your final liability. If you leave work part way through the year and earn less than expected, you may have overpaid. HMRC usually reconciles this after the tax year ends, or you can claim a refund using form P50 or P53 if you do not return to work soon.
Are legal fees in a settlement agreement taxable?
If your employer pays your legal fees directly to your solicitor for advice on the settlement agreement, and the payment is made under the agreement, it is normally not treated as a taxable benefit. This is a long-standing concession for the cost of taking independent legal advice, which the law requires for a valid settlement agreement. Keep the solicitor's invoice and the wording in the agreement to support the tax-free treatment.
Does a settlement payment affect my Personal Allowance?
It can. Your Personal Allowance is GBP 12,570 in 2026/27, but it is reduced by GBP 1 for every GBP 2 of income above GBP 100,000 and disappears entirely at GBP 125,140. A large taxable settlement, especially the part above GBP 30,000 plus your notice pay, can lift your total income into that band and create a 60% effective tax rate on income between GBP 100,000 and GBP 125,140. Pension contributions can sometimes reduce this.
Is statutory redundancy pay taxed?
Statutory redundancy pay is a genuine compensation payment for loss of employment, so it counts towards the GBP 30,000 tax-free exemption and is free of National Insurance. If your total termination payment, including statutory and any enhanced redundancy, stays within GBP 30,000, it is paid tax-free. Only the excess above GBP 30,000 is taxed. Earned pay such as outstanding salary, holiday pay and notice pay is always taxed in full and sits outside the exemption.
Can I pay a settlement into my pension to save tax?
Sometimes. An employer can pay part of a termination payment into your pension as an employer contribution, which is not taxed as income to you and can keep more of the award out of the higher tax bands. The pension Annual Allowance is GBP 60,000 in 2026/27. This is a planning option, not automatic, and depends on your employer agreeing and on your available allowance. Take independent advice before agreeing the structure of the payment.
Which calculator should I use to check the tax?
Use a take-home pay or Income Tax calculator and enter your expected total income for the year, including salary already earned, notice pay, holiday pay and the taxable part of the settlement above GBP 30,000. This shows your likely tax and National Insurance and whether the lump sum pushes you into a higher band. Remember to add the first GBP 30,000 of genuine compensation back as tax-free when working out your final cash position.
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Related reading
Tax on Redundancy Pay UK 2026: What's Actually Tax-Free?
The £30,000 tax-free exemption, how statutory redundancy is calculated, PILON rules since April 2018, the PENP formula, settlement agreements, and NI changes from April 2020. Worked examples and 8 FAQs.
Redundancy Pay Over GBP 30,000: How It Is Taxed in 2026/27
How redundancy pay over GBP 30,000 is taxed in the UK for 2026/27: the tax-free band, what counts as taxable, NI, PILON rules and how to cut your bill.
PILON Payment Tax Guide 2026/27: How Much You Keep
How is a payment in lieu of notice (PILON) taxed in 2026/27? Understand PENP, income tax, National Insurance and what lands in your pocket.