Tax on Redundancy Pay UK 2026: What's Actually Tax-Free?

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

The statutory basis for the UK's redundancy tax-free exemption is section 401 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA). It provides that a "termination payment" — a payment received in connection with the termination of employment — is exempt from income tax to the extent it does not exceed £30,000.

This threshold has remained at £30,000 since 1988. It has never been indexed to inflation. In 1988, £30,000 was equivalent to roughly £90,000 in today's money — meaning the real value of the exemption has fallen dramatically over nearly four decades.

The £30,000 exemption applies to:

• Statutory redundancy pay (always covered if genuinely paid on redundancy)
• Contractual or discretionary enhanced redundancy payments from your employer
• Ex gratia lump sums paid on termination
• Certain compensation payments in settlement agreements (the "injury to employment" element only)

The £30,000 is a per employment limit. If you have held multiple jobs at the same employer under separate contracts, you may have separate £30,000 limits — but this is complex territory requiring professional advice.

What is explicitly NOT covered by the exemption:

• Pay In Lieu of Notice (PILON) — taxed in full since April 2018
• Accrued holiday pay — taxed as earnings
• Contractual bonuses due at the time of termination — taxed as earnings
• Salary owed up to the termination date — taxed as earnings
• Payments for restrictive covenants (non-compete clauses) — taxed as earnings

How statutory redundancy pay is calculated

Statutory redundancy pay is the legal minimum your employer must pay you if you have at least two years' continuous service. The amount depends on three factors: your age at the time of each year of service, your length of service (capped at 20 years), and your weekly pay (capped at £719 for redundancies on or after 6 April 2025).

The multiplier table

The calculation works year by year — you use the age you were during that specific year of service, not your current age.

Maximum statutory redundancy pay: 30 weeks × £719 = £21,570 (achievable by someone aged 61+ with 20+ years of service earning at or above the cap).

Quick statutory redundancy examples

Example 1 — Under the cap: Emma, age 38, 8 years' service, weekly pay £500. All 8 years fall in the 22-40 band: 8 × 1 × £500 = £4,000

Example 2 — Above the cap: David, age 50, 14 years' service, weekly pay £900.

• 9 years aged 41+: 9 × 1.5 × £719 = £9,707
• 5 years aged 40: 5 × 1 × £719 = £3,595
• Total: £13,302 (cap applies — actual pay of £900 is above £719)

All statutory redundancy pay falls within the £30,000 exemption so is tax-free in practice (the maximum £21,570 is comfortably below £30k).

PILON: taxable in full since April 2018

Pay In Lieu of Notice (PILON) is the payment your employer makes instead of requiring you to work your notice period. Before 6 April 2018, whether PILON was taxable depended on whether your contract contained an explicit PILON clause — without a clause, a non-contractual PILON could potentially sit within the £30,000 exemption.

The April 2018 reform eliminated this distinction entirely.

From 6 April 2018, all PILON is taxable as employment income — whether or not your contract has a PILON clause. HMRC achieved this through the Post-Employment Notice Pay (PENP) formula, which is applied to every termination payment to extract the notice-period element.

The PENP formula

PENP = ((BP × D) ÷ P) − T

Where:

• BP = "Basic pay" received in the last pay period before the "trigger date" (the date notice was given, or employment ended if no notice was given)
• D = Number of days of the post-employment notice period (the unserved notice days)
• P = Number of calendar days in the last pay period before the trigger date
• T = Any contractual PILON already paid and taxed as earnings

The PENP result is treated as taxable earnings and taxed through PAYE. Only the portion of the termination payment that exceeds PENP can potentially fall within the £30,000 exemption.

PENP worked example: Sarah earns £4,000/month (BP). Her notice period is 3 months (92 days, D). Her last pay period was 31 days (P). No contractual PILON was paid (T = 0).

PENP = (£4,000 × 92) ÷ 31 − 0 = £368,000 ÷ 31 = £11,871

This £11,871 is taxed as earnings. If her total termination package is £40,000, then £40,000 − £11,871 = £28,129 can be assessed against the £30,000 exemption (and falls within it, so is tax-free).

Settlement agreements: tax treatment explained

A settlement agreement (formerly a compromise agreement) is a legally binding contract where you agree not to pursue employment tribunal claims in exchange for a payment. They are extremely common in redundancy situations, especially where the employer wants certainty.

The tax treatment of settlement agreement payments is not automatic — it depends on what the payment is for:

Key point: Many settlement agreements bundle multiple payment types together. It is essential that the agreement clearly allocates the payment between taxable and non-taxable elements, otherwise HMRC may challenge the treatment. Always insist on a written tax indemnity clause from the employer if there is any ambiguity.

