Termination Payments and Tax in 2026: The £30,000 Exemption, PENP, Notice Pay and Class 1A

When someone leaves a job with a settlement, a redundancy package or a payment in lieu of notice, the tax treatment depends on what each pound is for. Some of it is ordinary pay, taxed and subject to National Insurance in full. Some of it is compensation for losing the job, which gets the £30,000 tax-free allowance. And since 2018, part of many packages has to be carved out as post-employment notice pay (PENP) and taxed as earnings. This guide is for employers running the final payroll and for employees checking a settlement offer in 2026-27. It covers what's taxable, the £30,000 rule, the PENP formula, employer Class 1A National Insurance, and a full worked example.

Quick answer

The first £30,000 of genuine compensation for losing a job (statutory redundancy pay, enhanced or ex gratia severance and non-cash benefits) is usually tax-free. Anything above that is taxed at your normal rates, with no employee National Insurance, while the employer pays Class 1A at 15% on the excess. Pay, holiday pay, bonuses and notice pay, including PENP worked out from basic pay for any unworked notice, are taxed as earnings in full.

• PENP formula: ((basic pay × days of unworked notice) ÷ days in pay period) − any taxable PILON

• Statutory redundancy pay is never treated as PENP but does use up the £30,000

• Payments made after the P45 are taxed on 0T week 1/month 1, which often overtaxes

• Injury or disability payments, employer pension contributions and legal fees paid direct are exempt

• Class 1A on termination awards is reported and paid in real time through payroll

What counts as a termination payment

A termination payment is anything paid when an employment ends, whether through redundancy, dismissal, resignation or a negotiated exit. GOV.UK groups it into items that are just earnings and items that are compensation. The distinction drives everything else, so it's worth getting right before any numbers are run.

Taxed and subject to National Insurance as earnings, with no exemption:

• unpaid wages and overtime up to the leaving date;
• accrued but untaken holiday pay;
• bonuses and commission, including any bonus the contract entitles you to on leaving;
• payments for agreeing to a restrictive covenant, such as a non-compete clause;
• pay in lieu of notice, whether paid under a contractual PILON clause or as part of the severance, and gardening leave pay.

Compensation that qualifies for the £30,000 exemption, known in the legislation as relevant termination awards:

• statutory redundancy pay;
• enhanced redundancy pay above the statutory amount;
• ex gratia or compensation payments for loss of office;
• the value of non-cash benefits you keep, such as a company laptop or car transferred to you.

Exempt entirely, under GOV.UK's guidance:

• payments because an injury, illness or disability stops you continuing the job;
• employer contributions to a registered pension scheme as part of the package, up to the annual allowance;
• legal costs your employer pays directly to your solicitor for advice on the termination.

People who weren't UK tax resident for the tax year the employment ended, and seafarers, may get part of the payment tax-free under foreign service rules. Serving armed forces members should ask their employer about special rules.

The £30,000 rule

The first £30,000 of relevant termination awards is usually free of income tax and employee National Insurance. GOV.UK's wording is that you'll pay tax on any amount over a combined total of £30,000. "Combined" matters: the limit covers statutory redundancy pay, enhanced severance and non-cash benefits added together, and it applies across all qualifying payments from the same employment, not to each payment separately.

The £30,000 figure hasn't changed for decades, and no change had been announced as of October 2026. With the Autumn Budget due on 28 October 2026, it's worth checking for changes before you agree a package that will be paid next year.

Termination payments at a glance (2026-27)

£30,000

Tax-free compensation limit

combined, per employment

15%

Employer Class 1A on the excess

since 6 April 2020

£0

Employee NI on the award

earnings still attract NI

£751

Statutory redundancy weekly pay cap

maximum £22,530

Statutory redundancy pay always fits inside the £30,000, because the statutory maximum is £22,530 for dismissals in 2026-27. It still counts towards the limit, though, so a package of statutory redundancy plus enhanced severance can go over it. Our redundancy pay guide shows how to calculate the statutory amount from age, service and the £751 weekly cap.

