Pay in lieu of notice: how it's taxed

The short answer

Pay in lieu of notice is taxed and has National Insurance taken off in full, like your normal salary. It doesn't matter what the payment is called, whether your contract mentions it, or whether it's paid with your redundancy pay.

Post-employment notice pay (PENP)

When employment ends without the full notice being worked, payroll works out post-employment notice pay: broadly, the basic pay you'd have earned over the notice you didn't work. That amount is taxed as earnings, even if the payment is labelled compensation.

Only the rest of a termination payment, above PENP, can count towards the £30,000 that's free of income tax and employee National Insurance. Statutory redundancy pay also counts towards that £30,000.

If you work your full notice, or spend it on garden leave, PENP doesn't apply. It only matters when some of the notice isn't worked.

An example

You earn £2,600 a month, have 2 months' notice and leave straight away. Your employer offers £15,000 described as compensation. About £5,200 of that is treated as PENP and taxed as salary. The remaining £9,800 can be tax free, as long as your total tax-free payments stay within £30,000.

What to check in an offer

• Which part of the payment is notice pay, and which is compensation
• That holiday pay and salary to the leaving date are listed separately, since they're taxed too
• Whether payments will come after your P45, which means tax code 0T and more tax at first