Is Redundancy Pay Taxed?

One of the most common questions people ask when facing redundancy is whether they will have to pay tax on their redundancy payment. The short answer is that redundancy pay up to £30,000 is tax-free in the UK. But the full picture is more nuanced, and understanding exactly what counts towards that threshold, what falls outside it, and how HMRC treats different parts of your final pay packet can make a real difference to the amount you take home.

This guide explains the UK tax rules for redundancy payments in plain English, covering statutory pay, enhanced packages, notice pay, holiday pay and National Insurance.

The £30,000 Tax-Free Threshold

Under UK tax law, the first £30,000 of a genuine redundancy payment is completely free from income tax. This applies regardless of whether you are a basic-rate, higher-rate or additional-rate taxpayer. The exemption is set out in the Income Tax (Earnings and Pensions) Act 2003 and has remained at £30,000 for many years.

It is important to understand that the £30,000 limit is a lifetime allowance for the specific employment that is ending. If you have been made redundant before from a different employer and received a payment then, that earlier payment does not count towards your current £30,000 threshold. However, if you receive multiple payments from the same employer in connection with the same redundancy, they are added together.

What Counts Towards the £30,000?

The following payments fall within the £30,000 tax-free allowance:

• Statutory redundancy pay -- the amount calculated using the statutory formula based on your age, weekly pay and length of service. The current maximum is £21,570.
• Enhanced or contractual redundancy pay -- any additional lump sum your employer pays above the statutory minimum as part of their own redundancy scheme or as a negotiated settlement. This is added to your statutory amount, and the combined total is tax-free up to £30,000.
• Ex-gratia payments -- goodwill payments made by the employer specifically in connection with the termination of your employment.

Because the maximum statutory redundancy pay is currently £21,570, most employees receiving only the statutory amount will be well within the tax-free limit. It is when employers offer enhanced redundancy packages that the £30,000 ceiling becomes relevant.

Example

Sarah, aged 48, has worked for her company for 15 years and earns £719 per week. Her statutory redundancy pay is around £21,570. Her employer offers an enhanced package of £30,000 in total. Because the entire amount is at or below the tax-free threshold, Sarah pays no income tax on the redundancy payment itself.

What IS Taxed as Normal Earnings

Not everything in your final pay packet qualifies for the £30,000 exemption. HMRC treats the following as ordinary earnings, subject to income tax and National Insurance in the usual way:

Pay in Lieu of Notice (PILON)

If your employer asks you to leave before the end of your notice period and pays you instead of having you work, that payment is taxed as earnings. This is the case regardless of whether your contract contains a PILON clause. Since April 2018, HMRC has required all payments in lieu of notice to be treated as taxable earnings. You can read more about this on our PILON guide.

The taxable amount is based on your basic pay for the notice period you would have worked. Specifically, HMRC calculates the "post-employment notice pay" (PENP), which is the pay you would have received during your statutory or contractual notice period, whichever is longer.

Outstanding Wages and Salary

Any wages owed to you up to your termination date, including your final month's salary, are taxed through PAYE as normal.

Accrued Holiday Pay

Payment for holiday you have accrued but not taken is treated as earnings. It is subject to income tax and National Insurance.

Bonus Payments

If your employer pays you a bonus as part of your leaving package, this is usually treated as earnings rather than as part of the redundancy payment, especially if it relates to work already performed. It will be taxed in the normal way.

Benefits in Kind

Continued use of company benefits after termination, such as a company car or private medical insurance, can also attract a tax charge.

National Insurance on Redundancy Pay

The rules for National Insurance are slightly different from income tax, and in many cases more favourable for the employee:

• Up to £30,000: No employee National Insurance and no employer National Insurance on redundancy pay.
• Above £30,000: The employee still pays no National Insurance on the excess. However, the employer must pay Class 1A National Insurance contributions on the amount above £30,000.
• PILON, holiday pay and wages: These are subject to both employee and employer National Insurance as normal.

This means that even if your total redundancy payment exceeds £30,000, you will never pay employee National Insurance on any part of the genuine redundancy element. This is a meaningful saving compared to ordinary income.

How Tax Is Collected on Redundancy Payments

Your employer is responsible for deducting the correct amount of tax through the PAYE system before making your final payment. In most cases, you do not need to do anything yourself. Your employer should separate out the different elements of your pay: the tax-free redundancy amount, the taxable PILON, holiday pay, wages and any excess above £30,000.

If you believe too much tax has been deducted, you can claim a refund from HMRC. This sometimes happens when a large redundancy payment pushes you into a higher tax band temporarily, or when PAYE is applied on a cumulative basis. You can write to HMRC or call their helpline, and you may receive a refund after the end of the tax year when your total earnings are reconciled.

Tax on Payments into a Pension

One strategy some employees use to reduce the tax impact of a large redundancy package is to ask their employer to pay part of the amount directly into a pension scheme. Employer contributions to a registered pension scheme are not subject to income tax or National Insurance (within annual and lifetime allowance limits). If your employer agrees, this can be a highly tax-efficient way to receive a redundancy payment that would otherwise exceed the £30,000 threshold.

However, this must be a genuine employer contribution, not a salary sacrifice arrangement set up solely to avoid tax on the redundancy payment. You should seek independent financial advice before pursuing this option.

Settlement Agreements and Tax

If you sign a settlement agreement (sometimes called a compromise agreement), the tax treatment of the payment depends on what the payment is for. The settlement agreement should clearly break down the payment into its component parts: statutory redundancy, enhanced redundancy, notice pay, holiday pay, and any compensation for loss of employment. Each element is then taxed according to the rules above.

It is common for employers to include an indemnity clause in settlement agreements stating that the employer has made reasonable efforts to apply the correct tax treatment, but that the employee will be responsible for any additional tax HMRC may later assess. This is standard practice and generally not a cause for concern if the breakdown is accurate.

Key Points to Remember

• The first £30,000 of a genuine redundancy payment is tax-free.
• Statutory and enhanced redundancy pay both count towards the £30,000.
• Notice pay, PILON, holiday pay and wages are always taxed as earnings.
• You never pay employee National Insurance on redundancy pay, even above £30,000.
• Amounts above £30,000 are subject to income tax at your marginal rate.
• Consider pension contributions to reduce tax on amounts above the threshold.