The Real Cost of Redundancy Pay – Everything You Need to Know

No employer wants to let go of their workers – but when your business comes under pressure, difficult decisions have to be made. Redundancy payments are part of that process. Yet, with so much focus on supporting employees, the tax treatment of these payments is easily overlooked.

Getting it wrong can be costly. A lack of planning could leave you footing the bill for tax and National Insurance liabilities that could have been avoided. For HR and payroll teams already juggling heavy workloads, it’s easy for key tax rules to slip through the cracks. In this blog, we will explain some of the main points you need to keep in mind.

The £30,000 exemption for redundancy pay – everything you need to know

What is covered by the £30,000 redundancy pay exemption?

Many employers assume the first £30,000 of a redundancy package is automatically tax-free. Unfortunately, it’s not that straightforward.

The £30,000 exemption only applies to payments that are compensatory in nature and are not classed as earnings. In other words, they must be made to compensate an employee for the loss of their job rather than reward them for work they’ve done.

Genuine redundancy payments fall into this category. This includes both statutory redundancy pay and non-statutory compensation payments – provided they aren’t contractual payments or treated as earnings.

Where the conditions are met, these payments can be made free from Income Tax and National Insurance contributions up to the £30,000 limit.

What isn’t covered?

Before applying the £30,000 exemption, employers need to consider one key question: Is it an earnings payment?

Payments that arise through the employment contract or form part of an employee’s normal remuneration package are treated as earnings and taxed in the usual way. This includes:

• Outstanding salary and wages
• Bonuses and commission payments
• Accrued holiday pay
• Contractual payments in lieu of notice
• Payments that, while not written into a contract, are customarily made and expected by employees

Even if these amounts are paid as part of a redundancy package, they don’t qualify for the £30,000 exemption. They remain fully subject to Income Tax and National Insurance contributions.

Other important rules to keep in mind

The £30,000 exemption isn’t unlimited. If qualifying redundancy payments exceed the threshold, the excess is subject to Income Tax – although it remains free from employee National Insurance contributions.

There are also circumstances where redundancy payments can fall outside the UK tax regime altogether. For example, employees who have worked entirely overseas may qualify for a full exemption, while those with both UK and overseas service could benefit from partial relief.

Employers should also consider pension contributions as part of a redundancy package. Contributions to a tax-exempt or approved pension scheme can be made free from tax, provided they aren’t an entitlement under the worker’s contract of employment.

The key takeaway? Not every payment made on redundancy is treated the same for tax purposes. Taking the time to identify which elements are earnings and which qualify for relief can help employers avoid unexpected tax bills and ensure redundancy packages are structured as efficiently as possible.

How AAB can help

Redundancy is rarely straightforward. Alongside supporting employees and meeting legal obligations, employers also need to make sure the tax treatment of every payment is right.

A misunderstanding over what qualifies for the £30,000 exemption, or how different elements of a termination package should be taxed, can lead to unexpected costs and additional administration.

At AAB, our tax specialists work with businesses to take the uncertainty out of the process. For more information about our People Services, get in touch with Louise McCosh, your usual AAB contact, or a member of the People Team.