Termination payments – a quick guide for employees
If you’re being offered a termination payment then you will want to learn more about what such payments are, what value of payment you can receive, and how these payments are taxed. Our specialist employment solicitors consider these issues below
- What is a termination payment?
- What can you expect to receive as a termination payment?
- How are termination payments taxed?
- What should you consider if you have been offered a termination payment?
What is a termination payment?
A ‘termination payment’ is a payment which is paid to employees upon the termination of their employment by the employer as compensation for the termination of their employment. These payments are generally paid for a variety of reasons, including (among others):
- Termination payments are quite tax-efficient for employees;
- They are generally offered as a ‘sweetener’ for employees to enter into a settlement agreement, whereby the employee will generally agree to waive any claims that they have against their employer in return for a monetary payment (and other non-financial benefits);
- As a gesture of goodwill by employers to employees
What can you expect to receive as a termination payment?
The answer to this question is ‘it depends’ – the amount of the termination payment that you can expect to receive will depend on a variety of factors, including (and others):
- How long you have worked for your employer;
- Your salary in your job;
- The quality of the relationship that you have with senior management at your job;
- The industry that you work in (in our experience the highest termination payouts are made in the technology, financial services, accountancy, and pharmaceutical industries); and
- The strength of your potential claims against your employer – generally, the stronger your potential claims, the more likely that you are to receive a higher payout
In general, we would normally expect you to receive the following type of termination package ‘on average’ (as standard ballpark figures)
- Your salary and any holiday due to the termination date of your employment;
- Your notice pay;
- Any other contractual sums owed (bonus pay, commission etc.);
- A termination payment of two to three months’ gross salary (although this can be between three and six months depending on the type of claims you have, and sometimes up to twelve months’ gross salary or more)
How are termination payments taxed?
Tax-free termination payments
A termination payment paid as compensation for the termination of your employment can be paid free of tax and employees’ National Insurance Contributions up to a maximum of £30,000. The remainder over £30,000 will be subject to tax but not employees’ National Insurance Contributions (although employers’ National Insurance Contributions are payable on sums of compensation over £30,000, a change which was introduced in 2018).
Contractual sums that you are owed
Sums that you are contractually owed by your employer (known as ‘contractual emoluments’) are subject to tax and national insurance in full – this includes sums such as notice pay, holiday pay, bonuses, commission, benefits (e.g. car allowance, private medical insurance), and sums paid under Long Term Incentive Plans etc.
Writing off loans
If your employer is proposing to write off a loan that you owe them then the amount to be put towards this will generally be treated as earnings on which income tax and National Insurance Contributions are payble – however, if your employer is offering you less than £30,000 as compensation for the termination of your employment then it is more tax efficient to increase the termination payment to enable you to repay the loan and therefore use the full tax-free exemption (for termination payments).
You may also (subject to the rules of your pension scheme) be able to pay part of your termination payment into your pension – this can be a tax-efficient way of dealing with payments on termination. However, it is strongly recommended that you check your pension ‘annual allowance’ and ‘lifetime allowance’ and, further, that you seek specialist tax advice advice on your personal tax and pension circumstances.
There are also other limited tax exemptions available on termination of your employment, depending on your circumstances including:
- Your employer can pay your legal costs free of tax if one of the following criteria apply: 1) the payment of costs is made pursuant to an order of a court or tribunal; and 2) under the terms of a settlement agreement where the payment is made by the employer direct to your legal adviser (such as your solicitor);
- If you had a period of ‘foreign service’ during your employment then some or all of your termination payment may be exempt from income tax (however, from 6 April 2018 employees cannot claim foreign service relief if you are tax resident in the UK in the tax year in which your employment terminates (and we also recommend that you seek specialist tax advice on such situations);
- If you suffer from a recognised medical condition or disability which prevents you from carrying out your job at the date of the termination of your employment and the payment is made exclusively on account of that disability or injury then it may be paid free from income tax (again, we recommend that you seek specialist tax advice on such situations);
- As compensation if you have suffered a personal injury during the course of your employment;
- As compensation for an injury to feelings that you have suffered prior to the termination of your employment (normally relevant to some form of discrimination, harassment or victimisation claim)
As above, we recommend that you seek specialist advice if you consider that any of the circumstances at points 1 to 5 apply in you situation.
What should you consider if you have been offered a termination payment?
If you have been offered a termination payment by your employer then you should generally consider the following:
- What sum are you being offered as a termination payment? Are you happy with this, or do you wish to negotiate?
- What other non-financial benefits do you wish to try and negotiate? For example, do you want to try and negotiate a good reference, agreed wording for the announcement of your termination or stronger confidentiality clauses?
- Are there ways in which you can make the termination payment more tax-efficient (addressed above)
- Are you being offered a settlement agreement? If so, you will need to take legal advice from a solicitor on the terms of the settlement agreement (your solicitor can advise you on the termination payment and seek to negotiate it for you)