Severance pay tax: what you pay tax and national insurance on

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What you pay tax and national insurance on depends on what is included in your termination payment.

Parts of your severance pay may be considered income, meaning it is subject to tax and national insurance. You will pay tax and national insurance on:

  • unpaid wages
  • vacation pay
  • bonuses
  • payments you receive from your employer for agreeing to enter into a restrictive covenant
  • any payment you receive instead of working during your notice period – this may be a payment in lieu of notice (PESTLE) or be part of any severance package

What you don’t pay tax and national insurance on

You will not pay tax and national insurance on:

  • contributions your employer pays into a registered pension plan as part of your severance pay – you will pay tax on any employer contributions that exceed the annual allowance
  • legal fees related to the settlement that your employer pays directly to your attorney
  • severance pay you receive because of an injury, illness or disability that prevents you from continuing to do your job

What may be tax exempt

You generally pay no tax on the first combined £30,000 of:

  • statutory severance pay
  • additional severance pay or enhanced severance pay your employer pays you
  • non-monetary benefits, such as company assets you keep after your job ends

You will pay tax on any amount over a combined total of £30,000.

Your employer will pay the employer Class 1A National Insurance on any amount over a combined total of £30,000.

If you don’t work your full notice period

You will pay tax and National Insurance on a portion of your severance pay equivalent to what you would have earned if you were working.

This can apply to:

  • fixed compensation in lieu of notice (PESTLE)
  • the salary you are given during your “gardening leave” (where you remain on the payroll but are asked not to work)
  • part of any severance, enhanced termination or non-monetary benefits you receive (known as post-employment notice pay (PENP)

Yes PENP applies to you, your employer will determine how much tax and national insurance you have to pay.

If the amount of PENP is greater than the total of any severance pay, enhanced severance pay, or non-monetary benefits you receive, you will only pay tax on the amount you actually receive.

Example 1

You are entitled to statutory redundancy pay of £10,000. PENP does not apply to statutory severance pay, so you will not pay tax or national insurance on this.

Your employer adds £5,000 severance pay.

The total you are entitled to is £15,000.

You didn’t need to work your 4 weeks notice. As you earn £500 a week, this means you would have earned £2,000 in taxable wages.

You will pay tax and national insurance on £2,000 of your severance pay.

You pay no tax on the remaining £13,000 of your total payment, as it is less than £30,000.

Example 2

You are entitled to statutory redundancy pay of £10,000. PENP does not apply to statutory severance pay, so you will not pay tax or national insurance on this.

Your employer adds £3,000 severance pay.

The total you are entitled to is £13,000.

You didn’t need to work your 4 weeks notice. As you earn £1,000 a week, this means you would have earned £4,000 in taxable wages, bringing your PENP to £4,000.

You will pay tax and national insurance on the full £3,000 of your severance pay.

You pay no tax on the remaining £10,000 of your total payment, as it is less than £30,000.

If you are a tax resident of another country, sailor or service member

You may be able to get part of your termination payment tax-free, if you are:

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