What is redundancy pay?

Redundancy pay is compensation provided to employees who lose their job due to their role no longer being necessary – this can be in voluntary redundancy or compulsory redundancy situations. It is typically offered as a financial cushion to help individuals transition between jobs, as a gesture of goodwill, and/or to settle potential Employment Tribunal claims.

Redundancy pay can be either statutory (mandated by law) or contractual (as agreed in an employment contract).

Tax-free threshold for redundancy payments

In the UK, redundancy payments up to £30,000 are tax-free if they are paid as compensation for termination of employment – payments above this threshold are subject to income tax but not employee national insurance contributions. This includes statutory redundancy pay and ex-gratia payments (although contractual redundancy payments will normally be subject to tax and national insurance).

Tax implications for payments exceeding £30,000

Any amount of redundancy payment exceeding £30,000 is taxed at your normal income tax rate, but will normally not be subject to employee national insurance contributions (if the redundancy payment is being paid as compensation for termination of employment).

Types of redundancy payments and their tax status

• Statutory redundancy pay: tax-free up to £30,000.
• Contractual redundancy pay: subject to tax and national insurance in the normal way.
• Compensation for termination of employment (ex-gratia payments): typically tax-free up to £30,000.
• Payments in lieu of notice (PILON): subject to tax and national insurance in the normal way.
• Holiday pay: subject to tax and national insurance in the normal way.

Components of a redundancy package

These are the standard components of a redundancy package.

Statutory redundancy pay

Statutory redundancy pay is a legal entitlement based on age, length of service, and weekly earnings, subject to a weekly earnings cap set by the government. This payment is always tax-free up to £30,000.

Payments in lieu of notice (PILON)

PILON is compensation for the notice period when an employer chooses to terminate employment immediately. PILON is taxable as it is considered earnings rather than as compensation for termination of employment.

Holiday pay and other accrued benefits

Any accrued but unused holiday pay is taxable, as it is treated as regular earnings. Similarly, other accrued benefits, such as bonuses, are also taxable.

Compensation for termination of employment

This is also referred to as “enhanced redundancy pay” (as your employer is paying you  a greater amount of redundancy pay than you are entitled to by law). These are discretionary payments made by employers, and are tax-free up to £30,000. Your employer will often ask you to sign a settlement agreement as the ‘quid pro quo’ for paying you tax-free compensation for termination of your employment.

Managing tax on your redundancy payment

We have included below some tips on managing tax on your redundancy payment.

Checking your tax position with HMRC

It is advisable to review your tax calculation and confirm its accuracy with HMRC. You can use the HMRC online services to check your tax record and payment history.

Seeking professional tax advice

A tax advisor can help you understand your tax liabilities, identify eligible exemptions, and ensure compliance with HMRC regulations. We are not accountants, but expert employment lawyers, and expert accountants will help you to determine whether your redundancy pay is taxable (and at what rate).

Who deals with the tax on the redundancy pay?

The employer will usually deduct tax and NI contributions from your final payslip, but employees still have a responsibility to ensure these are correct and to check what elements of the redundancy pay are taxable (and what are not). Because redundancy pay tax calculations can sometimes be complex employers may not always get them right, and you should always double-check.

There is a general assumption that the first £30,000 of a redundancy payment will always be tax-free, but it isn’t always this straightforward – the calculation of tax on final redundancy payments can often be quite complex. You should always carefully evaluate your position and get advice from the appropriate experts.

If you are owed a redundancy payment then you may be worried that your employer has not clearly set out to you which payments are tax-free and which redundancy payments are taxable. We can also advise you on whether your redundancy has been fair and what options you have regarding an Employment Tribunal claim.