How are settlement agreement figures calculated?

Most settlement agreement payments are made up of some or all of the following components. Understanding each one separately is important — both for assessing fairness and for understanding how the payment will be taxed.

Components of a settlement agreement payment

Component	What it is
Notice pay	Payment in lieu of your notice period — either your statutory minimum or your contractual entitlement, whichever is greater. Notice pay is generally taxable in full.
Holiday pay	Any accrued but untaken annual leave owed to you at the date of termination. Holiday pay is taxable in full.
Redundancy pay	Where you are being made redundant and have at least two years' qualifying service, you are entitled to a statutory redundancy payment. Some employers offer an enhanced amount above the statutory minimum. Redundancy pay can generally be paid tax-free up to the £30,000 threshold.
Ex gratia payment	An additional payment made by the employer as a gesture of goodwill — typically to compensate for the claims being waived and to incentivise agreement. Ex gratia payments can often be paid tax-free up to the £30,000 threshold.
Outstanding salary and wages	Any salary, wages or overtime earned up to the termination date but not yet paid. These sums are owed to you as a matter of contract and are taxable in full.
Pension and contractual benefits	Outstanding pension contributions, commission, bonuses, share scheme entitlements and other contractual benefits may also need to be addressed in the agreement.
Consideration for new clauses	Where the agreement introduces new confidentiality obligations or post-termination restrictions, an additional sum may be included as consideration for those clauses.
Contribution to legal costs	It is standard practice for employers to include a contribution to the employee’s legal fees. This is typically paid directly to your adviser rather than to you.

One of the most important things to understand about settlement agreement payments is the tax treatment — and in particular the £30,000 threshold.

Certain qualifying termination payments — which can include redundancy pay and ex gratia payments — can be paid free of income tax up to a combined total of £30,000 per employment. Anything above that threshold is typically subject to income tax in the normal way.

However, not all payments within a settlement agreement qualify for this tax-free treatment. Payments that are taxable in full regardless of the £30,000 threshold include:

• Notice pay — whether worked or paid in lieu
• Accrued holiday pay
• Bonus or commission payments
• Any payment that is simply a continuation of your salary

There is no single formula for calculating what a settlement agreement figure "should" be — it depends on a range of factors specific to your circumstances. The key question is whether the payment adequately compensates you for what you are giving up.

Factors that typically influence the level of an ex gratia payment include:

Factors that influence settlement agreement figures

Factor	Why it matters
Strength of potential claims	If you have a strong unfair dismissal or discrimination claim for example, the settlement figure will typically need to be higher to reflect the value of what you are waiving.
Length of service	Longer-serving employees are generally entitled to higher settlement payments. This is because certain payments, such as redundancy, can be linked to length of service.
Your salary	The financial value of lost employment is directly related to what you were earning.
Age	Age can be a relevant factor — older employees may find it harder to secure equivalent employment, and statutory redundancy calculations also take age into account.
Employer’s financial position	An employer’s ability to pay will inevitably influence what they are willing to offer, particularly in smaller organisations or where a business is under financial pressure.
Employer’s desire for resolution	Where the employer is particularly keen to avoid a formal process or potential tribunal proceedings, there may be more room to negotiate a higher figure.
Outstanding contractual entitlements	Unpaid bonuses, commission or benefits owed to you, for example, will typically need to be addressed in the figure.
Legal representation	Having experienced legal advice can make a material difference to the outcome. An adviser who understands the value of your claims and how to present them effectively may help secure a better result.

Ready to get advice? Get in touch today — advice is provided within 24 hours of onboarding and is free to employees.