Settlement agreements are a tool often used to deal with workplace problems, which can help bring employment to an end in a mutually acceptable way. Although what the settlement agreement will consist of it is primarily up to the employer, the main aspect is most often a financial payment to the employee.

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. From April 6th 2018, all payments in lieu of notice will be taxed as income and will therefore be subject to income tax and national insurance contributions, too.

Speak to a local Leicestershire employment law specialist

If you need help with negotiating a settlement agreement, call to speak to one of our expert employment law solicitors today.  Bray & Bray has three main offices in Leicestershire, contact us to discuss an enquiry, using the telephone numbers below:

Leicester call us on 0116 254 8871

Hinckley call us on 01455 639 900

Market Harborough call us on 01858 467 181