Settlement Agreement Pay Explained Notice, Holiday, Bonus, Tax and Benefits
Settlement Agreement pay explained: notice, holiday, bonus, tax and benefits
Quick answer
Settlement agreement payments are usually made up of several different elements. Some amounts, such as salary, notice pay, holiday pay, bonus and commission, may already be owed and must be taxed as earnings. A separate compensation or enhanced redundancy payment may qualify for the combined £30,000 termination-payment threshold, but the tax position depends on what each payment is really for. The agreement should provide a clear breakdown rather than one unexplained headline figure.
Key takeaways
- Separate contractual payments from any additional settlement or compensation payment.
- Salary, holiday pay, bonus, commission and notice-related payments must be paid subject to tax and National Insurance.
- The £30,000 threshold does not make the whole exit package tax free.
- Check how benefits, pension contributions, shares and commission will be treated after employment ends.
- The agreement should state each payment amount, the deductions to be made and when payment is due.
- Employment solicitors can check whether the package reflects both your existing rights and the claims you are giving up, but cannot usually advise on tax.
A settlement agreement may show an attractive headline payment, but the total can combine money already owed with compensation for settling employment claims.
That distinction affects both value and tax. Ask your employer for a clear schedule explaining every payment and deduction.
Start by separating what you are owed from what is being offered
A useful way to review settlement agreement pay is to divide the package into two groups.
- Contractual and statutory entitlements, such as salary, accrued holiday, notice pay, expenses, earned commission or bonus and redundancy pay.
- The additional settlement payment, which is usually offered in return for waiving the employment claims identified in the agreement.
An employer should not present money you are already entitled to receive as though it is extra compensation. The agreement should show the components separately, together with which payments will be subject to tax and National Insurance deductions.
1. Salary and other pay up to the termination date
You should receive your salary up to the termination date, together with any benefits, overtime, allowances, expenses or other sums normally due.
These are usually processed through payroll with tax and National Insurance deducted.
2. Notice pay, PILON and garden leave
Your contract and statutory rights determine how much notice you should receive. The agreement may provide for you to work your notice period, remain employed on garden leave or leave immediately with a payment in lieu of notice, often called PILON. Subject to your contract, how your notice period is treated is usually a decision for your employer.
If you work your notice period or remain on garden leave, you continue to be employed. Salary and contractual benefits will usually continue during that period. If your employment ends immediately, the agreement should explain what the PILON includes and whether benefits such as pension contributions or private medical insurance are reflected.
Notice-related payments are normally taxed as earnings. The GBP 30,000 termination-payment threshold does not apply to post-employment notice pay, including an amount treated as notice pay under the statutory post-employment notice pay rules.
3. Accrued holiday pay
When your employment ends, an employer should pay for any accrued but untaken statutory holiday.
You do not accrue holiday after the termination date, so if you are being paid in lieu of notice, you are not entitled to holiday that would have accrued during your notice period. If you work your notice period or remain on garden leave, you continue to be employed so will continue to accrue holiday, however, your employer can force you to take any unused holiday prior to the termination date.
If you are owed holiday pay, the calculation should reflect your working pattern and the applicable holiday-pay rules. Normal holiday pay can include elements such as commission and regular overtime in some circumstances.
Holiday pay is taxable and subject to National Insurance. The agreement should state the number of days being paid and the gross amount, rather than leaving the calculation unclear.
4. Bonus and commission
Bonus and commission can be significant where the termination date falls close to a payment or vesting date. Entitlement depends on the contract, scheme rules and any requirement to remain employed or not be under notice.
Check whether the agreement deals with:
- bonus or commission already earned but not yet paid;
- a pro-rata payment for the current financial year;
- sales completed before departure but paid later;
- deferred awards, share options or long-term incentive plans; and
- any good-leaver or bad-leaver provisions.
Any agreed amount should be written into the settlement agreement. Bonus and commission payments are normally taxed as earnings.
5. Redundancy payments
If the exit is genuinely by reason of redundancy, the package may include statutory redundancy pay, which can be paid tax free. There may also be an enhanced or contractual redundancy payment. Statutory redundancy pay is separate from notice pay and is based on factors including age, length of service and weekly pay, subject to statutory limits.
