Termination payments vary significantly depending on the circumstances of the termination, as well as the employment contracts in place
Navigating the complexities of employment termination can be challenging for both employers and employees. Termination payments can play a crucial role when employees are facing redundancy, resignation, dismissal or negotiation of a settlement agreement. Understanding the various types of termination payments, the legal implication and rights of employees is essential.
Termination payments may consist of many elements, for example:
- Accrued holiday pay;
- Bonus;
- Payment in lieu of notice (PILON);
- Restrictive covenant payments;
- Continued benefits; and
- Compensation for loss of employment.
The reason for paying each element separately must be determined as each could be treated differently for tax and national insurance contributions.
Loss of employment payments
Payments and benefits provided to an employee “directly or indirectly in consideration or in consequence of, or otherwise in connection with the termination of their employment”, can be paid free from national insurance contributions. It will only be subject to income tax to the extent that the amount exceeds £30,000.
While it may seem like a relatively straightforward exemption, payments and benefits provided to employees on termination can and often do take a number of different forms, meaning that it can be difficult in practice to establish whether the payments fall within the scope of the exemption.
For example, the £30,000 exemption does not apply if there is some other reason for the payment, such as a reward for employment service, a payment for a new restrictive covenant or a payment on or in anticipation of retirement. In these cases, such payments are subject to income tax and national insurance contributions in full.
Loss of employment by way of redundancy
An employee will be entitled to statutory redundancy pay where the employee being made redundant has continuously worked for the employer for two years or more. Statutory redundancy pay is calculated based on the length of employee’s work history, wages and age.
Statutory redundancy payments will generally be tax free up to £30,000. However, if the termination package includes additional redundancy payments above and beyond the statutory entitlement, those additional payments will be taxed as general earnings in respect of the amount which exceeds the £30,000 tax-free threshold.
Payment in lieu of notice (PILON)
Most employees who have been employed for at least one month are entitled to a notice period, and the length will usually be stipulated in their employment contract. Unless the reason for the termination is as a result of gross misconduct, in which case the employee will not be entitled to their notice pay.
It can be agreed instead of working the notice period, for an employee to receive a payment in lieu of notice (PILON). It therefore means that employers will pay the lump sum to the terminated employee, equivalent to the wages that they would be entitled to for the required notice period.
PILON payments will be subject to tax and national insurance contributions in the same way as regular salary.
Salary, holiday pay and other benefits
Another element of the termination payment could also be unpaid wages, accrued but untaken holiday up to the termination date, continued private medical insurance and company benefits, such as a bonus.
An employee should get their final pay on the date on which they are normally paid.
Similarly, to PILON these payments will also be subject to tax and national insurance contributions.
Payment for restrictive covenants
Payments in consideration of new post-termination restrictions or obligations in relation to confidentiality are subject to tax and national insurance contributions.
Legal fees and outplacement counselling
There are some exceptions to benefits which can be made to an employee without attracting tax provided that payment is made directly to the provider of the service:
- Legal fees incurred solely in connection with the termination through a Settlement Agreement; and
- Outplacement counselling for the purposes of finding new employment, if the employee has at least two years’ service.
Next steps
Understanding termination payments is vital for both employers and employees. These payments can vary significantly depending on the circumstances surrounding the termination, as well as based on the employment contracts in place.
If you would like advice to support with any aspect surrounding the termination of employment, please get in touch with Emily Morrison by calling 01727798106, or emailing Emily.morrison@salaw.com.
