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Income tax, National Insurance and net pay for any UK salary, 2026-27.
The Office for National Statistics estimated 114,000 redundancies in its most recent quarterly figures, a rate of 3.9 per 1,000 employees [1]. Many of those exits end with a payment in lieu of notice (PILON), and since 6 April 2018 every such payment has been subject to income tax and Class 1 National Insurance through the post-employment notice pay rules [2] [3].
A PILON lets an employer end employment immediately and pay the employee for the notice period instead of having it worked. The concept is simple, but the payroll treatment is not. The amount owed depends on statutory and contractual notice, the presence or absence of a PILON clause, and a formula in the Income Tax (Earnings and Pensions) Act 2003 that decides how much of any termination package is taxed as earnings.
This guide explains the statutory notice framework, what a PILON must include, how the post-employment notice pay (PENP) formula works with worked examples, how tax and National Insurance apply, and how the payment is reported through Real Time Information.
Key takeaways
- Statutory notice from the employer is 1 week for service of 1 month to 2 years, then 1 week per complete year, up to a maximum of 12 weeks.
- An employer can only impose a PILON where the contract allows it; otherwise the employee must agree, or the employer risks a breach of contract claim.
- Since 6 April 2018, all notice pay, contractual or not, is taxed as earnings and subject to Class 1 National Insurance via the PENP formula.
- The PENP formula is ((BP x D) ÷ P) − T, and only the termination payment above PENP can benefit from the £30,000 tax-free threshold.
- Employer Class 1A National Insurance applies to termination awards above £30,000.
- PILON paid after a P45 is issued is taxed on code 0T on a week 1 or month 1 basis and flagged as a payment after leaving on the FPS.
Notice periods: the legal starting point
A PILON is valued by reference to the notice the employee would otherwise have received, so the first step is always to establish that notice period.
Statutory minimum notice
Section 86 of the Employment Rights Act 1996 sets minimum notice for employees with at least one month of continuous employment [4]. The table below sets out the employer's minimum obligation.
| Continuous employment | Minimum notice from employer |
|---|---|
| Less than 1 month | No statutory minimum |
| 1 month to less than 2 years | 1 week |
| 2 years to less than 12 years | 1 week per complete year of service |
| 12 years or more | 12 weeks |
An employee with one month's service must give at least 1 week's notice to resign, whatever their length of service [4]. A contract can provide longer notice but never shorter than the statutory minimum [5].
Contractual notice and the right to waive
Where the contract sets a longer period, the longer period applies. Section 86(3) allows either party to waive notice on a particular occasion or to accept a payment in lieu of notice [4]. That waiver mechanism is the statutory basis for PILON.
Employees whose contractual notice is less than one week longer than statutory notice also benefit from sections 87 to 91, which protect pay during the statutory notice period in situations such as sickness or holiday [6]. Where contractual notice exceeds the statutory minimum by a week or more, those protections do not apply [6].
How a PILON works in practice
A PILON ends the employment on the day it takes effect. The employee stops working immediately, and the employer pays a sum that stands in for the notice period [7].
With and without a PILON clause
If the contract contains a PILON clause, its wording determines whether the employer can insist on paying in lieu [7]. If there is no clause, the employer can ask the employee to accept a PILON but cannot force it, and dismissing without notice exposes the employer to a breach of contract claim [7].
A PILON should not be confused with garden leave. During garden leave the employee remains employed, receives normal pay and benefits, and is simply told not to work, whereas a PILON ends the contract straight away [7]. The Moonworkers guide to garden leave covers that alternative in detail. The table below compares the three ways a notice period can play out.
| Feature | Notice worked | Garden leave | PILON |
|---|---|---|---|
| Employment continues to end of notice | Yes | Yes | No, ends immediately |
| Employee works | Yes | No | No |
| Paid through normal payroll | Yes | Yes | Lump sum |
| Contractual benefits continue | Yes | Yes | Only if contract or agreement provides |
| Holiday keeps accruing | Yes | Yes | No |
What the payment should include
GOV.UK states that a PILON covers the basic pay the employee would have received during the notice period, plus any extras the contract provides, such as pension contributions or private health insurance [5]. Acas notes that where a contractual clause applies, the clause defines what is paid, and other benefits are unlikely to be owed unless it says so [7].
