Settlement Agreement Tax Calculator

How a settlement agreement is taxed - notice pay (PENP), holiday pay, the £30,000 exemption, legal fees and pension. Calculator for 2026/27.

2026/27 tax year

Employment & Career
Employee
UK-wide

A settlement agreement is not tax free as a whole. Up to £30,000 of the compensation for losing your job is free of Income Tax and National Insurance. Everything you would have earned anyway is taxed in full: salary to your leaving date, holiday pay, bonuses and, since 6 April 2018, the notice pay you would have had for notice you do not work, however the agreement labels it (ITEPA 2003 s.402D, HMRC EIM13874). Enter the figures from your draft agreement to see how each part is taxed.

Compensation for loss of employment (the termination or ex gratia payment)

You are paid

Notice you will not work (post-employment notice pay) Work it out My employer's figure None

Basic pay for your last pay period

Before tax, without overtime, bonus, commission or allowances (s.402D(7)). Include any pay you gave up under salary sacrifice.

Notice not worked

Unit

My basic pay is the same every month (equal monthly instalments)

Use months only if you are paid equal monthly instalments and your contract sets notice in whole months. Otherwise enter calendar days. The longer of your contractual and statutory notice counts.

Contractual payment in lieu of notice

Only a PILON paid separately under your contract. It is taxed as earnings and reduces the notice pay worked out above.

Salary to your leaving date, paid with the package

Holiday pay owed

Bonus, commission or other earnings

This bonus was expected (due under my contract or a bonus scheme)

Only changes the NI estimate when paid after you leave: HMRC treats an expected bonus as a regular payment and an unexpected one as irregular (CWG2 para 1.14).

Payment for a restrictive covenant

Statutory redundancy pay included, if any

Paid by your employer into your pension

Legal fees paid by your employer direct to your lawyer

Other taxable income this tax year (pay already received, etc.)

Income Tax

Paid

Enter your figures and press Work out the tax.

The three ways each part is taxed

Ask your employer for a breakdown. HMRC's employer guide says each element of a single leaving payment "must be considered separately" (CWG2 2026/27, para 5.11).

1. Taxed in full: Income Tax and your Class 1 NI

Salary to your leaving date, holiday pay, bonuses and commission. These are earnings already, so the termination rules do not apply to them (ITEPA s.401(3)).
A payment in lieu of notice your contract provides for. CWG2 puts it in gross pay for both PAYE and NI.
Post-employment notice pay (PENP). The part of the compensation equal to the basic pay for notice you do not work is "treated as an amount of earnings" (s.402B, s.402C). CWG2 includes it in gross pay for Class 1 NI.
A payment for a restrictive covenant, such as agreeing not to work for a competitor. It is treated as earnings (s.225) and is in gross pay for NI (CWG2).

2. The £30,000 threshold: Income Tax only above it

What is left of the compensation after PENP, plus any statutory redundancy pay, "counts as employment income ... if and to the extent that it exceeds the £30,000 threshold" (s.403(1)). It is not in gross pay for Class 1 NI, so you pay no NI on any of it. Above £30,000, your employer pays Class 1A at 15% (SSCBA 1992 s.10(1A), in force from 6 April 2020; rate from HMRC rates and thresholds for employers 2026/27). The £30,000 is one threshold per employee across the same employment, other employments with the same employer and employments with associated employers: all those payments are added together (s.404(1)). Payments spread over two tax years use the threshold against the earlier ones first (s.404). Damages for unfair or wrongful dismissal agreed in a settlement fall here too, unless they are pay you were due under your contract (CWG2 table item 8), but only after the PENP has been carved out of them: they are part of the relevant termination awards that s.402C splits.

