When an employee is dismissed, made redundant, or agrees to leave by mutual consent, payroll teams will be required to process a termination payment reflecting the agreed reason for leaving the business. This differs from a final payslip, and although the two may be run at the same time, the differences should be clearly communicated and recorded.
This is the first part of a series of articles looking at the different elements that may be included in a termination payment, how tax thresholds apply and what payroll teams need to know when completing them.
MSP Payroll can help with any aspect of termination payments, from a full outsourced service, through to completing BACS payments or consultancy to support payroll teams.
Speak to us to find out more.
What is a termination payment?
A termination payment, according to the HMRC website, is the additional remuneration you may receive if you have been made redundant, are dismissed from your role, or you choose to leave your role by mutual agreement with the organisation. Termination payments may include statutory redundancy pay, enhanced redundancy, or any payments received instead of working a notice period. This is in addition to your final pay, which will include your accrued holiday and any unpaid wages and benefits.
This guide will look at the individual elements of a termination payment. Please note that HR and possibly legal counsel are responsible for the reasons a termination payment is made to an employee, so this isn’t covered in this article. Focus is instead placed on the actions required and the legislation and expectations attached to payroll processing.
Which components may be included in a termination payment?
There are four main elements that may be included in an exit package, depending on the circumstances of the employee’s reason for leaving.
Statutory Redundancy Pay
If an employee has a minimum of two years’ continuous service and has been through a redundancy process, then they will be entitled to statutory redundancy pay. The amount they receive depends on their age, length of service and their weekly pay.
Statutory redundancy pay qualifies under the £30,000 tax-free exemption, as long as the total package stays within the threshold.
The statutory limit on redundancy pay is a maximum of £751 per week (£783 in Northern Ireland) as of April 6th 2026. The maximum statutory payment is £22,530 (£23,490 in Northern Ireland). The employee must have a contract of employment to qualify, and fixed-term contracts over two years may also receive statutory redundancy.
Payroll teams will need to receive data from HR that the employee meets the criteria above to ensure that payments are accurate and won’t be subject to issues with HMRC following completion of the redundancy.
Enhanced Redundancy Pay
An enhanced redundancy payment is one where the organisation is paying the employee an amount above the statutory rate. To ensure the payment is recorded as a genuine redundancy, it should not be a reconstituted way of paying a notice period or bonus, and payroll teams should have written confirmation from stakeholders in the organisation to support this.
Enhanced redundancy pay is eligible for tax-free exemption under £30,000.
MSP Payroll can help process redundancy payments in a number of ways. Contact our team to find out more.
Payment In Lieu of Notice (PILON)
Pay in Lieu of Notice, often abbreviated to PILON, is a payment made to an employee instead of asking them to work their notice period. PILON is not eligible for tax-free exemption and therefore should be included in tax and National Insurance Contribution payments. The payment itself is called Post Employment Notice Pay (PENP), and the formula for this defines what deductions are made from a PILON payment. We will cover this in detail in the next part of our guide to termination payments.
In the meantime, if you need support or resources to help calculate or process PILON payments, please contact our team.
Ex Gratia Payments
An ex gratia payment is made without contractual obligation by an employer. This could be a goodwill payment, or a lump sum paid as part of a compromise agreement or additional severance. Ex gratia payments are eligible for tax-free status, up to the £30,000 threshold, as long as it is clearly shown that these payments aren’t instead of notice pay or any contractual bonuses or commission payments. Ex gratia must also be separate from holiday or pension payments (unless part of the severance lump sum is paid into a pension).
An Ex Gratia sum can be comprised of multiple reasons for payment. Payroll teams will need to be made fully aware of what the amount is comprised of to ensure it is processed correctly and communicated accurately on the employee’s payslip.
If you are making ex gratia payments to your employees and need advice or practical support, contact our team.
How does tax impact termination payments?
What payments are subject to tax and NIC
Payroll teams will need to ensure that any PILON payments made to an employee, or any payments which are made for agreeing to a restrictive covenant, have deductions made for PAYE and National Insurance. Also, any contractual or normal final payments, such as unpaid salary, accrued holiday or bonuses, should be run through PAYE and NIC as normal.
What may be exempt from tax and NIC
If an employer makes a payment into a pension scheme as part of the agreed termination package, then as long as the payment is below the annual allowance, it will be exempt to tax exemptions.
If an employee receives a termination payment because they have been injured or are too ill to work, then this is also tax and NIC-free.
What payroll teams need to know about the £30,000 tax threshold
The £30,000 threshold for tax-free payments is a combined eligible figure of an employee’s termination payment. This could be a combination of statutory and enhanced pay, ex gratia payments and any non-cash benefits that aren’t already included in their contract.
Note that the threshold is not per payment but instead the combined amount. This is an area where payroll teams and employees are unsure, and it can lead to difficult conversations or lost productivity.
The example provided by HMRC is as follows:
- Statutory redundancy is £10,000
- Additional severance is £5,000
- Total amount due to the employee is £15,000
- Employee doesn’t work their month’s notice, which would have been £2,000
- Therefore:
- The employee pays tax on £2,000 of the severance package (£5,000) as this qualifies as PILON and is not eligible for tax-free status
- The remaining £13,000 is tax-free because it is under the threshold of £30,000 and qualifies as redundancy and severance.
We can provide a full support service, help with calculations, make final payments on your behalf (BACS) or provide consultancy support. Find out more here.
How can MSP Payroll help?
Our experts can provide comprehensive support for payroll teams processing termination payments. This could include:
- Facilitating BACs payments for your organisation to employees
- Calculating or reviewing termination payments before they are completed
- Consultancy support on termination payments with guidance on PILON or PENP
- We are specialists for all payroll regulations and provisions, including SSP, SMP, pensions, seasonal payments, PAYE and National Insurance Contributions.
Contact us here if you would like to discuss implementing payroll support.
Part 2: What payroll teams need to know about PILON
The next article in our series on termination payments will focus in detail on PILON payments, what they are, how they work and PENP calculations for payroll teams.
Termination Payments: Frequently asked questions
Is a termination payment the same as a final salary payment?
A final salary payment covers the employee’s last period of normal pay, which might include wages, holiday accrued and any bonuses or statutory payments. A termination of employment payment, whether that’s for dismissal, mutual agreement or redundancy, is a separate additional payment. This means it is subject to its own tax and National Insurance Contribution rules. Often, payroll teams will process both at the same time; they should be treated as distinct and have separate records.
Does it make a difference to processing payroll whether the termination is a redundancy, dismissal or mutual agreement?
Payroll teams should have clear instructions from HR teams on why employment ends, as HMRC views termination payments differently depending on the reason for tax and NIC purposes. If the employee is receiving statutory redundancy pay, then they should be marked as being genuinely made redundant (and HR should have followed the appropriate process). Ex Gratia payments are subject to different rules (see above), and therefore, the employee’s payment should be clearly marked with the correct reason for termination. If there is any confusion, HR should be able to provide accurate data.
Are accrued holiday payments processed as part of the termination payment?
Holiday entitlement accrued by an employee is a contractual obligation, and so will be processed through PAYE and is subject to tax and Class 1 NICs as per normal. Holiday pay is not tax-exempt and is not included in the £30,000 threshold calculation. Usually, holiday pay and termination pay are included in a final payment run for convenience and efficiency, but clearly separated in payroll records.
Speak to us, and we can provide more information on the termination payments and advice, support and resources in processing them.
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