Post-employment notice pay (PENP)

Before April 2018, employers could avoid tax on notice pay by leaving the PILON clause out of the contract and paying a lump sum of damages instead, all within the £30,000. PENP closed that gap. HMRC's Employment Income Manual says that from 6 April 2018, where an employee is given no notice or less notice than they're entitled to, the employer must use a statutory formula to work out the basic pay they'd have earned during the unworked notice. That amount is taxed as earnings and attracts Class 1 National Insurance, whatever the contract says.

The formula in section 402D of the Income Tax (Earnings and Pensions) Act 2003 is:

The PENP formula

Step 1

BP

basic pay in the last pay period before notice

Step 2

× D

calendar days of unworked notice

Step 3

÷ P

calendar days in that pay period

Step 4

− T

any PILON already taxed as earnings

Step 5

= PENP

nil if negative; capped at the award

Basic pay excludes overtime, bonuses, commission, allowances, benefits and anything paid because of the termination. Where salary has been reduced by salary sacrifice, the manual tells you to use the pre-sacrifice figure. T is any payment in lieu of notice that is already taxable as earnings, so contractual PILON isn't taxed twice; holiday pay and termination bonuses don't count in T.

For monthly-paid staff there's a simplification. If the last pay period is a month, the contractual notice is in whole months, the unworked notice is a whole number of months and (from 6 April 2021) salary is paid in 12 equal instalments, P is treated as 1 and D is counted in months. In practice, three months' unworked notice on £4,000 a month gives PENP of £12,000.

The notice that matters is the notice the employee was entitled to, which is the longer of the contractual period and the statutory minimum. The statutory minimum is one week after a month's service, rising to one week per complete year of service up to 12 weeks. So a long-serving employee on a contract that says one month's notice may still be owed 12 weeks, and PENP has to be worked out on the longer period. If the employee works part of their notice and is paid off for the rest, D is only the unworked part.

Non-cash items count too. If the employee keeps a company car or laptop as part of the deal, its market value is part of the termination award and uses up some of the £30,000. That's often overlooked when a settlement agreement lists the cash figure prominently and the car in a schedule, and it can push an otherwise tax-free package over the limit.

Two points trip people up. PENP is capped at the total relevant termination awards: if it's bigger than the severance, only the severance is taxed, because you can't be taxed on money you didn't receive. And statutory redundancy pay is never treated as PENP, so it's left out of the cap calculation. GOV.UK's own example shows both: with £10,000 statutory redundancy, £3,000 severance and £4,000 of PENP, all £3,000 of the severance is taxed as earnings and the £10,000 statutory payment stays tax-free.

Employer Class 1A National Insurance on the excess

From 6 April 2020, employers pay Class 1A National Insurance on the part of a termination award above £30,000. The rate is the secondary Class 1 rate in force when the payment is made, which is 15% in 2026-27. The employee doesn't pay any National Insurance on the award itself.

Unlike Class 1A on most benefits in kind, which waits for the P11D(b) after the tax year ends, Class 1A on cash termination awards is reported and paid in real time. HMRC's National Insurance Manual says the award should be reported through RTI at the time of payment or before, using the Class 1A year-to-date data item, and HMRC's CWG2 employer guide confirms it's due in real time. In practice it's paid along with the PAYE and Class 1 bill for the month of payment.

HMRC's example shows the split. A £100,000 package made up of £15,000 of earnings, £20,000 of PENP and £75,000 of compensation gives Class 1 National Insurance on £35,000 and Class 1A on £45,000 (the £75,000 award less the £30,000 threshold): £6,750 at 15%.

Normal Class 1 rules apply to the earnings elements: employee National Insurance at 8% and 2% and employer National Insurance at 15%. Because a large lump in one pay period goes well past the monthly upper earnings limit, most of the employee's National Insurance on a big notice payment is at 2%.

Worked example: a redundancy package

Aisha earns £4,000 a month (£48,000 a year), paid monthly in 12 equal instalments, and is entitled to three months' notice. Her employer makes her redundant on 30 September 2026 without her working any notice. Her package is statutory redundancy pay of £7,510, an enhanced severance payment of £40,000 and £1,200 of accrued holiday pay. Her contract has no PILON clause, so nothing is in T.