Employer NI on redundancy pay above £30,000

Since 6 April 2020, employers have been required to pay Class 1A National Insurance contributions on the element of termination payments that exceeds £30,000. The current employer NI rate is 13.8% (rising to 15% from April 2025 under the Autumn Budget 2024 changes).

This is a cost to the employer, not the employee. As an employee, you do not pay employee NI on amounts within the £30,000 exemption, and you do not pay employee NI on the excess either (termination payments are excluded from employee NI even above £30k). However, the employer's NI liability means employers may factor this into the amount they offer in settlement negotiations.

Example: Employer pays £50,000 total termination payment. PENP = £5,000 (taxed as earnings, employer NI at full rate). Remaining £45,000 assessed against £30k exemption: £30k tax-free, £15k taxable + employer Class 1A NI = £15,000 × 15% = £2,250 employer NI cost.

Pension contributions from redundancy pay — a powerful planning tool

One of the most tax-efficient uses of redundancy pay (especially amounts above the £30,000 exemption) is contributing it to a registered pension scheme.

How it works:

1. You receive redundancy pay — the excess above £30k is taxed as earnings.
2. You make a personal pension contribution (or your employer makes an employer contribution into your pension as part of the severance package).
3. You receive income tax relief at your marginal rate on personal contributions. Higher-rate taxpayers get 40% relief; additional-rate taxpayers get 45%.
4. If the employer contributes directly into the pension, it is treated as an employer contribution — exempt from both income tax and NI entirely (as long as it does not exceed the £60,000 annual allowance).

The annual allowance constraint: In 2026/27, the pension annual allowance is £60,000 (or 100% of "relevant UK earnings" if lower). If your salary was £45,000, your relevant UK earnings for the year limit your personal contributions to £45,000 — but employer contributions into the pension are not subject to the "relevant UK earnings" cap.

Practical tip: If your employer is willing to make the enhanced redundancy amount (above £30k) as a direct employer pension contribution rather than a cash payment, this is often the most tax-efficient structure for everyone — the employer also avoids the Class 1A NI charge.

Worked example: 10-year employee, age 45, salary £45,000

Scenario:

• Sophie, age 45, 10 complete years of service
• Annual salary: £45,000 (weekly pay: £45,000 ÷ 52 = £865.38 — above the £719 cap)
• Total redundancy package offered: £50,000 (statutory + enhanced + ex gratia)
• Notice period: 2 months; employer pays PILON in cash

Step 1 — Calculate statutory redundancy pay:

• All 10 years fall in the 41+ band (she was 35 when she started; at age 41 she had 6 years' service; ages 35-40 = 6 years in 22-40 band; ages 41-44 = 4 years in 41+ band)

Wait — let me recalculate properly (Sophie is 45 now with 10 years' service, so she started at 35):

• Years 1-6 (ages 35-40): 6 years × 1 week × £719 = £4,314
• Years 7-10 (ages 41-44): 4 years × 1.5 weeks × £719 = £4,314
• Statutory redundancy total: £8,628

Step 2 — Calculate PILON / PENP:

• Monthly pay (BP): £3,750 (£45,000 ÷ 12)
• Unserved notice: 61 days (2 months)
• Last pay period: 31 days
• PENP = (£3,750 × 61) ÷ 31 = £7,379 (taxed as earnings)

Step 3 — Tax position on the full £50,000 package:

Step 4 — Pension alternative: If Sophie's employer agrees to pay the £12,628 taxable element directly into her pension (as an employer contribution):

• She avoids £5,051 income tax
• Employer avoids Class 1A NI: £12,628 × 15% = £1,894 (employer saves this too)
• Sophie's pension grows by £12,628 rather than a net cash £7,577

This shows why negotiating pension contributions from redundancy pay is worth exploring — both parties can benefit.

Tax on enhanced redundancy payments above £30,000

If your employer's enhanced redundancy offer takes your total termination payment (after deducting PENP/PILON) above £30,000, the excess is taxed as follows:

• Income tax: At your marginal rate — 20% (basic), 40% (higher), 45% (additional) or potentially the 60% effective rate if your income triggers the personal allowance taper (£100k–£125,140 income range)
• Employee NI: Not charged on termination payments above £30,000 (unlike regular salary)
• Employer NI (Class 1A): Charged on the excess above £30,000 at 15% (2025/26 onwards)

The income tax is collected through PAYE — your employer should include the taxable element in your final payslip (or issue a P45 with the correct tax deducted). If the wrong amount is withheld, you may need to complete a self assessment return to settle any underpayment.

Sources

• HMRC: EIM13850 — Termination payments: the £30,000 exemption
• HMRC: EIM13874 — Post-employment notice pay (PENP)
• gov.uk: Calculate your statutory redundancy pay
• gov.uk: Redundancy: your rights
• HMRC: National Insurance on termination payments
• HMRC: Guidance on settlement agreements