What is Payment in Lieu of Notice (PILON)? A complete employer guide

1. What does Payment in Lieu of Notice mean?
2. When should an employer use PILON?
3. What is a PILON clause and why does it matter?
4. What is included in a PILON payment?
5. How to calculate PILON pay
6. Is PILON taxable? Tax and National Insurance explained
7. Is PILON pensionable?
8. PILON vs Garden Leave: What's the difference?
9. PILON and redundancy: What employers need to know
10. How to process PILON: A step-by-step guide for employers
11. Frequently Asked Questions About PILON
12. Navigating PILON with PeopleHR

Payment in lieu of notice (PILON) is when an employer chooses to end an employee's contract immediately by giving them a lump sum payment, rather than requiring them to serve their notice period. The employee receives the pay they would have earned during that notice period, but their employment ends straight away.

PILON can be contractual (written into the employment contract via a PILON clause) or it can be agreed informally between employer and employee at the point of termination. It applies in both employer-initiated and employee-initiated departures, though it is most commonly used by employers.

It's important to understand that PILON is not the same as withholding notice. Notice is still given - the employee simply does not work it. Their employment ends on the termination date, and they are free to start a new role immediately.

PILON is most appropriate when it would be harmful or impractical for the employee to remain in the workplace during their notice period. Common scenarios include:

• Redundancy: allowing an immediate, clean exit as part of a restructure
• Senior or sensitive role exits: where continued access to confidential information, client relationships, or strategic plans poses a business risk
• Data and IP protection: where there is concern the employee could share or misuse sensitive information
• Mutual agreement: where both parties prefer a clean break over a prolonged notice period
• Role replacement: where a successor is already in place and a handover period is not needed

When PILON does not apply: Gross misconduct

If an employee is dismissed for gross misconduct, they are not entitled to notice pay — and therefore PILON does not apply. Gross misconduct (such as theft, fraud, or serious breach of company policy) allows an employer to terminate employment with immediate effect and without payment in lieu of notice. Always take legal advice before dismissing for gross misconduct to ensure the process is fair and defensible.

Risk of not having a PILON clause

If your employment contracts do not include a PILON clause, you can still offer PILON — but only with the employee's explicit agreement. Imposing PILON without their consent, and without a contractual right to do so, constitutes a breach of contract and could expose your business to legal action. See the section below on PILON clauses for more detail.

The contents of a PILON payment depend on the employment contract. As a baseline, PILON always covers basic salary for the unworked notice period. Beyond that, it depends on what the PILON clause specifies.

Always refer to the specific wording of the employment contract. If the PILON clause is silent on a particular benefit, seek legal advice before assuming it is excluded.

PILON is calculated based on what the employee would have earned had they worked their notice period in full. Here is the standard approach:

Step 1: Confirm the notice period: Use the contractual notice period, or the statutory minimum (whichever is greater). Under UK law, the statutory minimum is one week per year of service, up to a maximum of 12 weeks.

Step 2: Calculate the gross PILON amount: Multiply the employee's basic gross monthly (or weekly) pay by the length of the notice period.

Step 3: Add any contractual extras: Check the PILON clause for any additional entitlements (e.g. guaranteed commission, benefits in kind).

Step 4: Apply PAYE and National Insurance deductions: PILON is fully taxable. The net figure paid to the employee will be lower than the gross amount.

Step 5: Document the calculation: Provide the employee with a clear written breakdown to reduce the risk of dispute.

Worked example of PILON

Sarah earns a basic salary of £3,000 per month. Her contract specifies a two-month notice period. Her employer invokes the PILON clause and terminates her employment immediately.

Gross PILON = £3,000 × 2 = £6,000

Income tax and Class 1 National Insurance will be deducted from this amount via payroll before Sarah receives her lump sum. The net figure will depend on Sarah's tax code and NI category.

A note on Post-Employment Notice Pay (PENP)

Since April 2018, HMRC uses a formula called Post-Employment Notice Pay (PENP) to determine the taxable portion of any termination payment that relates to an unworked notice period. In most straightforward PILON cases, the entire payment will be subject to tax and NI under PENP rules. If the termination package includes other elements (such as a settlement payment), PENP determines how much of the total is treated as PILON for tax purposes. For complex cases, consult your payroll provider or a tax adviser.

Yes, PILON is fully taxable.

Since April 2018, all payment in lieu of notice is subject to Income Tax and Class 1 National Insurance contributions, regardless of whether a PILON clause exists in the employment contract. This applies to both the employee's and employer's NI contributions.

Important: The £30,000 tax-free termination payment exemption does not apply to PILON. This is a common misconception. The £30,000 exemption may apply to other elements of a termination package (such as genuine redundancy pay or ex-gratia payments), but never to PILON.

From April 2025, employer National Insurance contributions are charged at 15% on PILON payments above the secondary threshold. Ensure your payroll team accounts for this when calculating the total cost of a PILON exit.

Practical implication: Always calculate and communicate the gross PILON figure to the employee, and make clear that the net amount received will be lower after tax and NI deductions. Refer employees to GOV.UK for personal tax guidance.

PILON is not automatically pensionable.

Whether pension contributions apply to a PILON payment depends on two things:

1. The employment contract - specifically, whether the PILON clause includes pension contributions as part of the payment
2. The pension scheme rules - most defined contribution schemes are based on regular earnings and do not treat one-off termination payments as pensionable pay

In practice, the majority of PILON payments do not attract employer pension contributions, unless the contract explicitly requires it. Employees should not assume they will receive pension contributions as part of their PILON unless this is confirmed in writing.

For employers: Check your pension scheme documentation before making any assumptions. If the PILON clause is silent on pensions, seek advice from your pension provider or an HR/legal professional before the payment is made.

For employees: Review your employment contract and, if in doubt, ask your employer or an independent financial adviser to clarify your position before your termination date.

Both PILON and garden leave allow an employer to remove an employee from the workplace before their notice period ends - but they work very differently in legal and practical terms.

When to choose garden leave over PILON

If you need to enforce post-termination restrictions (such as non-compete or non-solicitation clauses), garden leave is generally more legally robust, as the employment relationship remains intact throughout the notice period. PILON, particularly without a contractual clause, can weaken the enforceability of those restrictions.

PILON is commonly used alongside redundancy to allow an immediate exit, rather than requiring the employee to work a notice period that may be weeks or months long.

It is important to understand that PILON and redundancy pay are separate payments - both may be made at the same time, but they are legally and financially distinct:

• Redundancy pay compensates the employee for the loss of their role
• PILON compensates the employee for the notice period they will not work

Tax treatment differs: Statutory redundancy pay (and genuine ex-gratia payments up to a combined total of £30,000) may qualify for the tax-free exemption. PILON does not — it is always fully taxable. Always itemise the two payments separately in your documentation to avoid confusion and ensure correct tax treatment.

If you are running a redundancy process, ensure your PILON calculation is based on the employee's notice entitlement under their contract (or the statutory minimum, whichever is greater), and that both payments are clearly set out in the termination letter and final payslip.