If you’ve been made redundant and are getting redundancy pay, you might be wondering if you have to pay tax on it. Redundancy pay is treated differently to income – and up to £30,000 of it is tax free. But, some other parts of your redundancy package, such as holiday pay and pay in lieu of notice, will be taxed in the same way as regular income.
What is tax free?
Up to £30,000 of redundancy pay is tax free.
Any non-cash benefits that form part of your redundancy package, such as a company car or computer, will be given a cash value. This will be added to your redundancy pay for tax purposes.
This might then take your total redundancy pay over the £30,000 limit.
What will I be taxed on?
Any redundancy pay over £30,000
When you get it, your employer will usually have deducted the tax – but it’s likely they won’t have taken off the right amount.
So you might need to claim tax back or pay extra tax. See ‘Overpayment or underpayment of tax’ below.
Holiday pay, pay in lieu of notice, wages owing and bonus payments
Holiday pay is treated in the same way as wages. So, tax and National Insurance contributions will be deducted as usual from these payments before you get them.
Unpaid wages, bonus or overtime will have tax and National Insurance contributions deducted. This is even if you receive the amounts after your employment has ended.
Where employment involves regular commission or bonuses, these can be taken into account when calculating redundancy pay using the average wage for the previous 12 weeks.
These payments would then qualify for the £30,000 tax-free exemption. Where these payments aren’t considered part of the employee’s normal weekly wage, these payments won’t qualify.
Tax on Payments In Lieu of Notice (PILON)
You might be expected to carry on working during your notice period. But your employer might allow you to leave early, or sometimes immediately after being made redundant.
Under these circumstances, you might receive Payment In Lieu of Notice (PILON). This is effectively compensation for ending your contract early.
All contractual and non-contractual PILON payments are subject to income tax and National Insurance deductions. It’s up to your employer to identify what you would have earned in basic pay if you had worked through your notice period.
All other non-contractual payments are included in the £30,000 tax-free redundancy pay limit.
Avoid nasty shocks – work out the tax on your redundancy pay in advance
Wondering what to do with your redundancy pay? Work out roughly what your redundancy package will be, taking into account what’s tax free and what isn’t.
Tax-free redundancy pay: Example 1
Colin receives a redundancy payment of £18,000, plus one month’s pay in lieu of notice. This totals £1,000.
The redundancy payment is tax free. But Colin’s employer will have to deduct tax and National Insurance contributions from the additional £1,000.
Tax on redundancy pay: Example 2
Kirandeep receives a redundancy lump sum of £32,000. She also gets to keep her company car, which is valued at £8,000.
The value of the car is added to the redundancy payment – making £40,000.
Only £30,000 is tax free. So Kirandeep will pay tax on the remaining £10,000 – as she’s a higher-rate taxpayer, that’s 40%.
Find out how much redundancy money you’re entitled to in our guide Redundancy pay
Overpayment or underpayment of tax
How much tax you pay is calculated on a yearly basis. So, if you’ve stopped working part way through the tax year, you might have paid too much.
It’s important not to assume your employer has got the calculations right. The tax deducted could be too much or too little.
It’s up to you to notify HM Revenue & Customs.
You might be asked to complete a Self Assessment tax return at the end of the tax year to pay any additional tax due.
Find out how to contact HMRC on the GOV.UK website
Making the most of your redundancy pay
If you don’t need all your redundancy money to meet your living expenses, it’s worth considering saving or paying off debts, or even contributing to your pension.
Putting your redundancy payment into a pension
Paying into a pension plan can be a tax-efficient option.
Are you a member of your employer’s pension scheme and going to receive a redundancy payment of more than £30,000? Then you might be able to avoid paying tax on the excess by asking your employer if they’ll agree to pay it into your pension.
But tax and pensions are rarely straightforward. And there are limits on how much you can pay in and receive tax relief. So it’s worth getting help from an independent financial adviser.