When an employee leaves, the final pay run is rarely as simple as one last salary payment. Depending on how and why they are going, you may be dealing with redundancy pay, payment in lieu of notice, accrued holiday, and sometimes a compensation payment. Each is taxed differently, and the rules around the famous £30,000 exemption are widely misunderstood. Get it wrong and you risk an HMRC enquiry or a tribunal claim.
This guide walks through the final payment from decision to payslip, and explains what is taxable, what is not, and what National Insurance applies.
The different ways an employee leaves
Termination covers resignation, dismissal, redundancy, retirement, and settlement agreements. The reason matters because it changes what you pay and how it is taxed. A resignation usually means salary to the leaving date plus accrued holiday. A redundancy adds statutory, and sometimes contractual, redundancy pay. A settlement agreement may add a negotiated compensation sum on top.
Statutory redundancy pay
An employee with at least two years’ service who is made redundant is entitled to statutory redundancy pay. The calculation is based on age, length of service up to a maximum of 20 years, and a week’s pay, which is capped. From 6 April 2026 the weekly cap is £751, which makes the maximum statutory redundancy payment £22,530.
For each full year of service the employee gets half a week’s pay for years worked while under 22, one week’s pay for years worked between 22 and 40, and one and a half weeks’ pay for years worked aged 41 and over. Statutory redundancy pay is tax free and carries no National Insurance, because it falls within the £30,000 exemption explained below.
The £30,000 tax exemption
Genuine termination payments, such as redundancy pay and compensation for loss of employment, are tax free up to £30,000. This is the rule everyone has heard of, and also the one most often misapplied. The exemption only covers payments that are genuinely compensation for the job ending. It does not cover anything the employee has actually earned, such as salary, bonus, or pay in lieu of notice.
Above £30,000, the excess is taxable. The employee pays Income Tax on it, but no employee National Insurance. The employer, however, pays Class 1A National Insurance at 15% on the amount over £30,000. Since April 2020 this employer Class 1A is collected in real time through payroll as part of the pay run, rather than after the year end, so it needs to be calculated correctly at the point of payment.
PILON and post-employment notice pay
Payment in lieu of notice, or PILON, is where you pay an employee instead of having them work their notice. This is one of the biggest traps in termination pay. Since April 2018, the part of any termination payment that represents unworked notice is fully taxable and subject to both employee and employer National Insurance. It cannot be sheltered by the £30,000 exemption.
HMRC uses a formula called post-employment notice pay, or PENP, to work out the minimum amount that must be treated as notice pay, regardless of what the contract or settlement says. If you try to dress up notice pay as tax free compensation, the PENP calculation catches it. This is precisely the sort of figure where a small error becomes an HMRC problem, which is why accurate final pay runs from Purely Payroll are worth the certainty.
Holiday pay in the final pay run
Almost every leaver is owed something for accrued but untaken holiday, and occasionally owes you for holiday taken in advance. Accrued holiday paid on termination is treated as earnings, so it is fully taxable and subject to National Insurance in the normal way. It does not benefit from the £30,000 exemption. Working out the accrual correctly for part-year and irregular hours staff is an area employers regularly get wrong.
What appears on the final payslip and P45
The final payslip should clearly separate the taxable elements, salary, PILON and accrued holiday, from any tax free element within the £30,000 exemption. Tax and National Insurance are applied to the taxable parts, and any Class 1A on an excess over £30,000 is processed through payroll. You then issue a P45 showing pay and tax to the leaving date, and report the leaver on your final FPS for that employee.
Our guide to starters, leavers, P45s and P60s covers the mechanics of issuing the P45 and reporting the leaver to HMRC.
Processing a leaver and want to be sure the numbers are right? Check our pricing or get in touch and we will handle the final pay run for you.
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