Will I pay tax on my settlement agreement payment?

There is no single answer for a settlement payment — HMRC taxes each element according to what it actually is, not what the agreement calls it. That is why the way your agreement is drafted matters.

How each element is taxed

• Ex-gratia termination payment — genuine compensation for the loss of your employment, not referable to salary or contract: the first £30,000 is exempt from income tax and employee National Insurance. Amounts above £30,000 are taxed as income but in most cases escape NI.
• Payment in lieu of notice (PILON) — fully taxable as earnings since the April 2018 rules, whether or not your contract contains a PILON clause. It is calculated on the basic salary you would have earned during notice.
• Contractual entitlements — outstanding salary, accrued but untaken holiday pay and contractual bonuses are fully taxable and can never shelter under the £30,000 exemption, even when paid via a settlement.
• Injury to feelings payments in discrimination settlements are generally tax-exempt if not treated as earnings — but this is a nuanced area needing specific advice.

A well-drafted agreement separates these elements clearly, so the ex-gratia portion is identifiable and the £30,000 exemption is used fully. Statutory redundancy pay, where it applies, also counts within the same £30,000 tax-free allowance.

Use the legal advice you are entitled to

A settlement agreement is only valid if you receive independent legal advice before signing — usually from a solicitor — and your employer typically contributes £500 to £1,000 plus VAT towards the cost. Tax structuring is precisely what that advice is for: ask your adviser to check how each element is described, whether the tax-free portion is maximised, and what happens if HMRC later takes a different view (many agreements make you liable for extra tax, so an indemnity clause matters).

Remember the agreement is voluntary: you can negotiate the amount and the structure, and the Acas Code recommends you be given at least 10 days to consider it. Once signed, it binds you — so get the tax position clear first, not after.