Everything you need to know about terminating contracts

Last updated on

When someone does lose their job, there is typically a termination payment of some sort. The type of payment depends on the departure itself and what is negotiated between the departing employee and the employer.

In this piece, we take a look at the different types of contract termination and the processes required to follow.


What is redundancy?

Redundancy is when a role becomes obsolete and therefore the person in the role is no longer required by that organisation.

What are the reasons behind redundancy?

There are several reasons as to why somebody may be made redundant. These include:

  • the company that employs the employee(s) ceases trading;
  • the company ceases trading from the location the employee is employed at;
  • there is a restructuring process within the company that leads to the employee’s job becoming surplus to requirements.

Who is entitled to a statutory redundancy payment?

Employees who were employed at a company for at least two years before they were made redundant are entitled to a statutory redundancy payment.

What are they entitled to?

An employee who is made redundant will be entitled to half a week’s pay for each full year worked up to and including the age of 21. If the employee worked between the ages of 22 and 40, they will be entitled to one week’s pay for each full year worked. For each year worked over the age of 41, an employee will be entitled to one and a half weeks’ pay.

Employments rights.

Employments rights.

How much redundancy payment can someone receive?

The length of the service is capped at 20 years and the redundancy payment itself is currently capped at £525 per week. Consequently, the maximum redundancy payment is £15,750.

Redundancy payment calculation

£525 x 1.5 = £787.50

£787.50 x 20 = £15,750

When the 2020/21 tax year kicks off on 6 April, there will be a 2.5% increase in statutory redundancy pay, rising from £525 to £538. The maximum redundancy payment will increase to £16,140.

Maximum redundancy payment calculation

£538 x 1.5 = £807 

£807 x 20 = £16,140

💵 Tax and National Insurance

Redundancy payments are included in the £30,000 tax-free threshold for termination payments.

Anything above £30,000 is taxable and there is never any employee National Insurance (NI) charge on a termination payment.

From the start of the 2020/21 tax year, employers will be due to pay Class 1A NI on termination payments above £30,000.

Settlement Agreement

What is a settlement agreement?

A settlement agreement is a mutual agreement between an employee and an employer to terminate the employment contract. Typically, the employer would offer the employee compensation as a settlement.

What payments/compensation are usually settled?

Several different payments can be included in a settlement agreement. These include:

  • compensation for the loss of employment;
  • compensation for the loss of any benefit;
  • ex-gratia - a voluntary gift or payment made by the employer;
  • payments in lieu of notice (PILON) are taxable, and NI must also be paid;
  • post Employment Notice Pay (PENP) is are taxable, and NI must also be paid.

💵 Tax and National Insurance

Settlement monies are included in the £30,000 tax-free threshold for termination payments. All PILONs and PENPs are subject to tax and NI.


What are the employer's obligations?

Unfortunately, from time to time, employees pass away. In this instance, employers are required to do things slightly differently.

An employer is required to immediately terminate a deceased employee’s contract and report this via the payroll for HMRC to be aware that this employee is no longer working.

💰 Pay as you earn (PAYE)

Tax is still due on the payment of a deceased employee; however, there is never any NI owed.

📝 P45

There is no need to issue a P45 in this case.


Why does it happen?

There are occasions when someone may be added to an employer’s payroll yet never actually turn up to work.

If HMRC has already been informed on the Full Payment Submission (FPS) that the employee has started, they will also need to be told that they are a leaver.

🔚 Termination process

In this situation, the employer would be required to terminate them as a non-starter, confirm that their end date is the same as their start date, and not issue a P45. Their year to date figures must also be reported as £0 on the FPS.

💸 Payments after leaving

What are they?

This form of payment is made to a former employee after the P45 has been issued—i.e. after HMRC have been informed the employee has left the company.

Why are they needed?

They may be needed for anticipated payments such as bonuses and commission and non-anticipated payments such as if an error has been made.


Any payments made after an employee leaves their role will have an 0T M1 tax code.

📁 NI

The NI treatment on payments after leaving will depend on the type of payment. If the payment is a “regular payment”, such as basic pay, then the normal NI period will apply—i.e. if the employer pays monthly, they will use a monthly NI calculation.

If the payment is an “irregular payment”, such as holiday pay or a bonus, then a weekly NIC calculation will always be used.

PayFit & terminations

Terminating employee contracts couldn’t be more straightforward on the PayFit app. Not only does it automatically calculate payments for base pay and annual leave, but it also processes PILON and statutory redundancy calculations.

Termination payments and the associated tax and NIC treatment can also be dealt with very easily by selecting the reason for an employee leaving.

Want to find out more about the ways PayFit can help automate your payroll and HR processes? Then why not book a demo with one of our product specialists today?

PayFit blog author

PayFit blog author


You may also like...

Why transparency between payroll providers and customers is always needed

In this short piece, we look at why transparency is so important when it comes to payroll and explain how we at PayFit have helped create a transparency tool to support customers. 

Accountant-run payroll — why payroll outsourcing needs to change

Although some accounting firms may have a payroll department, it is not always an area where accountants hold a great deal of expertise. 

Pauline’s Payroll Problems — End of Tax Year 

In this latest episode of Pauline's Payroll Problems, we look at end of tax year pain points and explain why moving to PayFit has helped Pauline manage this difficult period in the year. 

Stay up to date with the latest payroll, HR & PayFit news...