What is a settlement agreement?
A settlement agreement is a legal agreement between an employer and an employee under which an employee waives all legal rights to pursue any claims against the employer. These agreements are usually offered to employees as part of a disciplinary, redundancy or grievance procedure. Payments within the agreement can be contractual as well as out of goodwill.
Types of settlement agreement payments
There are different types of payment that will make up the settlement agreement and for the employee it’s important to consider the tax implications of each type of payment.
Ex gratia termination payments in settlement agreements
Ex gratia (i.e. not contractual) payments are a sum of money offered to you when the employer has no obligation to do so. These are often used as a sweetener by an employer, as incentive to prevent you from making a claim against them in the future.
This type of settlement agreement payment is good news for the employee as they offer a unique tax break. The first £30,000 of non-contractual and non-notice payments such as ex gratia are not subject to income tax or NI deductions. Any ex gratia payments in excess of the first £30,000 are taxable at whichever tax band your earnings fall under.
Redundancy payments in settlement agreements
If you have been made redundant and have been in continuous employment with the employer for a period of two years or more, you will be entitled to redundancy pay. Contractual and statutory redundancy payments fall within the collective £30,000 tax exemption.
Settlement agreement pension contributions
If your employer has made you redundant and you have been in continuous employment with them for a period of 2 years or more, you will be entitled to some redundancy pay. It can be wise to negotiate more payment into your pension if your payment exceeds the £30,000 exemption.
Other tax exemption payments in settlement agreements
- Death, injury and disability exemption
- Payments of compensation or damages for personal injury
- Payments of an employee’s legal costs
Taxable sums in settlement agreements
Taxable sums are usually payments which your employer is obliged to pay you. Contractually owed sums such as your salary, holiday pay, notice pay, bonus, and commission payments are all taxable. F
Speak to our employment law specialist
If you need help with negotiating a settlement agreement, call to speak to one of our expert employment law solicitors today.
