Tax on settlement agreement payments, explained

Not every part of your settlement payment is treated the same way by HMRC. Here's the general picture. Always confirm the specifics with your solicitor, since the exact tax treatment depends on your individual payment breakdown.

Is the first £30,000 of a settlement tax-free?

Genuine compensation for loss of employment can usually be paid tax-free up to £30,000. This applies to the part of your settlement that is compensation. Not a payment you were contractually owed anyway.

What parts of a settlement agreement are taxed as normal income?

Notice pay / payment in lieu of notice (PILON). Taxed and subject to National Insurance like ordinary salary, even if paid as part of a settlement
Outstanding salary and holiday pay. Taxed normally
Bonuses or commission you were contractually owed. Taxed normally
Any benefits in kind being paid out or continued. Usually taxable

Why does the settlement agreement tax breakdown matter?

A settlement agreement should itemise these elements separately, not present one lump figure. If everything is bundled together and labelled "compensation," it can look tax-free when parts of it legally aren't. Which can lead to an unexpected tax bill later, or issues if HMRC queries it. This is one of the most common things an independent solicitor checks.

What are the Post-Employment Notice Pay (PENP) rules?

Since 2018, rules around "Post-Employment Notice Pay" mean that even if your contract doesn't include a PILON clause, part of your termination payment equivalent to your notice period may still be treated as taxable earnings rather than tax-free compensation. This is a genuinely technical area. It's exactly the kind of thing your solicitor will calculate correctly rather than you needing to work it out yourself.

What should you check in your own agreement?

Is each payment element listed separately, with an amount against each?
Does the agreement say how tax will be handled. Deducted at source, or paid gross with you responsible?
Is there an indemnity clause asking you to cover any extra tax HMRC later decides is due? These are common. Worth understanding, not signing blind

This guide is general information, not a substitute for advice on your specific numbers. See GOV.UK's guidance on redundancy pay and tax for the government source, or send us your agreement and an independent solicitor can flag anything that needs a closer look.

r look before your solicitor calculates the detail.

Frequently asked questions

Is my whole settlement payment tax-free up to £30,000?

Only the genuine compensation-for-loss-of-employment element, not payments you were contractually owed anyway like notice pay, holiday pay or bonus. Those are taxed as normal income regardless of the £30,000 allowance.

What is an indemnity clause and should I worry about it?

It’s a clause asking you to cover any extra tax HMRC later decides is owed on your payment. It’s common and not necessarily a red flag, but you should understand what it means before signing. Your solicitor will explain it.

Does my employer sort the tax out, or do I?

This varies by agreement. Some deduct tax at source through payroll, others pay certain elements gross with the responsibility falling to you. Check which applies in your specific agreement.

Wherever you are in the process, Settlement Agreement Guide is here to help.