Holiday is a separate entitlement. Untaken statutory holiday accrued up to the termination date must be paid in the final pay, even in cases of gross misconduct [8]. Because a PILON shortens employment, holiday stops accruing on the termination date, unlike garden leave, where it continues to accrue to the end of notice. The accrual rules are explained in the guide to Working Time Regulations.
The PENP formula: how much is taxed as earnings
Before 6 April 2018, a non-contractual PILON was generally treated as damages for breach of contract and could fall within the £30,000 tax-free threshold. Finance (No. 2) Act 2017 removed that distinction [3] [9].
Employers must now apply the PENP formula to every "relevant termination award", whether or not a contractual or non-contractual PILON is paid [2]. The result is the slice of the package that is taxed as earnings. Only the remainder can use the £30,000 threshold.
The four terms
The formula, set out in section 402D ITEPA 2003, is ((BP x D) ÷ P) − T [10]. The table below defines each term.
| Term | Meaning | Key rule |
|---|---|---|
| BP | Basic pay in the last pay period before the trigger date | Excludes overtime, bonus, commission, gratuities and allowances; measured before salary sacrifice |
| D | Calendar days in the post-employment notice period | Minimum notice under contract or statute, less any notice actually given |
| P | Calendar days in the last pay period | Can be set to 1 with D in months for monthly-paid staff on whole-month notice |
| T | Taxable PILON already paid as earnings | Excludes holiday pay and termination bonuses |
Sources: [10], [11], [12], [13].
If the formula produces a negative figure, PENP is nil. If it produces more than the total termination award, PENP is capped at that total [10].
Monthly pay and the 30.42 rule
For monthly-paid employees on whole-month notice, P can be taken as 1 and D counted in months, provided salary is paid in 12 equal monthly instalments [12]. Where notice is not a whole number of months, P is replaced with 30.42 (365 ÷ 12), so the length of the final month does not distort the result [12].
That rule became mandatory from 6 April 2021, after a period from 16 October 2019 when it was available as a concession [12]. Six weeks' notice for a monthly-paid employee is therefore calculated as 42 days divided by 30.42, not by 28 or 31.
Why BP excludes bonus and overtime
BP is deliberately narrow. Overtime, bonus, commission, gratuities and allowances are excluded, as are taxable benefits and payments connected with termination [11]. Salary sacrificed under an arrangement is added back, so BP reflects pay before the sacrifice [11].
The narrow definition means PENP can be lower than the employee's true contractual notice entitlement. Any contractual bonus or commission due for the notice period is still taxable as earnings in its own right [14].
Worked examples
The three scenarios below show how the formula splits a package between taxable earnings and the £30,000 threshold.
Example 1: contractual PILON, no extra payment
An employee earns £3,000 a month (£36,000 a year), has a 3-month notice period and a PILON clause. The employer pays £9,000 under the clause. With monthly pay and whole-month notice, PENP is ((£3,000 x 3) ÷ 1) − £9,000 = nil [10] [12].
The £9,000 is already taxable as earnings under the contract, so all of it goes through PAYE with Class 1 National Insurance [15]. If paid alone in a monthly pay period, employee National Insurance is 8% between £1,048 and £4,189 and 2% above, about £347.50, while employer National Insurance is 15% above £417, about £1,287.45 [16].
Example 2: no PILON clause, lump sum paid
An employee with 5 complete years' service earns £600 a week, has 4 weeks' contractual notice and is dismissed without notice with a £12,000 lump sum. Statutory notice of 5 weeks exceeds contractual notice, so D is 35 days [4] [10]. PENP is ((£600 x 35) ÷ 7) − 0 = £3,000.
The £3,000 is taxed and subject to Class 1 National Insurance as earnings. The remaining £9,000 falls within the £30,000 threshold and is tax-free, reflecting the pattern in HMRC's own examples [14] [17].
Example 3: notice partly worked, severance above £30,000
An employee earning £4,000 a month with 3 months' notice works one month, then leaves with a £40,000 settlement and no PILON clause. D is the 2 months of unworked notice, so PENP is ((£4,000 x 2) ÷ 1) − 0 = £8,000 [10] [12]. The remaining £32,000 is a section 403 award.
