Employees receive severance pay upon termination of employment termed as “Termination Payments”. They can arise in various circumstances, including being fired or subjected to constructive dismissal, being made redundant, retiring, or quitting a post due to a disability. The £30,000 exemption does not automatically apply to a termination settlement. The application of taxes depends on the reason for the payment.

A termination package may include a payment in lieu of notice (PILON), a bonus, the continuation of private health insurance, and other types of compensation. The reason for each component must be assessed individually.

If the payment is severance pay (“Termination Payment”), the maximum amount exempt is £30,000. The £30,000 exemption does not apply if the payment is made owing to a new restricted covenant, in preparation for retirement, or as a bonus for employment service (earnings). These payments are subject to income tax and NI contributions. Following PILON, the £30,000 tax exemption and NICs exemption may be reduced if any portion of the Termination Payment consists of post-employment notice pay.

When the termination payment exceeds £30,000, it is generally exempt from employee national insurance contributions. Before April 6, 2020, the employer’s national insurance contribution was not needed to be paid on termination payments. However, if the termination occurs on or after April 6, 2020, the excess above £30,000 will be subject to Class 1A employer National Insurance Contributions (as well as income tax). Due to the alignment of employer NICs and income tax treatment of a Termination Payment, the cost to an employer of making a Termination Payment that exceeds £30,000 is raised by 13.8%.

Protection awards are not free from NICs. While the first £30,000 of a protective award is free from tax, the remainder is subject to employee and employer national insurance contributions.