In the UK, the first £30,000 of a qualifying termination payment is free of income tax, which is what people mean by the tax-free termination payment £30,000 threshold. The exemption sits in section 403 of the Income Tax (Earnings and Pensions) Act 2003 and covers genuine compensation for losing your job: statutory redundancy, enhanced redundancy top-ups, and ex-gratia sums.1Legislation.gov.uk. Income Tax (Earnings and Pensions) Act 2003 – Section 403 Anything above £30,000 is taxed as employment income at your normal rate, and several parts of your final pay packet never qualify at all, whatever the total.
What the £30,000 Actually Covers
The charging rule in section 401 catches payments received in connection with the end of your employment, a change in duties, or a change in earnings, but only where the money is not already taxable under some other part of the tax code.2Legislation.gov.uk. Income Tax (Earnings and Pensions) Act 2003 – Section 401 Within that box, the first £30,000 is exempt. The types of payment most commonly sheltered are:3GOV.UK. Tax on Termination Payments – What You Pay Tax and National Insurance On
- Statutory redundancy pay, calculated from the government formula on age, weekly pay, and service. Because statutory redundancy is relatively modest, it usually falls well inside £30,000 on its own.
- Enhanced redundancy pay, meaning anything your employer adds on top of the statutory figure under a policy or a negotiated deal.
- Ex-gratia payments made voluntarily as compensation for losing your position, with no contractual obligation behind them.
- Non-cash benefits, such as a company laptop or phone you keep, valued at market value against the threshold.
The threshold applies to the total of all qualifying payments connected to the same employment, added together before the exemption is applied.4HM Revenue & Customs. Employment Income Manual – EIM13500 It is a fixed figure. It does not scale with length of service, salary, or inflation.
The payment also has to be genuine compensation for the loss of the job rather than a reward for past service. If HMRC treats a sum as disguised earnings or a contractual entitlement for work already done, the exemption falls away and the whole amount is taxed as ordinary income.
Parts of Your Payoff That Are Always Taxable
Several elements of a final pay packet can never sit under the £30,000 exemption, because they are already taxable as earnings. They should appear separately on your final payslip:
- Unpaid salary up to your last day.
- Accrued holiday pay for leave earned but not taken.
- Bonuses earned before you left.
- Contractual payments in lieu of notice (PILON), where your contract expressly lets your employer pay you instead of having you work the notice.
All of these attract income tax and employee National Insurance in exactly the same way as your regular monthly pay. They sit outside the termination payments chapter altogether.
Post-Employment Notice Pay Shrinks the Exemption
Even if your contract has no PILON clause, the law still carves out the value of your unworked notice and taxes it as earnings. Section 402B of ITEPA 2003 does this through Post-Employment Notice Pay (PENP), which applies whenever you leave without working your full notice, regardless of what your contract says.5Legislation.gov.uk. Income Tax (Earnings and Pensions) Act 2003 – Section 402B
Your employer calculates PENP using a statutory formula based on your basic pay at the trigger date (the date notice was given, or your last day if no notice was given), the length of the unworked notice period, and any payments you already received for that period.6HM Revenue & Customs. Employment Income Manual – EIM13898 – PENP Formula Defined Terms The PENP figure is treated as general earnings, with both income tax and National Insurance deducted.
Only what is left of your termination payment after PENP has been stripped out can benefit from the £30,000 threshold.4HM Revenue & Customs. Employment Income Manual – EIM13500 For example, on a £40,000 termination payment with a PENP calculated at £36,800, only the remaining £3,200 is tested against the exemption, so no additional income tax is due on that residual.7HM Revenue & Customs. Employment Income Manual – EIM13877 – PENP Interaction With Section 27 ITEPA 2003 If PENP comes to more than the total termination payment you actually received, you only pay tax on what you were paid, not on a higher theoretical figure.3GOV.UK. Tax on Termination Payments – What You Pay Tax and National Insurance On
Payments for Injury or Disability Sit Outside the £30,000 Entirely
A separate exemption under section 406 of ITEPA 2003 covers payments made on account of injury to, or disability of, an employee.8Legislation.gov.uk. Income Tax (Earnings and Pensions) Act 2003 – Section 406 These payments do not count toward the £30,000 threshold and are free of income tax whatever their size.