The first £30,000 is tax-free, and £2,000 is taxed as specific employment income, with employer Class 1A National Insurance at 15% on that £2,000 [18]. The table summarises all three outcomes.
| Example 1 | Example 2 | Example 3 | |
|---|---|---|---|
| Total paid | £9,000 | £12,000 | £40,000 |
| PILON or PENP taxed as earnings | £9,000 | £3,000 | £8,000 |
| Class 1 National Insurance on | £9,000 | £3,000 | £8,000 |
| Covered by £30,000 threshold | £0 | £9,000 | £30,000 |
| Taxable above £30,000 (Class 1A) | £0 | £0 | £2,000 |
Statutory redundancy pay, where due, sits alongside these figures and also uses the £30,000 threshold, as explained in the guide to statutory redundancy pay.
Tax and National Insurance on each part of the exit
A final package often combines several elements, each with its own treatment.
Elements taxed as earnings
GOV.UK lists unpaid wages, holiday pay, bonuses, payments for restrictive covenants and payments instead of working notice, including PILON and PENP, as fully taxable earnings subject to National Insurance [14]. Contractual PILONs are earnings for Class 1 National Insurance because the employee is entitled to them under the contract [15].
Elements covered by the £30,000 threshold
Statutory redundancy pay, enhanced redundancy or severance pay and non-cash benefits share a single £30,000 tax-free threshold [14] [17]. Amounts above the threshold are taxed, carry no employee National Insurance, but attract employer Class 1A National Insurance where the award is paid and the employment ends after 5 April 2020 [18].
The Moonworkers article on whether redundancy pay is taxable works through the threshold in more depth.
Elements outside the charge
Employer contributions to a registered pension scheme up to the annual allowance, legal costs paid directly to the employee's solicitor and payments made because of injury, illness or disability that prevents the employee doing the job are not taxed [14]. The table summarises the position.
| Element | Income tax | Employee NI | Employer NI |
|---|---|---|---|
| PILON or PENP | Yes | Class 1 | Class 1 at 15% |
| Accrued holiday pay | Yes | Class 1 | Class 1 at 15% |
| Bonus or commission | Yes | Class 1 | Class 1 at 15% |
| Statutory redundancy and severance up to £30,000 | No | No | No |
| Severance above £30,000 | Yes | No | Class 1A at 15% |
| Employer pension contribution (within allowance) | No | No | No |
Running a PILON through payroll and RTI
The correct treatment depends on whether the PILON is paid before or after the P45 is produced.
Paid in the final pay run
When the PILON is paid with the final salary, it is processed on the employee's existing tax code, and the leaving date is reported on the Full Payment Submission. The employer then issues the P45, splitting parts 1A to 3 between the employee and the new employer [19]. The Moonworkers guide to the P45 form sets out each part.
Paid after the P45 has been issued
If the payment is made after the P45 has been issued, HMRC instructs employers to use code 0T on a week 1 or month 1 basis (S0T in Scotland, C0T in Wales), deduct National Insurance and student loan repayments as normal, and treat irregular payments as weekly payments [20]. The payment goes on the next FPS with the original leaving date, the same payroll ID and the "payment after leaving" indicator set [20].
A second P45 must not be issued. The employee instead receives written confirmation of the gross payment and deductions [20].
Common errors to avoid
The most frequent mistakes are treating a non-contractual PILON as tax-free, omitting PENP when a settlement agreement is silent on notice, using the wrong value of P for monthly-paid staff, and running a post-P45 payment on the employee's previous tax code. Each one produces either an underpayment HMRC can recover from the employer or an overpayment the employee must reclaim.
UK payroll software for SMEs that holds the HMRC Recognised badge applies 0T month 1, the payment after leaving indicator and the Class 1A split automatically. Bureaux processing several exits a month across clients rely on an accountant payroll platform to apply PENP consistently, while HR and settlement platforms can embed the calculation directly through an HMRC-recognised payroll API.
Estimate the deductions on notice pay
Because PILON and PENP are taxed as ordinary earnings, the PAYE and National Insurance on a notice payment can be sized like any other pay. The Moonworkers UK salary calculator applies the 2026-27 income tax and National Insurance rules to any gross figure.
