Redundancy tax calculator: How to work out tax on redundancy pay

1. What is redundancy tax?
2. How are redundancy payments taxed?
3. How to calculate tax on redundancy pay manually
4. Using a redundancy tax calculator
5. Employer responsibilities when paying redundancy
6. Redundancy tax FAQs
7. Get your redundancy calculations right with PeopleHR

Redundancy tax refers to the Income Tax and National Insurance that may apply to certain parts of an employee’s redundancy payment. In the UK, some redundancy pay can be received tax-free, while other elements are taxable depending on the payment type and amount.

Redundancy tax applies in the case of both involuntary and voluntary redundancy, as well as statutory or contractual redundancy. Statutory redundancy pay is the minimum amount required by law, based on an employee’s age, length of service and weekly pay, while contractual redundancy refers to any enhanced redundancy package offered by the employer beyond the statutory minimum. This may include higher levels of redundancy pay or additional benefits such as extended notice periods or outplacement support, so employers need to check that they’re meeting the specific redundancy terms outlined in the employee’s contract when calculating their tax liability.

Redundancy pay isn’t always taxed in the same way. Different parts of a payment package are treated differently, and it’s important that employers understand how to separate them. Let’s look at some examples of how a redundancy tax calculator helps to break down which elements are taxable and which can be paid tax-free.

Tax-free redundancy pay

The first £30,000 of genuine redundancy pay is typically tax-free in the UK. This includes statutory redundancy pay and any additional compensation directly linked to the loss of employment. However, once redundancy payments exceed £30,000, the excess amount becomes taxable at the employee’s usual rate of Income Tax. Employers should be careful not to confuse this with other termination payments, as only true redundancy payments qualify for the tax-free exemption.

Taxable redundancy pay

Any redundancy pay above £30,000 is subject to Income Tax through PAYE. This portion must be added to the employee’s other earnings for that tax year and taxed at their marginal rate. For higher earners, this may mean that a portion of their redundancy pay falls into the higher or additional tax bands. Using a redundancy tax calculator can help employers to quickly estimate how much tax to withhold and ensure that the correct deductions are made before processing the final payroll.

Payment in lieu of notice (PILON)

If an employee’s contract allows for payment in lieu of notice (PILON) instead of working their notice period, that payment is always taxable. HMRC treats PILON as regular earnings, meaning that it’s subject to both Income Tax and National Insurance contributions. Employers should process this payment through payroll and deduct the appropriate amounts before disbursement.

Holiday pay and bonuses

Any accrued but unused holiday pay, or bonuses due before termination, must also be taxed through payroll. These payments aren’t considered redundancy pay and are treated as normal earnings. If your business uses rolled up holiday pay, those payments are already accounted for in regular earnings and taxed accordingly, so you can disregard them. It’s important to keep these distinctions clear in your records to ensure accurate reporting to HMRC.

While most employers use payroll software or a tax on redundancy pay calculator, it’s still useful to understand the process behind the figures. To calculate redundancy tax manually, start by identifying the total redundancy payment. Subtract the £30,000 tax-free allowance, and the remaining amount is what’s taxable.

You then need to apply the employee’s marginal rate of Income Tax, based on their total income for the year, to that taxable portion. Finally, remember to add any other taxable payments, such as notice pay or holiday pay, before processing their pay through PAYE. This method ensures that you’re accurately accounting for every part of the payment and fulfilling your tax obligations correctly.

Here’s a quick guide to the steps for calculating redundancy tax:

1. Identify the total redundancy payment
2. Find the taxable portion
3. Apply the employee’s tax rate
4. Add any taxable notice or holiday pay

Using a redundancy tax calculator for UK employers can take the guesswork out of manual calculations. By entering details such as the employee’s salary, age, length of service and redundancy payment amount, the calculator estimates both the gross and net redundancy pay after tax.

Using a redundancy tax calculator can help businesses to plan redundancy budgets, communicate clearly with staff about what they’ll receive, and avoid errors that might lead to HMRC queries later. It’s particularly useful for comparing statutory and enhanced packages, or for understanding the impact of notice and holiday pay on overall redundancy costs.

As an employer, you have a legal responsibility to process redundancy payments correctly. This includes deducting the right tax, issuing documentation, and ensuring that statutory entitlements are met. Let’s look at some of the key responsibilities you’ll need to fulfil when paying redundancy.

Deducting the correct tax via PAYE

All taxable elements of a redundancy payment must go through PAYE so that Income Tax and National Insurance are deducted before payment. Employers are responsible for ensuring that only the taxable amounts are included in PAYE, and that the £30,000 tax-free threshold is applied correctly.

Issuing an accurate P45 and payslip

After making the final payment, you must issue an accurate P45 showing the total pay and tax deducted to date. The payslip for the final payment should clearly outline redundancy pay, notice pay and holiday pay separately. This transparency helps employees to understand how their redundancy package was taxed and ensures compliance with UK employment law.

Reporting payments to HMRC

Employers are required to report redundancy payments and tax deductions to HMRC through Real Time Information (RTI). Failing to report accurately or on time can result in penalties. Using reliable payroll software helps to automate this reporting and reduces the risk of mistakes.

Disbursing statutory entitlements

It’s also crucial that employees receive any statutory redundancy pay they’re entitled to under UK law. Even if your company offers enhanced redundancy packages, statutory entitlements form the legal baseline. Employers should calculate these separately to ensure that every eligible employee receives what they’re due.

Getting redundancy pay right isn’t just about accuracy; it’s about fairness, compliance and supporting employees during the transition. Understanding how redundancy tax works helps you to stay on the right side of HMRC rules, avoid errors, and protect your organisation’s reputation.

PeopleHR’s payroll software simplifies redundancy payments by automating calculations, tax deductions and reporting to HMRC. It integrates seamlessly with your existing HR processes, helping you to save time, reduce manual work and keep your records accurate.

If you’re ready to streamline payroll and handle redundancy payments with confidence, Watch our 4 minute payroll demo or contact us today to learn more about how PeopleHR can help.

If you enjoyed this article, you may be interested in reading:

1. What is the redundancy process & how long does it take?
2. What is voluntary redundancy and how does it work in practice?
3. Can I Re-Employ Someone I Made Redundant?