Tax on redundancy payments: what is tax-free?

Is redundancy pay tax-free?

Partly. Your package is made of two different kinds of payment, and only one kind gets the exemption:

• Statutory redundancy pay is a qualifying termination award and uses the exemption.
• Qualifying enhanced redundancy or severance can use it too — see enhanced redundancy pay explained.
• All such qualifying payments and benefits are added together and share a combined £30,000 exemption — not £30,000 each.
• Anything above the combined £30,000 is subject to Income Tax.
• There is no employee National Insurance on a genuine termination award, even the part over £30,000 — the employer pays Class 1A NI on the excess.

Which parts are taxed?

Salary, holiday pay, bonuses and notice pay stay earnings however and whenever they’re paid — they don’t touch the £30,000 exemption:

Your settlement agreement may label a payment “compensation”, “ex gratia” or “severance”. The label alone does not determine the tax treatment — what matters is what the payment is really for.

How the £30,000 tax-free exemption works

You add up the qualifying termination awards, take off £30,000, and tax what’s left:

You pay Income Tax on the £7,000 at your marginal rate, but no employee NI. Your employer pays Class 1A NI on it — for 2026/27 that’s 15%, so £7,000 × 15% = £1,050. That employer cost is not taken from your package.

A full redundancy package example

Putting earnings and the termination award side by side:

• Taxed as earnings — £8,700 (salary, holiday and notice pay): Income Tax, employee National Insurance, and Student Loan if applicable.
• Termination award — £25,514 (statutory + enhanced): below £30,000, so no Income Tax and no employee NI.

The exact tax on the earnings depends on your salary, tax code and how the payment is made, so use the redundancy pay calculator to estimate the annual Income Tax effect, the pay-period NI and any student loan.

PILON and PENP

If you don’t work all of your notice, some or all of the payment relating to that notice is normally taxed as earnings. HMRC’s Post-Employment Notice Pay (PENP) rules can reclassify part of a severance or enhanced-redundancy figure as taxable earnings — even where the “PILON” box is zero. Statutory redundancy pay itself is not caught by PENP, and your employer should work out the PENP figure. Read: PILON and PENP explained.

What if you’re paid after your P45?

There are two different numbers to keep apart — the deduction on the payslip, and your final tax for the year.

Initial payslip deduction. Once your P45 is issued, payroll usually uses an emergency 0T code (S0T for Scottish taxpayers, C0T for Welsh) on a Week 1 / Month 1 basis. That gives no Personal Allowance against the payment, so the up-front tax can look high.

Final annual tax. The 0T deduction isn’t necessarily your real tax for the year. Once all your income is counted you might be due a refund, owe a little, or be exactly square — HMRC reconciles it through a new job, a tax calculation or a claim.

Do you pay National Insurance?

Employee NI applies to salary, holiday pay, bonus, PILON, PENP and other earnings.

Employee NI does not apply to statutory redundancy, genuine termination awards, or the taxable excess above £30,000. Your employer pays Class 1A NI on that excess instead.

One detail people miss: employee NI on the earnings is worked out using the relevant pay period(often a one-off weekly period for a lump sum after leaving), not by simply adding the payment to your annual salary — which is why the NI can be lower than you’d expect.

Student loan deductions

Student Loan and Postgraduate Loan deductions can apply to the parts treated as earnings — salary, holiday pay and notice pay — and are taken per pay period. They do not normally apply to a genuine termination award using the £30,000 exemption. The calculator includes the weekly / monthly / director basis, and there’s more in the student loan repayment guide.

Multiple payments and different tax years

Splitting one termination package across two tax years does not create a new £30,000 exemption. The £30,000 is used against the earlier payments first, and only the remainder is available later.

Less common exemptions

• Employer-paid qualifying legal costs can have a separate exemption.
• Payments made wholly because of a qualifying injury or disability can be exempt — but “injury to feelings” is not automatically the same thing.
• International / non-resident cases can have extra rules (foreign-service relief).