3. Outside the termination rules altogether

Employer pension contributions made into a registered pension scheme as part of the termination arrangement and "in order to provide benefits for the person in accordance with the terms of the scheme" (s.408(1)). Any amount above the annual allowance you have available, including unused allowance carried forward from the previous three tax years, is taxed on you through the annual allowance charge. They count towards your annual allowance (£60,000 for most people in 2026/27; lower if you have flexibly accessed a pension or have a high income, per GOV.UK).
Legal fees for advice on the termination, where the settlement agreement provides for the employer to pay and the employer pays your lawyer directly (s.413A, EIM13740). Only legal costs: HMRC says accountancy fees are not covered.
Payments on account of injury or disability, or on death (s.406). "Injury" includes psychiatric injury but not injured feelings, so an injury-to-feelings sum is not exempt under this rule (EIM13610).

How post-employment notice pay is worked out

PENP = (BP × D ÷ P) − T (ITEPA s.402D, EIM13880). The employer must work it out whether or not a payment in lieu of notice is made (EIM13876).

BP is basic pay for the last pay period to end before the trigger date (the day notice is given, or the last day of employment if none is). Overtime, bonus, commission, allowances and benefits in kind are left out; pay given up under salary sacrifice is put back in (s.402D(7)).
D is the number of days from the end of your last day of employment to the earliest lawful termination date: the end of a period of minimum notice (under the law and your contract) counted from the trigger date (s.402E(5) and (7)). If that date falls on or before your last day, D is nil.
P is the number of days in that pay period. If you are paid equal monthly instalments, your contract sets notice in whole months and the notice not worked is whole months, P is 1 and D is counted in months (s.402D(6)). Other cases where monthly basic pay is paid in equal instalments use P = 30.42 (s.402D(6A)). If your monthly pay is not in equal instalments, P is the actual number of days in that pay period, for example 31 for 1 to 31 August (s.402D(3); EIM13888 example 1).
T is anything already taxable as earnings that is received in connection with the termination, in practice a contractual PILON. Holiday pay and a bonus for the termination are not part of T (EIM13896).

If the result is negative, PENP is nil. If it is more than the compensation, all of the compensation is taxed as earnings and no more (s.402C(3)). Statutory redundancy pay is never part of the PENP split (s.402C(2)). HMRC's own example: £3,000 a month, 14 days' notice not given, gives (£3,000 × 14) ÷ 30.42 = £1,380 (EIM13888). Its fuller example, with statutory redundancy, a bonus and a contractual PILON, is at EIM14000; the calculator reproduces it.

Worked example: a £40,000 offer

Basic pay £4,000 a month, three months' contractual notice that will not be worked, £1,500 of holiday pay and the final month's salary, leaving part way through 2026/27 with £24,000 already paid in the year. The employer offers £40,000 as compensation.

PENP: £4,000 × 3 ÷ 1 = £12,000, taxed as earnings with the salary and holiday pay: £17,500 in all.
Within the £30,000: £28,000. Nothing is above it, so the £40,000 is not "£40,000 tax free".
Income Tax on the package about £3,500, your Class 1 NI about £517.50, leaving about £41,483 of the £45,500 paid.
If £10,000 of the offer is paid into a registered pension instead, the cash is £35,500 and about £31,483 after tax and NI, with £10,000 in the pension. No tax is saved here, because that £10,000 was already inside the £30,000: paying compensation into a pension saves tax only on the part that would otherwise be above the threshold.
On a £50,000 offer with the same notice, £8,000 is above the threshold: Income Tax on the package rises to about £5,100, and the employer pays £1,200.00 Class 1A. That excess is where a pension contribution saves the most.

Computed by the calculator above from the 2026/27 England, Wales and NI rates. The employee NI figure assumes the earnings are paid in the final monthly payslip, using HMRC's published monthly thresholds.

