Settlement agreements for employers: when, how and the cost

When a settlement agreement makes sense

A settlement agreement lets you end employment on agreed terms, with the employee giving up the right to bring the claims listed. It's usually worth considering when:

• a performance or conduct process would be long, and the outcome uncertain
• there's an existing dispute or grievance and a claim looks likely
• a redundancy carries extra risk, such as a contested selection
• you're offering enhanced terms for voluntary exits and want certainty

It isn't a shortcut around a fair process. If the employee says no, you carry on as you would have done.

Holding a protected conversation

Under section 111A of the Employment Rights Act 1996, an offer to end employment on agreed terms can't be used as evidence in an ordinary unfair dismissal claim, even where there's no dispute yet. Where there is a dispute, the without prejudice rule may also apply.

The protection has limits. It doesn't cover discrimination, whistleblowing or other automatically unfair reasons, or breach of contract. It's lost to the extent a tribunal thinks just if you behave improperly. The Acas Code gives examples:

• harassment, bullying, intimidation or discrimination
• undue pressure, such as not allowing reasonable time to consider
• saying, before any disciplinary process has started, that the person will be dismissed if they reject the offer

Explain the reasons for the offer neutrally and say the person can decline or make a counter-offer. Allow at least 10 calendar days to consider the written terms and take advice. A companion isn't a legal right, but Acas recommends allowing one.

Pricing the offer

Start with what the person is owed anyway: salary to the leaving date, holiday, notice and any redundancy pay. The extra is what you pay for certainty. Base it on the risk you're buying out:

• the likely award if a claim succeeded, and how strong the claim would be
• the cost of defending it: legal fees and management time
• how long the person is likely to be out of work

That risk is rising. For an effective date of termination before 1 January 2027, the unfair dismissal compensatory award is capped at the lower of £123,543 or 52 weeks' gross pay. From 1 January 2027 the cap goes, and the qualifying period falls to 6 months. With 6-month time limits from 1 October 2026, claims can also come later.

Tax, National Insurance and legal fees

• Salary, holiday pay, bonus and notice pay are taxed as earnings, with Class 1 National Insurance.
• Where notice isn't worked, post-employment notice pay is worked out first and taxed as earnings, whatever the payment is called.
• The rest of a genuine termination payment, together with any redundancy pay, is free of income tax and employee National Insurance up to £30,000. Above that it's taxed, and you pay Class 1A National Insurance at 15% on the excess.
• Your contribution to the employee's legal advice isn't taxable for them if you pay the adviser directly, it's only for advice on ending the employment, and the agreement provides for it.

What makes it binding, and what to include

It must be in writing, relate to particular claims, and the employee must have taken advice from a named relevant independent adviser with insurance covering that advice. The agreement must say these conditions are met.

Agree the practical terms alongside the money: leaving date, reference wording, the announcement, return of property, any restrictions, and confidentiality.

From September 2027, the Employment Rights Act 2025 is expected to make void any clause that stops a worker alleging or disclosing harassment or discrimination at work. Review your standard confidentiality wording before then.

The alternatives, and agreeing terms first

If a claim has been raised or is likely, Acas can record a settlement in a COT3 through early conciliation. It's free, binding and doesn't need separate legal advice.

Most of the cost of a settlement comes from going back and forth. Agreeing the practical terms in writing first means the advisers start from an agreed position. Agree it in writing is included in the Business plan.