The statute defines injury carefully. Psychiatric injury (clinical depression, anxiety, or stress that prevents you from doing your job) qualifies. Injured feelings do not. Feeling upset about being made redundant is not the same as a diagnosable psychiatric condition that impairs your ability to work, and HMRC treats those very differently.
To claim the exemption, the condition must prevent you from carrying out the duties of your employment, and medical evidence must back that up.9HM Revenue & Customs. Employment Income Manual – EIM13610 – Termination Payments and Benefits: Exceptions: Payments on Account of Injury or Disability A general reference to “stress” in a settlement agreement, with nothing from a medical professional behind it, is unlikely to survive scrutiny. Compensation for injury to feelings can sometimes sit outside the termination rules altogether where it relates purely to discrimination that happened before the termination, in which case section 401 does not apply at all.10HM Revenue & Customs. Employment Income Manual – EIM12965 How the settlement agreement is drafted, and what evidence supports each component, tends to decide the outcome.
Employer National Insurance Above £30,000
You do not pay employee National Insurance on the tax-free portion of a termination payment, but your employer faces a National Insurance bill on anything above £30,000. Employer Class 1A contributions apply to that excess,3GOV.UK. Tax on Termination Payments – What You Pay Tax and National Insurance On at the current Class 1A rate of 15%.11GOV.UK. National Insurance Rates and Categories – Contribution Rates
It matters to you even though the liability is technically the employer’s. Employers factor Class 1A into redundancy budgets and negotiations. On a £40,000 offer, the £10,000 above the threshold carries a £1,500 employer NICs charge on top, which is one reason employers push to structure packages in ways that keep the taxable portion down.
Two Legitimate Ways to Reduce the Tax
Redirect Part of the Payment Into Your Pension
If your employer pays part of your termination package directly into a registered pension scheme, that contribution is free of both income tax and National Insurance, subject only to the pension annual allowance.3GOV.UK. Tax on Termination Payments – What You Pay Tax and National Insurance On Where your total payoff is well above £30,000, redirecting the excess into a pension can be far more efficient than taking it as taxable cash. It also removes the employer’s Class 1A NICs on the redirected amount, which gives you a real bargaining point.
Get Legal Fees Paid Direct to the Solicitor
Legal fees for advice on the settlement agreement are tax-free provided your employer pays your solicitor directly rather than reimbursing you.3GOV.UK. Tax on Termination Payments – What You Pay Tax and National Insurance On Most settlement agreements include an employer contribution toward legal advice. Check that it is structured as a direct payment to the law firm, not added on to your termination sum.
How the Tax Comes Off Your Payment
Your employer handles the deductions through PAYE, and the mechanics depend on when the payment lands relative to your leaving date.12HM Revenue & Customs. PAYE Manual – PAYE74015 – How Employers Operate PAYE on Termination Payments
For taxable amounts paid after you have already left, your employer uses tax code 0T on a week 1 or month 1 (non-cumulative) basis.13GOV.UK. What To Do When an Employee Leaves Non-cumulative means the tax is worked out on that payment alone, ignoring what you have earned earlier in the tax year. It avoids double-using your personal allowance if you have already started a new job, but it often deducts more tax than you actually owe.
You get a P45 when your employment ends. If a further payment is made after that, your employer must not issue a second P45; instead they give you written confirmation of the gross amount and the deductions.13GOV.UK. What To Do When an Employee Leaves Keep both documents to check your position at the end of the year.
Claiming Back Overpaid Tax
Because the 0T non-cumulative code often overshoots, refunds are common, especially if you leave partway through the tax year and your total income for the year ends up lower than the deduction assumed. HMRC will normally sort this out automatically once all the employer submissions come in, but it can take months.
If you have been unemployed for at least four weeks, you can move things along by sending HMRC a P50 form with parts 2 and 3 of your P45. Contact HMRC before completing it, since they may ask for more information depending on your circumstances. You can also flag a discrepancy through your Personal Tax Account on GOV.UK if you think the tax on your termination payment was wrong.