Severance pay is the money an employer pays when it ends someone's employment. UK law does not define "severance pay" as such. In practice it is a package made up of statutory redundancy pay where the employee qualifies, any enhanced or ex gratia compensation the employer adds, notice pay and accrued holiday. For dismissals on or after 6 April 2026, statutory redundancy pay uses a week's pay capped at £751, so the most anyone can receive is £22,530. On the tax side, the first £30,000 of genuine compensation for loss of employment is tax-free, but notice pay and holiday pay are taxed in full.
What a severance package usually contains
The labels in a settlement letter matter less than what each payment is actually for. Most packages break down into the same building blocks:
- Final salary. Pay up to the leaving date, taxed through payroll as normal;
- Accrued holiday. Untaken statutory leave must be paid out on termination under regulation 14 of the Working Time Regulations 1998;
- Notice pay. Either the employee works their notice or is paid in lieu. The statutory minimum is one week after one month's service, then one week per complete year from two years' service, up to 12 weeks after 12 years. The contract may give more;
- Statutory redundancy pay. Due only where the dismissal is by reason of redundancy and the employee has at least two years' continuous employment;
- Enhanced or ex gratia compensation. Anything the employer pays on top, often in exchange for the employee signing a settlement agreement.
How statutory redundancy pay is calculated
Section 162 of the Employment Rights Act 1996 sets the formula. Count back from the leaving date the number of complete years of continuous employment, up to a maximum of 20, and allow for each year:
- Age 41 or over. One and a half weeks' pay;
- Age 22 to 40. One week's pay;
- Under 22. Half a week's pay.
A week's pay is the normal contractual weekly pay where pay does not vary. For employees with no normal working hours it is the average over the 12 weeks before the calculation date. Either way, it is capped. The Employment Rights (Increase of Limits) Order 2026 raised the cap from £719 to £751 for cases where the relevant date falls on or after 6 April 2026. The maximum award is therefore 20 years × 1.5 weeks × £751 = £22,530. The Order applies in England, Wales and Scotland.
The employer must give a written statement showing how the redundancy payment was calculated (section 165). The employee loses the right to statutory redundancy pay unless, within six months of the relevant date, the payment has been agreed and paid, a written claim has been made to the employer, or a tribunal claim has been started (section 164).
Worked example
Priya is 46 and has worked for her employer for 10 complete years. She earns £52,000 a year (£1,000 a week) and is made redundant in October 2026. Her contract gives three months' notice, which the employer pays in lieu.
| Element | Calculation | Amount |
|---|---|---|
| Years at age 41 to 45 | 5 × 1.5 weeks | 7.5 weeks |
| Years at age 36 to 40 | 5 × 1 week | 5 weeks |
| Statutory redundancy pay | 12.5 weeks × £751 (capped) | £9,387.50 |
Her actual weekly pay of £1,000 is irrelevant to the statutory figure because the cap applies. If the employer offers a total compensation payment of £40,000, which includes the statutory amount, plus her three months' pay in lieu of notice and her untaken holiday, those payments are taxed in different ways.
How severance pay is taxed
Tax follows the nature of each payment, not its label:
- Salary, holiday pay and pay in lieu of notice. These are earnings, so income tax and both employee and employer Class 1 National Insurance apply. Since April 2018 the "post-employment notice pay" rules in section 402D of the Income Tax (Earnings and Pensions) Act 2003 make basic pay for any unworked notice taxable, whether or not the contract contains a pay-in-lieu clause;
- Compensation for loss of employment. Under section 403, this is taxable only to the extent that it exceeds the £30,000 threshold. Statutory redundancy pay is not taxed as earnings (section 309) but counts towards the £30,000;
- The excess over £30,000. This is subject to income tax and to Class 1A National Insurance at 15% for 2026/27. Class 1A is paid by the employer. No employee National Insurance is deducted from compensation for loss of employment, below or above £30,000, because a genuinely compensatory payment is not earnings for Class 1 purposes;
- Legal fees. Section 413A exempts the employer's contribution to the employee's legal costs where a settlement agreement provides for it and the payment goes directly to the employee's lawyer.
In Priya's case, £30,000 of the £40,000 is tax-free. The remaining £10,000 is taxed through PAYE with no employee National Insurance, and the employer pays £1,500 Class 1A on it. Her three months' notice pay and holiday pay are taxed in full as earnings, with Class 1 National Insurance. Payments on account of injury or disability and on death in service fall outside this regime altogether under section 406. Our guide to termination payments explains the order of the calculation in more detail.
Settlement agreements and enhanced packages
Employers who pay more than the statutory minimum usually want a settlement agreement in return, so the employee waives tribunal claims. Section 203 of the Employment Rights Act 1996 makes such an agreement binding only if it is in writing and relates to the particular complaints, and only if the employee has had advice from a relevant independent adviser, who must be identified in the agreement and covered by insurance or a professional indemnity. The agreement must also state that the statutory conditions are met. This is why employers commonly offer to pay a set amount towards the employee's legal fees.
From the employer's side, the main costing errors we see are:
- Treating the headline figure as the cost. Class 1A on compensation above £30,000 is an extra cost to budget for;
- Folding notice pay into the "compensation". Notice pay is taxed as earnings whatever the agreement calls it;
- Issuing the P45 too early. Payments made after the P45 must be taxed on code 0T on a non-cumulative basis, which can over-deduct tax.
Who does not get statutory redundancy pay
The statutory scheme does not cover everyone who leaves with a payment. An employee with less than two years' service has no right to it, and dismissal for misconduct is not redundancy. An employee who unreasonably refuses an offer of suitable alternative employment also loses the right. Any severance paid in these cases is contractual or ex gratia, and for tax purposes it is still analysed into earnings and compensation in the way described above.
Sources: Employment Rights Act 1996, section 162; Employment Rights (Increase of Limits) Order 2026; ITEPA 2003, section 403; Social Security Contributions and Benefits Act 1992, section 10; HMRC NIM02510; GOV.UK: redundancy pay; HMRC rates and thresholds for employers 2026 to 2027. See also our guides to the P45 and holiday pay.
Acumon processes leaver payments, including termination awards and Class 1A, as part of our payroll management service, and our employment tax team can review a proposed package before it is agreed.