Redundancy and settlement compensation are commonly considered together when applying the combined £30,000 tax-free threshold. The threshold applies to qualifying termination payments, not to wages, holiday, bonus or notice-related earnings.
6. The compensation or ex gratia payment
The additional compensation payment is the amount offered for settling the specified employment claims. It may be described as a termination payment, enhanced redundancy, compensation payment, severance payment or ex gratia sum.
The label is not conclusive. Tax treatment depends on the true reason for the payment. An amount that is really unpaid salary, bonus or notice pay does not become tax free simply because it is described as compensation. [5]
Where a payment qualifies under the tax free termination-payment rules, the first combined £30,000 of qualifying compensation, statutory redundancy pay and relevant enhanced redundancy payments may be paid without employee tax and National Insurance. Income tax and National Insurance contributions will be due on the excess, and the employer may have separate Class 1A National Insurance obligations.
7. Benefits, pension contributions and shares
Benefits ending at termination may include private medical insurance, life assurance, a company car, pension contributions and share awards.
The agreement should say whether benefits continue through notice or garden leave and whether any value is included in a PILON. Where appropriate, it may be possible to negotiate an employer pension contribution as part of the package.
Share plans should be checked separately against the governing rules and the settlement wording.
8. Legal fees and other employer-paid support
Employers commonly contribute towards the independent legal advice required for a settlement agreement. A qualifying payment made directly to your solicitor under a specific term of the agreement can be treated separately for tax purposes, provided the relevant conditions are met.
The package may also include outplacement, counselling or financial guidance. Confirm what is offered and any deadline for using it.
9. Payment dates, deductions and tax indemnities
The agreement should state when each payment will be made. Contractual payments may be processed through the normal payroll, while the settlement sum may be due within a specified number of days after the employer receives the signed agreement and adviser’s certificate.
Check any conditions attached to payment, such as returning company property, completing a handover, resigning from directorships or withdrawing a tribunal claim.
Many agreements contain a tax indemnity requiring the employee to reimburse the employer if HMRC later decides more tax is due, subject to stated exceptions. Review its scope carefully where tax treatment is uncertain.
A practical settlement-pay checklist
- List every contractual and statutory sum already owed to you.
- Check the termination date, notice period and whether you will work, take garden leave or receive PILON.
- Confirm the accrued holiday calculation and the number of days included.
- Review bonus, commission, shares and benefit-plan rules rather than relying on verbal assurances.
- Separate taxable earnings from the additional compensation or redundancy payment.
- Check how the £30,000 threshold has been applied and whether the employer has shown all deductions.
- Confirm payment dates, conditions, pension treatment, legal-fee contribution and any tax indemnity.
When should you contact employment solicitors?
Speak to employment solicitors once you are made an offer or receive a settlement agreement, and especially where the package includes disputed notice, bonus, commission, shares, pension contributions or restrictive covenants, or where existing entitlements appear to be included in the headline offer.
An employment solicitor can compare the agreement with your contract and identify terms needing clarification or negotiation.
Frequently asked questions
Is the first £30,000 of every settlement agreement tax free?
No. The threshold generally applies only to qualifying termination and redundancy payments. Salary, holiday pay, bonus, commission, restrictive-covenant payments and notice-related amounts are normally taxable as earnings.
Is notice pay included in the GBP 30,000 threshold?
No. PILON and amounts treated as post-employment notice pay are subject to tax and National Insurance, even if the agreement describes part of the package as compensation.
Must my employer pay unused holiday?
Not necessarily. Your employer must pay for accrued but untaken statutory holiday when your employment ends, but can force you to take and use your holiday if you work your notice period or are placed on garden leave.
Can I ask for some compensation to be paid into my pension?
It may be possible to negotiate an employer pension contribution. The tax treatment can differ from cash compensation, but the pension scheme rules and annual allowance must be considered before terms are agreed.
Check the breakdown, not only the headline figure
A fair package should explain what is already owed, what is offered in addition and how each part will be taxed and paid. That makes the real value easier to assess.
At Springhouse Solicitors we offer a range of services, so please contact our friendly customer services team to discuss further via hello@kilgannonlaw.co.uk or 0800 915 7777.
Disclaimer
The above provides a general overview of areas in employment law and is not intended nor construed as providing specific legal advice. This article is for information purposes only and is correct at the time of publication. It does not constitute legal advice.
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