Tax Free Termination Payments: Understanding the Tax Implications in the UK

Facing a job termination can be a daunting experience, but understanding how tax free termination payments work in the UK can help you make sense of what you’re entitled to keep — and what HMRC will take. Whether you’ve been made redundant, dismissed, or offered an ex-gratia payment, here’s everything you need to know about termination payments and their tax implications.

What could be included in a termination payment?

Your termination payment may include your statutory redundancy pay, any holiday pay, your outstanding wages (if any), some company benefits like bonuses or any payment in lieu of notice (PILON), ex-gratia payments, etc. 

How Are Tax Free Termination Payments Calculated in the UK? 

It is important to know that different types of termination payments are taxed differently by the UK government. While all PILON (Payment in Lieu of Notice) payments are fully taxable, the good news is that tax free termination payments of up to £30,000 are permitted by HMRC for qualifying ex-gratia payments and statutory redundancy payments combined.

To have a better understanding of how your termination payment is taxed in the United Kingdom, suppose you have received an ex-gratia payment of £50,000 from your employer. In such a case, you will be taxed only on £20,000 i.e. the amount beyond the threshold limit of tax exemption. However, statutory redundancy payments are entirely tax-free. In short, you are tax-free on your termination payments up to a combined total of £30,000. 

Remember things may be different if you are not a UK resident for tax purposes or you are someone who was working at sea or a serving member of the armed forces. In all these three scenarios, a sizeable part of your termination payment will be tax-free.

How tax and National Insurance are deducted?

In all probabilities, if there is any tax or national insurance due on your termination payment, it will be deducted automatically under pay-as-you-earn (PAYE) by your employer and will be reflected in your final payslip. However, if you have received your termination payment after receiving your P45 form from your employer, there is a tax deduction. It is made based on this assumption that you have utilized your personal allowance fully for a tax year. Your P45 form will reflect the amount of tax you have paid on your salary so far in that tax year.

If you’re still confused or unsure whether you’ve been taxed correctly, it’s recommended that you must consult a qualified professional or skilled UK accountant. Navigating tax free termination payments can be complex, especially when multiple payment types are involved. Getting it wrong could mean overpaying tax or falling foul of HMRC. Our team at CoreAdviz specialises in employment tax advice — get in touch today to make sure your termination payment is handled correctly.

What Qualifies as a Tax Free Termination Payment?

Not every payment made on leaving a job qualifies for the tax free termination payment threshold. To benefit from the £30,000 exemption, the payment must be made as a genuine termination payment — not as a reward for past services or in place of notice. Statutory redundancy pay always qualifies. Discretionary ex-gratia payments typically qualify too, provided they aren’t contractually obligated. PILON, however, is always fully taxable regardless of how it’s labelled.