If your employer has offered you a voluntary severance package, you may be wondering how much of the payment you will actually receive after tax.
Voluntary severance arrangements are often used when employers want to reduce staffing costs or agree an employee’s departure without proceeding through a compulsory redundancy process. However, voluntary severance and voluntary redundancy are not necessarily the same thing, and the circumstances of your departure can affect your employment rights.
In the UK, certain payments made when employment ends can qualify for an Income Tax exemption of up to £30,000. This means that some or all of your voluntary severance payment may be tax free.
However, not every payment included in a severance package qualifies for the exemption. Salary, holiday pay, bonuses and payments relating to notice are generally taxable.
The amount of tax you pay will depend on what each payment represents, rather than simply how your employer describes it in the agreement.
Before accepting voluntary severance, it is important to understand how your package is structured and whether the proposed payments have been treated correctly.
How does the £30,000 tax exemption work for voluntary severance?
Under UK tax legislation, qualifying payments made in connection with the termination of employment can benefit from an Income Tax exemption of up to £30,000.
This exemption may apply to genuine compensation for losing your employment, statutory redundancy pay and additional severance or enhanced redundancy payments.
For example, if you receive a qualifying voluntary severance payment of £25,000 and have no other payments using the exemption, the full £25,000 may be free from Income Tax.
If you receive a qualifying termination payment of £40,000, the first £30,000 may be exempt from Income Tax, while the remaining £10,000 will generally be taxable.
Importantly, the £30,000 exemption applies to the combined total of qualifying termination payments, not to each payment separately.
If your employer pays you £12,000 in statutory redundancy pay and an additional £25,000 in qualifying severance compensation, the payments will generally be considered together. In this example, £30,000 may be exempt from Income Tax, while the remaining £7,000 will generally be taxable.
The exemption is therefore not an additional £30,000 allowance on top of statutory redundancy pay.
It is also important to remember that the exemption does not automatically apply to every payment described as compensation or severance. The actual purpose of the payment determines its tax treatment.
Which voluntary severance payments are taxable?
A voluntary severance package often contains different types of payments, and these do not all receive the same tax treatment.
Any outstanding salary owed up to your leaving date will generally be subject to Income Tax and employee National Insurance contributions. The same applies to accrued but untaken holiday pay, contractual bonuses and other payments that represent earnings from your employment.
Payments relating to your notice period also require particular attention.
If your employer pays you instead of requiring you to work your notice period, this is commonly known as a payment in lieu of notice, or PILON. Such payments are generally subject to Income Tax and National Insurance in the same way as ordinary earnings.
Even where a payment is described as compensation, the post-employment notice pay rules may require an amount representing unworked notice to be treated as taxable earnings.
For this reason, an employer cannot make notice pay tax free simply by including it within a larger severance payment or describing it differently in a settlement agreement.
By contrast, genuine compensation for termination may qualify for the £30,000 exemption once any taxable notice-related amount has been identified.
The agreement should clearly explain what each payment represents. However, the wording alone does not determine how HMRC will treat it.
Do you pay National Insurance on voluntary severance?
The National Insurance treatment of voluntary severance is different from its Income Tax treatment.
Where a payment qualifies as a genuine termination payment, it is generally not subject to employee National Insurance contributions, even if the amount exceeds the £30,000 Income Tax exemption.
However, the employer is generally liable for Class 1A National Insurance contributions on the portion of qualifying termination payments exceeding £30,000.
Payments treated as ordinary employment earnings, including salary, holiday pay and taxable notice pay, will generally be subject to the usual employee and employer National Insurance rules.
This distinction can make a significant difference to the amount an employee receives and the overall cost of the severance package to the employer.
It is therefore important to distinguish between payments that qualify for the termination payment exemption and those that are treated as earnings.
Can voluntary severance be paid into a pension tax free?
Some employers may offer to make an employer pension contribution as part of a voluntary severance arrangement.
Employer contributions made directly into a registered pension scheme can receive different tax treatment from cash severance payments. They do not ordinarily use the £30,000 termination payment exemption.
However, pension contributions are subject to their own tax rules, including the pension annual allowance and any applicable restrictions.
This means that directing part of a severance package into a pension may be worth considering, but it should not be assumed that every contribution will be free from tax.
The arrangement must also be structured correctly. Receiving a taxable payment personally and then paying it into a pension is not necessarily treated in the same way as an employer making a direct contribution.
Where a substantial severance package includes pension arrangements, specialist tax or regulated financial advice may be appropriate before the terms are finalised.
Is voluntary severance the same as voluntary redundancy?
Voluntary severance and voluntary redundancy are sometimes used interchangeably, but they are not always legally identical.
Voluntary redundancy generally arises where an employer has a genuine redundancy situation and invites employees to volunteer for dismissal. An employee whose employment ends through voluntary redundancy may still qualify for statutory redundancy pay if the relevant legal requirements are satisfied.
Voluntary severance is a broader term. It can describe an agreed departure from employment that does not necessarily involve a genuine redundancy situation.
This distinction matters because agreeing to leave employment does not automatically mean that you are entitled to statutory redundancy pay.
Your entitlement will depend on the circumstances, your employment status, your length of service and the terms of any applicable redundancy scheme or agreement.
The distinction can also affect which employment rights you may be giving up and whether the employer’s proposed package provides appropriate compensation.
However, the label used for the departure does not, by itself, determine whether a payment qualifies for the £30,000 tax exemption.
Should you seek legal advice before accepting voluntary severance?
Before accepting voluntary severance, it is important to understand both the financial package and the legal consequences of leaving your employment.
You should establish what payments you are contractually entitled to receive, what additional compensation your employer is offering and whether the proposed termination date affects your rights.
It is also important to understand whether you are being asked to waive potential employment claims.
Many voluntary severance arrangements are recorded in a settlement agreement. A settlement agreement is a legally binding agreement that can prevent an employee from bringing specified employment claims against their employer.
For a settlement agreement to validly waive certain statutory employment claims, the employee must receive advice from a relevant independent adviser, such as a qualified solicitor, and the agreement must satisfy the applicable legal requirements.
Legal advice can help establish whether the agreement accurately reflects the proposed payments, whether your contractual entitlements have been included and whether any restrictive covenants or confidentiality provisions require further consideration.
The tax provisions should also be reviewed carefully. Settlement agreements commonly contain tax indemnities that may require the employee to reimburse the employer if additional tax becomes payable.
Such clauses can create financial exposure if a payment has been incorrectly classified.
A solicitor can advise on the contractual and employment law implications of those provisions. Where the tax position is complex or uncertain, separate specialist tax advice may also be required.
Can Pre-Law help with a voluntary severance agreement?
If you have been offered voluntary severance, it is important to understand what you are agreeing to before signing.
Although part of your severance payment may qualify for the £30,000 Income Tax exemption, other elements of the package may be taxable. The terms of your departure may also affect your employment rights, future restrictions and ability to bring a claim against your employer.
At Pre-Law, we provide employment law advice to employees considering voluntary severance, voluntary redundancy and settlement agreements.
We can review the proposed agreement, explain your contractual and statutory employment rights, assess the terms of your departure and advise on potential negotiations.
Where specialist tax advice is required, we can identify the issues that should be clarified before the agreement is completed.
If you have received a voluntary severance offer, contact Pre-Law to discuss your circumstances and understand your options before signing.
