What is the £30,000 tax-free threshold for settlement agreements?

Genuine compensation for loss of employment, known as termination payments, can be paid tax-free up to £30,000. Amounts above this threshold are subject to income tax at your marginal rate. Employer National Insurance contributions also apply on termination payments above £30,000, though employee NICs do not. The £30,000 exemption is cumulative: if you have received a previous tax-free termination payment from the same employer, it may reduce your available allowance.

What else should I consider about tax when accepting a settlement agreement?

There are several important considerations: the tax year in which you receive the payment matters and spreading payments may be beneficial in some cases; it may be possible to make a payment directly into your pension to reduce tax liability; and if you have had multiple employments the £30,000 exemption is cumulative and earlier termination payments may affect your allowance. Always seek qualified tax advice specific to your situation.

Settlement Agreement Guide

Tax Implications of Settlement Agreements

Q: What payments in a settlement agreement are always taxable?

Some payments are always subject to income tax and National Insurance regardless of how they are structured: outstanding salary or wages, accrued holiday pay, bonus payments, commission owed, payment in lieu of notice (PILON) where your contract includes a PILON clause, and restrictive covenant payments.

Q: How is payment in lieu of notice taxed in a settlement agreement?

The tax treatment of PILON depends on your contract. If your contract includes a PILON clause, the payment is fully taxable through PAYE. If no PILON clause exists, the Post-Employment Notice Pay (PENP) rules apply: a calculation determines how much is taxable, and any excess may qualify for the £30,000 tax-free exemption.

Q: What settlement agreement payments can be tax-free?

Payments that may qualify for the £30,000 tax-free exemption include: ex-gratia payments (compensation for loss of employment), statutory redundancy pay, enhanced redundancy pay above the statutory minimum, compensation for unfair dismissal or discrimination, and damages for breach of contract beyond notice.

Last updated: 2 May 2026

Understanding what is taxable and how to maximise your tax-free payments

Key Point: £30,000 Tax-Free Threshold

Genuine compensation for loss of employment (termination payments) can be paid tax-free up to £30,000. Understanding what qualifies is crucial to maximising your payment.

What payments in a settlement agreement are always taxable?

Certain settlement agreement payments are fully subject to income tax and National Insurance regardless of how they are labelled in the agreement. These include outstanding salary, accrued holiday pay, bonuses, commission, and PILON where a contractual PILON clause exists. Use our settlement calculator to see roughly how your settlement breaks down between the tax-free £30,000 and the taxable portion.

Payment Type	Tax Treatment
Outstanding salary/wages	Fully taxable (PAYE)
Accrued holiday pay	Fully taxable (PAYE)
Bonus payments	Fully taxable (PAYE)
Commission owed	Fully taxable (PAYE)
Payment in lieu of notice (PILON)	Taxable (see note below)
Restrictive covenant payments	Fully taxable (PAYE)

How is payment in lieu of notice taxed in a settlement agreement?

Since April 2018, all contractual and non-contractual PILON is taxable as earnings under the Post-Employment Notice Pay (PENP) rules in ITEPA 2003, s.402B. The PENP formula calculates a notional notice pay amount that is treated as employment income regardless of whether your contract contained a PILON clause -- only any excess above that calculated figure can potentially qualify for the £30,000 exemption.

If your contract includes a PILON clause: The payment is fully taxable through PAYE
If no PILON clause exists: Under "Post-Employment Notice Pay" (PENP) rules, a calculation determines how much is taxable. Any excess may qualify for the £30,000 exemption.

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What settlement agreement payments can be tax-free?

Genuine compensation for loss of employment -- collectively called termination payments -- can be paid free of income tax and employee National Insurance up to £30,000 under section 401 ITEPA 2003. This covers ex-gratia payments, statutory and enhanced redundancy pay, and compensation for unfair dismissal or discrimination. The key test is whether the payment flows from the employment relationship or from its termination.

Ex-gratia payments (compensation for loss of employment)
Statutory redundancy pay
Enhanced redundancy pay above statutory minimum
Compensation for unfair dismissal or discrimination
Damages for breach of contract (beyond notice)

How does a typical settlement agreement tax breakdown work?

In a typical settlement the total payment combines several components, some fully taxable and some qualifying for the £30,000 exemption. The example below shows how a £50,000 package splits: the taxable elements are processed through PAYE in the normal way, while the ex-gratia element up to £30,000 is paid gross.

Sample Settlement: £50,000 Total

Outstanding wages £2,000 (taxable)

Accrued holiday £1,500 (taxable)

PILON (3 months contractual) £15,000 (taxable)

Ex-gratia compensation £30,000 (tax-free)

Additional compensation (above £30k) £1,500 (taxable at marginal rate)

Tax-free amount £30,000

What else should you consider about tax when accepting a settlement agreement?

Beyond the £30,000 exemption, several structural choices can affect your tax position. These include the tax year in which payments are received, whether any sum can be routed into your pension, and whether previous termination payments from the same employer reduce the available allowance. A specialist solicitor will flag these points during the review.

National Insurance

Termination payments over £30,000 attract employer's NICs but not employee's NICs (as of current rules).

Multiple Employments

The £30,000 exemption is cumulative. If you received a previous tax-free termination payment, it may affect your allowance.

Pension Contributions

Consider whether any payment can be made directly into your pension to reduce tax liability.

Timing

The tax year in which you receive the payment matters. Spreading payments may be beneficial in some cases.

Disclaimer

This guide provides general information only and should not be relied upon as tax advice. Tax rules are complex and subject to change. We recommend consulting with a qualified tax adviser for advice specific to your circumstances.

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