The head of your company is retiring soon and you want you send her off in style with a lump sum payment. Will the exemption that allows employers to pay a departing employee up to £30,000 tax and NI free apply?

Rewarding departing workers

In recent years the tax and NI rules for payments to employees on the termination of their employment (or directorship) have been made tougher. For example, all payments in lieu of notice are taxable and liable to NI. Even before the changes the rules were less generous than was commonly understood. For example, the £30,000 exemption for termination payments didn’t apply to golden handshakes.

Trap. All payments made to an employee or director which reward them for past service are taxable as earnings and are fully liable to PAYE tax and employees’ and employers’ NI. This means you must treat them in the same way as salary.

How much is taxable?

Where the amount of a non-contractual termination payment is specified, the whole amount, less the £30,000 exemption if applicable, is taxable and liable to NI. However, if the payment covers a number of elements you must use a special formula to work out how much of the payment is taxable as earnings and how much can qualify for the £30,000 exemption. In the right circumstances both rules can be side-stepped and a tax and NI-free payment, even a golden handshake, can be made.

Pension contribution

A golden handshake can be tax and NI free if, instead of being a cash payment, it’s in the form of an employer’s contribution to a registered pension scheme. HMRC has no objection to this under the current rules. The trouble is that the employee or director isn’t able to access the cash until they are 55 (57 from April 2028).

Tip. To pay a golden handshake to an individual who’s 55, or soon will be, a pension contribution is an uncontroversial way to provide some tax and NI-free cash. If it’s paid into a new pension plan for an employee they can take 25% of the amount contributed (after pension company admin charges) tax and NI free. The balance can be taken as taxable income straightaway or left to grow (tax free) until they take it.

Make it tax free

If an employee or director still has some years before they reach 55 (or 57, see above) a golden handshake in the form of a pension contribution might be less attractive to them. In that case a tax and NI-free cash payment of up to £30,000 is possible if you can make it so that the termination payment rules apply. However, there’s a risk HMRC will argue that the whole sum is taxable earnings.

Tip. To persuade HMRC that the termination payment rules apply, make sure that in letters and other documents approving the payment, you don’t refer to it as a golden handshake or reward for past work. Say that the payment is not made under any obligation on the part of the company, but is wholly a goodwill gesture. You could also make the payment partly as a pension contribution and partly as a cash sum. This should reduce the risk of attack from HMRC. The smaller the cash sum the less argumentative HMRC is likely to be.

This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit or call 01233 653500.