What to check before you sign

It must meet the legal conditions. A settlement agreement only stops you bringing an employment tribunal claim if it is in writing, relates to the particular complaint, you have had advice on its terms and effect from a relevant independent adviser (such as a qualified lawyer, or a certified trade union or advice centre adviser) who has insurance or professional indemnity cover for that advice, it names the adviser, and it states that the conditions are satisfied (Employment Rights Act 1996 s.203(3)). An adviser acting for your employer does not count (s.203(3B)). In Northern Ireland the equivalent is article 245 of the Employment Rights (Northern Ireland) Order 1996.
The breakdown. Notice, holiday pay, salary and bonus should be listed separately from the compensation, and PENP should be identified. A label does not change the tax: the PENP rule applies to the substance.
Who pays your legal fees, and how. For the s.413A exemption the agreement must provide for the employer to pay, and the payment must go directly to your lawyer.
Pension route. If you want part paid into your pension, ask for the agreement to say so. Section 408 requires an employer contribution to a registered scheme made as part of the termination arrangement; in practice that means the employer pays the scheme, rather than paying you and you paying it in. Check your available annual allowance first.
When it is paid. The tax year in which the payment is received decides which year's bands apply: a cash payment is received when it is paid or when you become entitled to require payment (s.403(2) and (3)). A payment after you have your P45 is taxed on code 0T on a week 1 or month 1 basis, so payroll may over- or under-deduct for the year (CWG2).
Benefits that continue, such as a company car or health cover after you leave, are part of the package: the rules cover "payments and other benefits" (s.401), and the £30,000 is set against non-cash benefits after cash (s.404(5)). See our redundancy pay tax guide for how those are valued.

Announced, not yet law: the Budget on 28 October 2026 says the government is "clarifying the legislation around the tax treatment of termination payments", through Finance Bill 2026-27 with effect from 28 October 2026. It has not published the detail on that page. This page and the calculator apply the law as it stands.

Frequently asked questions

Is a settlement agreement payment tax free up to £30,000?

Only the compensation part, and only after notice pay is taken out of it. The first £30,000 of a non-contractual payment for loss of your job is free of Income Tax (ITEPA 2003 s.403). But salary, holiday pay, bonuses and any payment in lieu of notice are taxed in full, and since 6 April 2018 the employer must also treat the notice pay you would have had (post-employment notice pay) as taxable earnings, even if the agreement calls the whole sum compensation.

How is notice pay taxed in a settlement agreement?

As earnings, with Income Tax and Class 1 National Insurance. If you do not work your notice, the employer works out post-employment notice pay with the formula in ITEPA 2003 s.402D: basic pay for the last pay period, times the days of notice not worked, divided by the days in that pay period, less any payment in lieu of notice already taxed as earnings. That amount is carved out of the compensation and does not get the £30,000 exemption.

Do I pay National Insurance on a settlement payment?

Not on the compensation that falls under the £30,000 rules: HMRC's employer guide (CWG2) says such payments are not included in gross pay for Class 1. You do pay Class 1 on notice pay, holiday pay, salary and bonuses. Your employer pays Class 1A, at 15% for 2026/27, on the part of a termination award above £30,000 (SSCBA 1992 s.10(1A)).

Are my legal fees for a settlement agreement taxable?

Not if the conditions in ITEPA 2003 s.413A are met: the payment covers legal costs incurred only in connection with the end of your employment, the settlement agreement provides for the employer to pay them, and the employer pays your lawyer directly. A payment under a court or tribunal order also qualifies. Accountancy and other non-legal fees are not covered.

Can part of my settlement go into my pension tax free?

It can be, if your employer contributes it to a registered pension scheme as part of the termination arrangement, to provide you with benefits under the scheme's terms: ITEPA 2003 s.408 then takes it outside the termination-payment rules. It counts towards your annual allowance, £60,000 for 2026/27 for most people (lower if you have flexibly accessed a pension or have a high income). Anything above the allowance you have available, including unused allowance carried forward from the previous three tax years, is taxed through the annual allowance charge.

Is compensation for injury to feelings in a settlement agreement tax free?

Not under the injury exemption. ITEPA 2003 s.406 exempts payments on account of injury or disability, and says injury includes psychiatric injury but not injured feelings. An injury-to-feelings sum paid in connection with the end of your job is treated like other compensation: it can use the £30,000 threshold, and anything above that is taxable.