Tax-Efficient Redundancy Planning UK 2026: Maximise Your Settlement

If you're being made redundant in the UK, the structure of your settlement matters as much as the headline number. With careful planning around the £30,000 Section 401 ITEPA 2003 exemption, the PENP rules, and pension contributions, a higher-rate taxpayer can routinely add £5,000-£15,000 to their take-home from a £100,000+ package. This guide covers the legitimate planning levers for 2026/27.

The structure of a typical redundancy package

A standard package contains:

1. Statutory redundancy pay - based on age + length of service, capped at £21,000 maximum (2026/27).
2. Enhanced redundancy - anything above statutory, paid as a discretionary employer top-up.
3. PILON - Pay In Lieu of Notice (taxable as ordinary income since 2018).
4. Garden leave or worked notice - your normal salary during the notice period.
5. Holiday pay - accrued unused statutory holiday.
6. Pension contribution - sometimes maintained through notice.

The tax treatment varies by component, and the planning opportunity is in how the components are structured before you sign anything.

The £30,000 Section 401 exemption

Under Section 401 ITEPA 2003, the first £30,000 of a "termination payment" is tax-free. Anything above £30,000 is taxed as ordinary income (subject to employer NIC at 15% on the excess since 2020).

What counts as "termination payment":

• Statutory redundancy pay.
• Enhanced redundancy (the genuine "compensation for loss of office" element).
• Settlement amounts for non-PILON, non-bonus reasons.

What does NOT count (taxed in full):

• PILON.
• Bonuses earned before termination.
• Holiday pay.
• Restrictive-covenant payments.
• Some cash-in-lieu-of-benefits.

The PENP calculation (Post-Employment Notice Pay) ensures any PILON-equivalent amount is taxed as ordinary income, even if the contract didn't explicitly call it PILON.

Strategy 1 - Pension contribution from the settlement

The single most powerful tax-planning lever: direct part of your settlement into your pension.

Up to your Annual Allowance (£60,000 in 2026/27) plus any carry-forward from the previous 3 tax years (each up to £60,000), you can:

• Have the employer pay the contribution directly to your pension scheme, OR
• Receive the cash and contribute personally (claiming relief via Self Assessment).

For a higher-rate taxpayer with £40,000 of pension headroom, redirecting £40,000 of settlement saves:

• £16,000 income tax (40% × £40,000).
• £800 employee NI (2% above the UEL).
• £6,000 employer NI (15% × £40,000) - sometimes shared with you as additional pension contribution.

Net after-tax saving: typically £17,000-£23,000 on a £40,000 pension contribution from settlement.

This works best when:

• You have substantial unused Annual Allowance (especially carry-forward).
• You're under 55 (or willing to wait until age 55, rising to 57 in 2028, before accessing pension money).
• You're a higher- or additional-rate taxpayer in the tax year of redundancy.

Strategy 2 - Spread the settlement across two tax years

If your settlement crosses 6 April, splitting payments between two tax years can reduce your higher-rate tax exposure.

Worked example: £80,000 settlement.

• Paid all in 2025/26: £30,000 tax-free, £50,000 added to your salary tax bracket. If salary is £60,000, the £50,000 settlement pushes you well into higher rate.
• Paid £40,000 in 2025/26 and £40,000 in 2026/27: each year the marginal rate impact is smaller.

The employer must agree to the timing - most are flexible if asked early in negotiation.

Strategy 3 - Restructure PILON into settlement (where legitimately possible)

The 2018 PENP rules tightened this dramatically - pure PILON-relabeling no longer works. But where the payment is genuinely for compensation for loss of office (not contracted notice), it can fall under Section 401.

The legal test: was the payment contractually due (PILON) or discretionary compensation (Section 401)?

For senior packages, your employment lawyer can structure the settlement agreement to legitimately maximise the Section 401 component. Don't try this without legal advice - HMRC enquiries on suspicious settlements are common.

Strategy 4 - Restrictive covenant payment

If your settlement includes payment for accepting a restrictive covenant (non-compete, non-solicit, non-dealing), that payment is fully taxable as ordinary income - but it's separate from the £30,000 Section 401 exemption.

This means the restrictive-covenant payment doesn't eat into your £30,000 tax-free amount.

For senior roles where the restrictive covenant is meaningful (genuine restraint on next employment), this can be £5,000-£25,000. Negotiate it as a separate line item.

Strategy 5 - Outplacement support (often missed)

Employer-provided outplacement support is fully exempt from tax + NI under specific HMRC rules.

This includes:

• CV review and rewriting.
• Career coaching.
• Interview preparation.
• Networking introductions.

Outplacement firms typically charge £500-£3,000 for these services. Negotiate the employer to fund this directly (not as a cash payment to you) - you avoid tax on the benefit AND get the practical job-search support.

Strategy 6 - Continuing benefits

If your employer extends benefits (private medical insurance, life cover) for 3-12 months post-employment:

• The benefits are taxable as P11D items in the tax year they're provided.
• But you save the cost of buying them privately.

For someone aged 50+ with health concerns, post-employment medical insurance can be worth £1,500-£4,000/year in market value vs. perhaps £500 in actual P11D tax cost. Strong negotiation point.

Strategy 7 - Unwrap the package against AA capacity

Coordinate the settlement structure with your pension Annual Allowance position:

• Use any carry-forward from prior years (up to 3 years × £60,000 each).
• Avoid triggering an AA charge by keeping pension contributions inside your headroom.
• For substantial settlements, consider Scheme Pays for any unavoidable AA charge.

This requires careful pension calculations BEFORE signing the settlement agreement.

What NOT to do

• Don't sign the settlement agreement without independent legal advice (employer typically pays £500-£1,500 for the lawyer).
• Don't accept a "take it or leave it" offer - most settlements have negotiating room of 10-25%.
• Don't skip the pension contribution analysis - for higher-rate taxpayers, this is often the single biggest tax-saving lever.
• Don't trigger temporary non-residence rules - if you leave the UK shortly after redundancy with substantial unallocated settlement, special rules may apply.

When to use a specialist

For substantial redundancy packages (£50,000+), the cost of a specialist tax + employment lawyer pays back many times over. Specialists can:

• Negotiate higher headline figures.
• Restructure the settlement for maximum tax efficiency.
• Identify pension carry-forward you may have overlooked.
• Manage the AA charge planning.
• Draft the settlement agreement to be enforceable AND tax-optimal.

For routine packages under £30,000 (entirely tax-free), DIY using ACAS guidance + a quick legal review is sufficient.

Disclaimer

PayslipIQ provides automated educational guidance based on the figures you supply. It is not regulated tax, employment-law, or pension advice. Redundancy settlement structuring is technical and individual circumstances vary substantially - for substantial settlements (especially above £50,000 or where pension AA carry-forward applies), use a CTA-qualified tax adviser working alongside an employment solicitor.