Bonus and deferred compensation in a settlement agreement

What happens to your bonus when you sign a settlement agreement?

It depends on whether the bonus is contractual or discretionary, and whether it has already accrued when you leave. A contractual, accrued bonus should be paid in full alongside other sums due. A discretionary or unvested bonus is not automatic, so the settlement agreement needs to say specifically what happens to it.

How that payment is taxed also matters: see our tax guide for how it sits alongside notice pay and any ex gratia sum.

Discretionary bonus vs contractual bonus: why the difference matters

A contractual bonus is one your contract or an incorporated policy commits your employer to pay once specified conditions are met, for example a formula tied to hitting a sales target. Once those conditions are satisfied, it is owed like any other earned pay and should not need to be negotiated for, only correctly calculated and included.

A discretionary bonus is one where the employer decides whether to pay it, and often how much, typically under wording such as "the Company may, in its absolute discretion, award a bonus." Discretion is not the same as an unfettered choice, though. Courts have repeatedly held that where a contract gives an employer a discretionary power, that power must be exercised honestly, in good faith, and not arbitrarily, capriciously or irrationally: the implied duty usually referred to as the Braganza duty, after Braganza v BP Shipping Ltd [2015] UKSC 17. It does not turn a discretionary bonus into a guaranteed one, but it gives you a basis to challenge a decision that looks like it was driven by your departure rather than a genuine, considered assessment against the normal criteria.

Malus, clawback, and financial-services remuneration rules

Malus lets an employer reduce or cancel an unvested bonus award before it is paid, typically where misconduct, a risk-management failure or a material restatement comes to light. Clawback is the equivalent power to recover a bonus after it has already been paid. Both are contractual or plan-rule mechanisms, not automatic entitlements for the employer: they only apply if the bonus scheme or plan rules actually contain them, and normally only within a defined window and on defined trigger events.

If you work in banking, insurance or a regulated investment firm, malus and clawback may also be shaped by the FCA and PRA Remuneration Codes (the relevant chapter of the FCA Handbook is SYSC 19A, 19B, 19C or 19D depending on your firm's prudential category, which is a fact-specific question your solicitor can help you check against your own contract). These codes generally require firms to be able to apply malus for a set period after an award is made, and clawback for a further period after it vests, for identified staff whose role can materially affect the firm's risk profile. Because which code applies, and for how long, depends on the type of firm and your role, treat this as the starting question to ask your solicitor rather than an answer to assume: get the actual clause in your contract or plan rules checked, do not rely on a general description of the regime.

Bonus-round timing versus your termination date

Many bonus plans require you to be "in employment" or "not under notice" on a specified record date to qualify for that year's award. If your termination date falls just before a bonus round, you may lose an award you would otherwise have earned for a full year's work; if it falls just after, the position can be stronger. This is one of the most common places where the settlement agreement's termination date, and not just the compensation figure, is worth negotiating: a short extension to your termination date can sometimes bring a bonus record date within scope where the figure alone could not replicate that value.

Deferred awards: what a settlement agreement can and cannot preserve

Deferred cash or share-based bonus awards vest over future years and are governed by the plan rules that created them, not by the settlement agreement. A settlement agreement can confirm what the employer has agreed to do with a deferred award on your specific facts, for example treating you as a "good leaver" so deferred tranches continue to vest on their original schedule, or paying out an accelerated cash equivalent. What it generally cannot do is unilaterally rewrite the plan rules themselves or bind a separate scheme administrator who is not a party to the agreement. Always check the leaver definitions in the actual plan document before assuming the settlement agreement's wording is enough on its own, and where the deferred award is in the form of options or RSUs rather than cash, read our guide to share options and RSUs alongside this one.

How bonus interacts with PENP and the £30,000 exemption

Bonus payments are taxable as earnings and sit outside the £30,000 termination-payment exemption regardless of how the settlement agreement labels them. They can still interact with the post-employment notice pay (PENP) calculation that determines how much of any payment in lieu of notice is taxable, because PENP is calculated from your basic pay, not your bonus, but a bonus paid alongside a termination payment affects the overall tax position of the package as a whole. Our tax guide and PILON guide cover PENP in detail. We do not advise on tax; we tell you what to ask a solicitor, and where the numbers are large or unusual, an accountant, to check before you sign.

What to ask for: a clause-by-clause checklist

Some of this is simply owed to you and should already be in the first draft; some of it is genuinely negotiable and depends on your leverage and the specific facts.

A worked example: structure, not figures

Consider an employee whose termination date is set for three weeks before their firm's annual bonus record date, with a deferred award from two years ago still one tranche short of full vesting. The structure a solicitor would typically check is: first, whether the accrued and unpaid elements of last year's bonus are correctly listed as a separate, taxable payment; second, whether a short extension to the termination date is worth requesting to bring the employee inside this year's bonus record date, rather than losing that year's award entirely; and third, whether the deferred tranche can be preserved under a good-leaver classification, recorded in the settlement agreement, rather than lapsing on the standard leaver terms. None of that requires knowing the pound figures in advance, it is a structural review of what the agreement does and does not currently cover.

Bonus and deferred compensation: frequently asked questions