Of the £48,710 package, £30,000 is tax-free and £18,710 is taxable. Aisha's salary from April to September was £24,000, so her total taxable income for the year is £42,710, which is all inside the basic rate band. Her correct bill for the year is about £6,030 at 20%, assuming she has no other income.

Payroll won't deduct exactly that at the time. If the package goes through her final payslip on her normal cumulative 1257L code, the payroll only gives her six months' share of the basic rate band (about £18,850 of taxable pay), so a large part of the lump is taxed at 40%. Her tax to date would come to roughly £10,800. If the employer issues her P45 first and pays the package later, it must use 0T on a month 1 basis, giving one month's basic rate band and pushing part of the payment into the 45% band; the total deducted over the year ends up at a similar level.

Either way, Aisha has overpaid around £4,800, which comes back once her full-year income is known: through a new employer's cumulative payroll if she starts work in the same tax year, through an in-year P50 claim if she doesn't expect to work again for a while, or through HMRC's P800 reconciliation after 5 April. Employers should explain this when they hand over the breakdown, because a payslip that takes almost half of a lump sum is the commonest cause of complaints after a redundancy.

How employers process a termination payment

Final payroll for a leaver with a termination payment

1. 1

   Split the package

   Separate earnings (pay, holiday, bonus, contractual PILON) from the termination award. Work out PENP for any unworked statutory or contractual notice and move it into earnings.

   Tip: Use the notice the employee was entitled to under their contract or the statutory minimum, whichever is longer.

2. 2

   Apply the £30,000

   Deduct no tax on the first £30,000 of the award, including statutory redundancy pay. Tax the excess through PAYE with no employee National Insurance.

3. 3

   Choose the pay run

   Paying on the final payslip uses the employee's normal cumulative code. Payments after the P45 must use 0T week 1/month 1 with the 'Payment after leaving' indicator.

4. 4

   Report on the FPS

   Report the taxable pay and tax as normal, and the Class 1A on the award above £30,000 in real time.

5. 5

   Pay HMRC

   Pay the PAYE, Class 1 and Class 1A together by the usual deadline: 22nd of the next tax month (19th by post).

6. 6

   Give the paperwork

   Issue the P45 and a written breakdown of the package so the employee can check the £30,000 and claim any overpayment.

Our P45 guide covers the leaving date and payments after leaving in more detail, and the holiday entitlement guide explains how to calculate accrued holiday pay.

Settlement agreements and common mistakes

Most negotiated exits use a settlement agreement, in which the employee gives up the right to bring claims in return for a payment. The tax treatment follows the rules above: the label "compensation" doesn't make something tax-free if it's really notice pay, a bonus or holiday pay. Employers usually include a tax indemnity so that if HMRC later decides more tax was due, the employee repays it. Employees should look at how the package is split and ask for the PENP calculation.

The mistakes that come up most often:

• Treating all severance as within the £30,000. If notice wasn't worked, part of it is PENP and fully taxable.
• Forgetting holiday pay and bonuses are earnings. They need tax and Class 1 National Insurance whatever the agreement calls them.
• Missing the Class 1A. It's due in real time on the excess over £30,000, not at year end.
• Not warning the employee about the deduction. A large lump taxed in one pay period, especially on 0T week 1/month 1 after the P45, is usually overtaxed; explain how the refund works.
• Counting statutory redundancy as PENP. It's excluded from the PENP cap but still uses up the £30,000.
• Paying legal fees to the employee. The exemption only covers fees paid directly to the employee's solicitor for advice on the termination.

Getting overpaid tax back and Self Assessment

If too much tax was taken, usually because the payment was made after the P45 on 0T, the money comes back in one of three ways. If you start a new job in the same tax year and give the new employer your P45, the cumulative calculation there refunds it. If you're not working and don't expect to for at least four weeks, you can claim in-year on form P50. Otherwise, HMRC will reconcile your tax after 5 April and send a P800 calculation. Our emergency tax code guide explains each route.

If you file Self Assessment, GOV.UK says to include the termination payment in the additional information section of the return so the exemption is applied correctly. Your employer's payroll figures will already be with HMRC, so the return just needs to match the breakdown you were given.

