The letter says forty-two thousand pounds. The payslip that arrives a fortnight later shows something closer to thirty-four, and nobody in HR seems able to explain the gap without reaching for a jargon word like "PILON" that means nothing to anyone outside payroll. This happens to thousands of people in the UK every year, and most of them assume they've been shortchanged. Usually they haven't — they've just run headfirst into one of the more misunderstood corners of the tax system: the £30,000 redundancy exemption.
What the £30,000 exemption actually covers
Genuine redundancy pay — the compensation for losing your job, as distinct from wages for work already done — is free of income tax and National Insurance up to £30,000. This isn't a new rule dreamed up to soften a recession; the £30,000 figure has sat unchanged in UK tax law since 1988, which on its own tells you something about how far it's failed to keep pace with wages over four decades. A skilled professional in London made redundant on a six-figure salary can burn through that allowance with a fairly ordinary severance package, while someone on a modest wage in a smaller town might never get close to it. Statutory redundancy pay — the legal minimum, based on age, length of service and a capped weekly wage that sits somewhere around £700–£750 depending on the tax year — falls inside this tax-free band automatically. So does any additional, non-contractual severance payment an employer chooses to offer on top, whether that's called an ex-gratia payment, a settlement payment or simply "extra". The confusion starts because a redundancy settlement almost never consists of just that one component, and only part of the total is actually redundancy pay in the eyes of HMRC.
Who actually qualifies
Statutory redundancy pay isn't automatic from day one of a job — you need at least two years of continuous service with the employer before the legal entitlement kicks in. Below that threshold, an employer can make you redundant without paying a penny of statutory redundancy, though many still choose to offer something voluntarily, particularly larger companies protecting their reputation as an employer. The formula itself is banded by age: half a week's pay for each full year worked under 22, a full week's pay for each full year between 22 and 40, and a week and a half's pay for each full year worked at 41 or older, capped at 20 years of service. Multiply the smaller number than most people expect against the weekly pay cap, and the statutory figure alone is often modest — which is exactly why the additional ex-gratia top-up an employer offers tends to matter far more to the final total.
The bundle problem
Employers typically fold several different payments into one final settlement figure, and HMRC treats each of them differently, which is where most of the confusion originates. Outstanding salary up to the termination date is ordinary earnings — fully taxed, fully subject to National Insurance, no different from any other payslip you've ever received. Accrued but untaken holiday pay is the same: it's pay for work you've effectively already banked, so it's taxed exactly as your salary was, regardless of how the settlement letter chooses to describe it. Any contractual bonus that had already been triggered before the redundancy — say, a commission payment earned the month before — is taxable too, because it was owed to you regardless of whether the redundancy happened at all. A settlement letter quoting "£38,000 total compensation" might therefore only have £22,000 of genuine tax-free redundancy money in it once salary, holiday and a triggered bonus are stripped back out. None of these three categories touch the £30,000 exemption in any way, and lumping them into the same mental bucket as "redundancy money" is the single most common source of disappointment when the payslip finally lands.
Then there's PILON — pay in lieu of notice — which is the part that trips up the most people. If your contract lets your employer end things immediately instead of making you work your notice period, and pays you a lump sum equivalent to that notice instead, that lump sum is taxable in full. Since April 2020, HMRC closed off what used to be a genuinely useful loophole: PILON is now taxed and subject to Class 1 National Insurance regardless of whether your contract has a specific PILON clause. Before that reform, some settlement agreements dressed notice pay up as compensation to slide it under the £30,000 umbrella. That door is shut now.
- Basic pay and accrued holiday to your last working day are taxed as normal earnings, no different from any other payslip you've had.
- PILON, whether contractual or not, has been taxed and subject to National Insurance since the April 2020 reform.
- Any bonus or commission already earned before the redundancy — taxed as normal.
- Genuine termination compensation is tax-free up to £30,000, taxable above it, and occasionally redirectable into a pension instead.
There can be other components in a package too — a company car allowance being wound down, or private medical cover running on for a few extra months, for example — but these four are the ones settlement letters muddle together most often.
Where people actually lose money
Here's the part that catches people out even when they've read the £30,000 headline correctly.
Once your genuine termination payments — the bit that's actually compensation for job loss, not wages, holiday or notice — pass £30,000, the excess is taxed as ordinary income and does attract employer National Insurance, though not employee National Insurance, which is a small mercy. If you're already a higher-rate taxpayer, or the payment itself tips you into the higher band for that tax year, the slice above £30,000 can lose 40% to income tax before you've even accounted for the loss of your personal allowance if total income for the year climbs past £100,000. A £45,000 settlement, taxed carelessly, can shed several thousand pounds more than most people expect. Not because the rule itself is unfair, but because nobody sat down and explained which £15,000 of the £45,000 was ever exempt in the first place, and payroll software rarely volunteers that explanation unprompted. Redundancy pay is also usually paid alongside the final month's normal salary, so PAYE can apply an emergency-style tax code to the whole lump sum on the assumption you'll be earning that much every month for the rest of the year — which overtaxes most people at the point of payment, even before the £30,000 mechanics come into it. That overtaxed amount is recoverable, but only if you notice it and claim it back rather than assuming the number on the payslip is final.
Timing matters more than most people realise, and this is where I'd push back on the instinct to just take the cheque and move on. If a redundancy payment lands in a tax year where your income is otherwise low — because you've already left your job and haven't started a new one, for instance — negotiating the payment date, even by a few weeks either side of 6 April, can shift a chunk of the excess into a lower tax band entirely. Ask your employer whether the payment date is flexible before you sign the settlement agreement, not after.
The pension route
There's a second lever worth pulling, and it's the one HR departments mention least often because it benefits you, not them. Employers can pay some or all of the amount above £30,000 directly into your pension as an employer contribution instead of paying it to you in cash. Done this way, that slice avoids income tax altogether, subject to your annual allowance, which for most people sits around £60,000 including any employer contributions already made that year. It won't suit everyone — you obviously can't touch pension money the way you can touch cash, and if you need the funds immediately to cover a gap between jobs, locking it away until retirement defeats the purpose. But for anyone with savings elsewhere to bridge the gap, redirecting the taxable excess into a pension is close to a free upgrade, and it's worth raising with your employer before the settlement agreement is finalised rather than after.
Get your employer to itemise the settlement figure before you sign anything. A one-line total on a settlement agreement tells you nothing about which parts are exempt, and by the time the payslip lands the split has already been decided for you.
Reading your own payslip
The P45 and final payslip should, in theory, break the payment down into its taxable and non-taxable components — but "should" is doing a lot of work in that sentence, and payroll systems get this wrong more often than anyone would like to admit. Look for separate line items: basic pay, holiday pay, PILON, and then a genuinely separate "termination payment" or "ex-gratia payment" line showing the tax-free portion up to £30,000 and any taxed excess above it. If everything is lumped into one number with a single tax deduction applied across the whole thing, that's worth querying immediately, because it usually means tax has been taken from money that should have been exempt.
If you think you've overpaid tax on a redundancy settlement — and it happens more often through simple payroll error than through any deliberate shortcut — you can claim the difference back from HMRC directly, either through your Self Assessment return if you complete one, or via a P50 form if you weren't planning to work again before the end of the tax year. Neither route is instant, but both are more reliable than arguing with a former employer's payroll team months after you've left.