Redundancy Pay and Tax: What You'll Actually Receive
Your employer says you're getting £45,000. You start planning. Then the money arrives and it's thousands less than you expected. I've seen this happen so many times, and it's always because people didn't understand how the tax works on redundancy pay. Let me walk you through it so you know exactly what to expect.
The £30,000 Tax-Free Threshold
This is the big one. The first £30,000 of a genuine redundancy payment is completely tax-free. No income tax. No National Insurance. That threshold hasn't changed in years, and it applies no matter what you earn or what tax band you're in.
It covers both statutory redundancy pay and any enhanced amount your employer adds on top. So if your total redundancy payment is under £30,000, you keep every penny. If it's over that, only the bit above £30,000 gets taxed.
What Counts Towards the £30,000 Threshold
Here's where people get tripped up. Not everything in your leaving package falls under that £30,000 shelter. Some parts get taxed as normal earnings no matter what, and getting these confused can be an expensive mistake.
| Payment Type | Tax Treatment |
|---|---|
| Statutory redundancy pay | Tax-free (within £30,000) |
| Enhanced redundancy pay | Tax-free (within £30,000) |
| Ex-gratia payments | Tax-free (within £30,000) |
| Payment in lieu of notice (PILON) | Taxable as earnings |
| Outstanding salary and wages | Taxable as earnings |
| Accrued holiday pay | Taxable as earnings |
| Bonus payments | Taxable as earnings |
Notice Pay and the Post-Employment Notice Pay Rules
This is the one that catches people out most. The rules changed back in April 2018, and plenty of employers still get it wrong. If you're let go without working your full notice period, HMRC automatically treats a chunk of your payout as taxable earnings. They call it PENP -- post-employment notice pay.
The thinking behind PENP is simple: the money you would have earned during your notice period should always be taxed like normal pay. Your employer can call it whatever they want -- redundancy, ex-gratia, goodwill -- but HMRC doesn't care about the label. They'll tax the notice element regardless.
How PENP Is Calculated
The formula: take your basic pay, divide by the number of pay periods in a year, multiply by the unworked notice days in the pay period, then subtract anything already paid for the notice period. So if you earn £45,000 and your employer tells you not to work your three-month notice, your PENP is roughly £11,250. That's taxed as earnings, even though it looks like part of your redundancy package.
Ex-Gratia Payments
An ex-gratia payment is money your employer gives you voluntarily -- they don't owe it, they just choose to pay it. Sometimes it's a goodwill gesture, sometimes it's part of a settlement deal. If it's genuinely connected to the end of your employment (rather than being a dressed-up bonus), it can sit within the £30,000 tax-free threshold.
But HMRC isn't stupid. If that "ex-gratia" payment is really just a relabelled bonus, they'll tax it as earnings. The test is straightforward: would the payment have been made even if you hadn't been let go? If yes, it's taxable. End of story.
National Insurance on Redundancy Payments
Good news here. Redundancy payments under £30,000 are exempt from National Insurance for both you and your employer. If the payment goes over £30,000, your employer pays employer's NI (at 13.8%) on the excess, but you don't pay any employee NI on it. That's actually a decent tax advantage compared to normal pay.
Everything classified as earnings -- notice pay, holiday pay, bonuses -- gets hit with both income tax and NI in the normal way. No special treatment there.
Pension Contributions as a Tax Efficiency Strategy
This is the best-kept secret in redundancy tax planning. If your payout is over £30,000, ask your employer to put the taxable excess straight into your pension as an employer contribution. Employer pension contributions aren't subject to income tax or NI for either party, as long as you stay within your annual allowance. It's completely legitimate and can save you thousands.
The annual allowance for 2025/26 is £60,000 (or 100% of your earnings, whichever is lower). Got unused allowance from the last three years? You can carry that forward too.
Settlement Agreements and Tax
If a settlement agreement lands on your desk, it should break your total payment into separate parts: statutory redundancy, enhanced redundancy, PILON, and any ex-gratia amount. Each piece gets taxed differently based on the rules above.
Get a solicitor to check the tax breakdown before you sign. Most settlement agreements include a tax indemnity clause, which means if HMRC later decides something was taxed wrong, you foot the bill. Not your employer. You. That's why getting the breakdown right matters so much.
How Your Employer Will Process the Payment
Your employer handles the tax deductions through PAYE. The taxable bits (salary, holiday pay, notice pay) go through normal payroll. The redundancy payment gets processed separately, with the first £30,000 paid gross and anything above taxed at your marginal rate.
Mistakes happen more often than you'd think. Employers misclassify notice pay, or forget to apply the £30,000 exemption properly. If you think you've been overtaxed, check your Personal Tax Account on GOV.UK or phone HMRC. You can get the overpayment back.
Summary: Putting It All Together
The key is to stop thinking of your redundancy package as one lump sum. Break it apart. Statutory and enhanced redundancy pay? Tax-free up to £30,000. Notice pay? Always taxable. Holiday pay, bonuses, outstanding salary? Normal earnings. And if you're over the £30,000 threshold, pension contributions could save you a significant chunk of tax.
Use our redundancy pay calculator to work out your statutory entitlement, then apply the principles above to figure out what actually hits your bank account.