Tax Guide
The first £30,000 of your settlement agreement is tax-free in 2026. Here is how the exemption works and what is taxable.
From 6 April 2026, the first £30,000 of a settlement agreement is tax-free in the UK. This rule comes from Section 403 of the Income Tax (Earnings and Pensions) Act 2003 ¹. The exemption applies to statutory redundancy pay, ex-gratia compensation, and occupational redundancy. Notice pay, holiday pay, and salary are fully taxable. Use this guide to see how the limit applies to your offer.
Key tax rules for settlement agreements
- The £30,000 exemption only applies to genuine compensation for losing your job.
- You pay no employee National Insurance contributions on any part of your termination payment.
- Your employer covers your legal fees for this process, which is paid tax-free under HMRC rules.
What is the £30,000 tax-free settlement rule?
The £30,000 rule is a statutory tax exemption. It allows employers to pay termination payments up to £30,000 without deducting income tax. This limit applies to all payments related to the loss of your employment.
If your package is under £30,000, you will pay no income tax on qualifying components. If your package exceeds £30,000, you pay tax only on the portion above this limit.
This exemption is a lifetime limit for one employment. It applies to the total of all termination payments from the same employer. It also applies to payments from connected employers.
What qualifies for the £30,000 tax-free exemption?
Only specific parts of your settlement agreement qualify for the £30,000 tax-free limit. Other components are always fully taxable.
Qualifying tax-free payments
- Statutory redundancy pay (capped at £22,530 in Great Britain ², see our 2026 cap guide).
- Ex-gratia payments, which are discretionary payments to compensate for losing your job.
- Damages for unfair dismissal or breach of contract.
- Injury to feelings payments, provided the discrimination occurred before your termination ³.
Payments that are not linked to losing your job do not qualify. Holiday pay, accrued salary, and contractual bonuses are fully taxable.
Tax Treatment of Settlement Agreement Components
Each component of your settlement agreement has its own statutory tax rules. Below is how each payment type is treated.
| Component | Income Tax | National Insurance | Statutory Basis |
|---|---|---|---|
| Statutory Redundancy | Tax-free up to £30,000 | No employee NICs. Employer Class 1A on excess over £30,000. | ITEPA 2003 s.403 ¹ |
| Ex-Gratia Payment | Tax-free up to £30,000 | No employee NICs. Employer Class 1A on excess over £30,000. | ITEPA 2003 s.403 ¹ |
| PILON (Notice Pay) | Fully taxable as earnings | Fully taxable for both employee and employer. | ITEPA 2003 s.402D ⁴ |
| Holiday Pay | Fully taxable as salary | Fully taxable for both employee and employer. | Normal payroll rules |
| Legal Fees Contribution | Fully tax-free | Tax-free (exempt from all taxes). | HMRC ESC A81 ⁵ |
| Pension Contribution | Fully tax-free | Tax-free (exempt from all taxes). | Registered pension rules |
| Injury to Feelings (Pre-termination) | Fully tax-free | Tax-free (exempt from all taxes). | ITEPA 2003 s.406 ⁶ |
Figures and rules reflect current UK employment tax legislation for the 2026/27 tax year.
Worked Examples: How the £30,000 Tax Limit Works
These three examples show how the tax-free limit applies to different settlement agreement values.
Example 1: Redundancy package under £30,000
You receive a statutory redundancy payment of £6,000 and an ex-gratia payment of £15,000. You work your notice period.
The total termination package is £21,000. Because this is below the £30,000 limit, the entire £21,000 is paid tax-free.
You pay no income tax and no National Insurance on this amount.
Example 2: Redundancy package exceeding £30,000
You receive a statutory redundancy payment of £12,000 and an ex-gratia payment of £25,000. The total is £37,000.
The first £30,000 is paid tax-free. The remaining £7,000 is subject to income tax.
Your employer deducts income tax from the £7,000 excess. You pay no employee National Insurance on the £37,000.
Your employer must pay Class 1A National Insurance on the £7,000 excess.
Example 3: Settlement with notice pay (PILON)
You receive a £5,000 PILON payment and an ex-gratia payment of £28,000. The total package is £33,000.
The £5,000 PILON is fully taxable. Your employer deducts income tax and National Insurance from it.
The £28,000 ex-gratia payment is separate. It is below the £30,000 limit, so it is paid tax-free.
The tax indemnity clause: What you need to know
Every settlement agreement contains a tax indemnity clause. This clause is standard in UK employment law.
The clause states that you are responsible for any unpaid tax on your settlement. If HMRC decides that more tax is due, you must pay it.
This includes any interest or penalties. It also means you must refund your employer if HMRC bills them.
This indemnity shows why correct tax structure is vital. If your employer gets the tax wrong, you carry the financial risk.
Your solicitor will check the tax wording to ensure it is standard. They will make sure you only pay what you legally owe.
What to do if your employer structures the tax incorrectly
If your employer gets the tax structure wrong, you may pay too much tax. You might also face an HMRC bill later. Here is what to do:
- 1
Ask payroll for a detailed tax breakdown
They must show how they calculated the tax on your payments.
- 2
Verify the notice pay portion
Ensure they did not lump notice pay and ex-gratia compensation together.
- 3
Request amendments before you sign
Ask your employer to separate the tax-free ex-gratia sum from the taxable notice pay.
- 4
Have your solicitor review the tax indemnity
Your solicitor will verify the tax structure before signing the agreement.
Your employer covers your solicitor fees for reviewing and signing the settlement agreement. This legal requirement protects you from making costly tax errors.
Check your settlement offer now
Verify your statutory redundancy entitlement and calculate how much of your settlement is tax-free.
Check my offerFrequently asked questions
Is a settlement agreement always tax-free up to £30,000?
No. The £30,000 exemption only applies to genuine compensation for losing your job, such as redundancy pay or ex-gratia payments. Notice pay, holiday pay, and salary are always taxable.
Do I pay National Insurance on settlement payments over £30,000?
No. You do not pay employee National Insurance contributions on any part of your termination payment, even if it exceeds £30,000. You only pay income tax on the amount above £30,000. Your employer, however, must pay Class 1A National Insurance on the excess.
Is my employer's contribution to my legal fees tax-free?
Yes. Your employer can pay your legal fees directly to your solicitor tax-free under HMRC rules. This payment does not count towards your £30,000 exemption limit.
Can I pay my settlement into my pension to avoid tax?
Yes. You can request that your employer pays some or all of your settlement directly into your pension scheme. This payment is tax-free and does not use up your £30,000 exemption, provided it stays within your annual pension allowance.
References and Legislation
- Income Tax (Earnings and Pensions) Act 2003, Section 403
- Employment Rights Act 1996, Section 227 (as amended by SI 2026/310)
- Income Tax (Earnings and Pensions) Act 2003, Section 401
- Income Tax (Earnings and Pensions) Act 2003, Section 402D
- HMRC Extra-Statutory Concession A81 (ESC A81)
- Income Tax (Earnings and Pensions) Act 2003, Section 406 (exception for death or disability)
Disclaimer: Tax calculations on this page are statutory estimates based on 2026/27 HMRC rates. They do not constitute formal legal or tax advice. Confirm your specific offer using our free calculator.