Official links

• Tax on termination payments (employees)What's taxable, £30,000, PENP examples
• Making staff redundant: taxEmployer overview
• PENP formula (EIM13880)HMRC manual
• Class 1A on termination awards (NIM13205)Worked example
• What to do when an employee leavesP45 and payments after leaving
• Rates and thresholds for employers 2026 to 2027Class 1 and Class 1A rates

What to do next

If you're an employer, split every exit package into earnings, PENP and award before you run the final payroll, and tell the employee how much tax the payroll will take and how any overpayment comes back. If you're an employee, ask for the breakdown and check the £30,000 has been applied only to genuine compensation. For the statutory amount itself, use our redundancy pay guide, and the employer National Insurance guide explains the Class 1 rates on the earnings elements.

This is general information, not legal or tax advice — confirm on the official source or with a professional.

Frequently asked questions

Is the first £30,000 of a termination payment always tax-free?

Only the part that is genuine compensation for losing the job. The first £30,000 of statutory redundancy pay, enhanced or ex gratia severance and non-cash benefits is usually tax-free. Wages, holiday pay, bonuses, restrictive covenant payments and any pay in lieu of notice, including post-employment notice pay (PENP) carved out of the package, are taxed in full as earnings.

What is post-employment notice pay (PENP)?

PENP is the basic pay you'd have earned if you had worked your full notice period but didn't. Since 6 April 2018, employers must calculate it with HMRC's formula and treat that part of any severance as taxable earnings with National Insurance, even if the contract has no payment in lieu of notice clause. Statutory redundancy pay is not subject to PENP.

Do I pay National Insurance on a termination payment?

You don't pay employee National Insurance on the part that counts as a termination award, including the slice above £30,000. You do pay it on earnings such as notice pay, PENP, holiday pay and bonuses. Your employer pays Class 1A National Insurance at 15% on the termination award above £30,000, and normal employer Class 1 National Insurance on the earnings elements.

Why was so much tax taken off my termination payment?

If you were paid after your P45 was issued, your employer must use code 0T on a week 1 or month 1 basis, so no Personal Allowance is given and the payment may be taxed at higher rates. Large one-off payments in a single pay period can also push the calculation into the higher rate. Any overpayment comes back after the tax year ends, or sooner if you start a new job or claim.

Are legal fees paid under a settlement agreement taxable?

No, if your employer pays your solicitor directly for advice on the termination. GOV.UK lists legal costs paid directly to your solicitor as free of tax and National Insurance. Fees paid to you as cash, or for advice unrelated to the termination, don't qualify.

Do I need to put a termination payment on my tax return?

Only if you already file Self Assessment or the payment means you must. If you do, include the termination payment in the additional information pages so HMRC can apply the £30,000 exemption correctly. Your employer will already have reported the payment and any tax deducted through payroll.

Sources & verification

Figures on this page were checked against the sources below when it was last reviewed on 12 October 2026. Each rate and limit is stored once with its own official source and review date, and official update channels are monitored daily so changes are picked up. How we verify

1. 1.Tax on termination payments — HMRC / GOV.UK · accessed 12 October 2026
2. 2.EIM13876 — Post-employment notice pay (PENP) — HMRC · accessed 12 October 2026
3. 3.EIM13880 — PENP formula — HMRC · accessed 12 October 2026
4. 4.EIM13886 — PENP formula: how to calculate P — HMRC · accessed 12 October 2026
5. 5.NIM13205 — Class 1A NICs on termination awards: example — HMRC · accessed 12 October 2026
6. 6.NIM13203 — Class 1A NICs on termination awards: reporting — HMRC · accessed 12 October 2026
7. 7.Rates and thresholds for employers 2026 to 2027 — HMRC · accessed 12 October 2026
8. 8.2026 to 2027: Employer further guide to PAYE and NICs (CWG2) — HMRC · accessed 12 October 2026
9. 9.Termination Awards and Sporting Testimonials – real-time Class 1A NICs guidance — CIPP · accessed 12 October 2026
10. 10.Making staff redundant: giving staff notice — GOV.UK · accessed 12 October 2026