£ per month
e.g. 1257L, S1257L, BR, D0
S = Scotland · C = Wales · W1/M1 = non-cumulative
Enter a salary or hourly rate above
About this calculator
This calculator gives you a close estimate of your UK payroll deductions for 2026-27, using HMRC's exact percentage method with periodised thresholds. It handles the three tax territories, K codes with the 50% regulatory limit and its carry-forward, weeks 53, 54 and 56, the cumulative and W1/M1/X bases, student and postgraduate loans, and pension contributions on qualifying earnings. It still won't match your payslip to the penny in every case: it does not cover in-year tax code changes, payrolled benefits in kind, NI deferral across more than one employment, directors on the annual earnings period, or employer-level annual adjustments such as the Employment Allowance and the apprenticeship levy. Powered by the same engine as the Moonworkers Payroll API.
Frequently asked questions
Why might the result differ from my payslip?
This calculator uses your current gross pay and tax code to produce an estimate. K-code carry-forwards and weeks 53, 54 and 56 are handled, and the Year-to-date section reproduces a specific period exactly. What your employer may apply that this does not: a mid-year tax code change, benefits in kind processed through payroll, or NI deferral across more than one employment. For most employees on a standard tax code the difference is negligible.
What tax code should I enter?
Use the tax code shown on your most recent payslip or the PAYE Coding Notice (P2) from HMRC. If you're not sure, 1257L is the standard code for most employees resident in England, Wales, or Northern Ireland. Use S1257L for Scotland or C1257L for Wales if you pay Scottish or Welsh income tax.
Which NI category applies to me?
Most employees use Category A. Use M if you are under 21, H if you are an apprentice under 25, or C if you are over State Pension age. Your employer is responsible for assigning the correct category — if in doubt, check your payslip.
Which student loan plan am I on?
Your plan depends on when and where you studied. Plan 1 covers students who started before September 2012. Plan 2 is for English and Welsh students who started from September 2012 to July 2023. Plan 5 applies to English students who started from August 2023. Plan 4 covers Scottish students. You can check your plan at gov.uk or on your payslip.
What is the YTD cumulative PAYE mode?
HMRC's standard method calculates income tax on your total earnings to date each period, then subtracts tax already paid. If you're mid-year and want to see exactly what tax should be deducted in a specific period, expand the Year-to-date section and enter your running totals from previous periods only.
Conclusion
A payment in lieu of notice is no longer a route to a tax-efficient exit. Since the 2018 reforms, the PENP formula ensures that whatever an employer calls a termination payment, the part that replaces unworked notice is taxed and subject to National Insurance as earnings. The £30,000 threshold remains, but it applies only to what is left once notice pay has been carved out.
For payroll, the real complexity lies in the inputs rather than the arithmetic: the correct notice period, a properly narrow basic pay figure, the 30.42 rule for monthly staff and the timing of the payment relative to the P45. Employers that capture those facts when an exit is agreed can process the payment correctly in a single run, rather than correcting it through an Earlier Year Update months later.
Frequently asked questions
Is payment in lieu of notice taxable if the contract has no PILON clause?
Yes. Since 6 April 2018, the post-employment notice pay rules tax notice pay as earnings whether or not the contract contains a PILON clause. The employer calculates PENP using the formula ((BP x D) ÷ P) − T, and that amount is subject to income tax and Class 1 National Insurance. Only the part of a termination payment above PENP can use the £30,000 tax-free threshold.
Does an employee accrue holiday during a payment in lieu of notice?
No. A PILON ends the employment on the date it takes effect, so statutory holiday stops accruing on that day. Any holiday accrued but untaken up to the termination date must still be paid in the final pay. During garden leave, by contrast, employment continues and holiday keeps accruing until the notice period ends.
What tax code applies to PILON paid after the P45 is issued?
The employer uses code 0T on a week 1 or month 1 basis, or S0T and C0T for Scottish and Welsh taxpayers. National Insurance and student loan deductions are made as normal. The payment is reported on the next Full Payment Submission with the original leaving date and the payment after leaving indicator, and no second P45 is issued.
Can an employer pay in lieu of notice without the employee's agreement?
Only if the employment contract contains a PILON clause that allows it. Without a clause, the employer can offer a PILON, but the employee is not obliged to accept. Terminating without notice and without contractual authority is a breach of contract, which can lead to a claim at an employment tribunal.
