Payment in lieu of notice: a UK employer’s guide

Need to let an employee go with immediate effect? A payment in lieu of notice could be the answer. But before you jump in with both feet, it’s worth understanding the expectations, statutory requirements, tax implications, and what should be included and excluded in the calculations. Otherwise, you may be making a costly mistake. 

Payment in lieu of notice, also called a PILON payment, is the sum paid by an employer to an employee when the worker must leave their role immediately, rather than working through their notice period. Payment in lieu of notice is normally based on the employee’s contractual salary. Employment ends as soon as the payment is made. 

This is different to post-employment notice pay (or PENP), which is an amount calculated by HMRC. 

When an employment contract has a payment in lieu of notice clause, the payment is treated as normal earnings. The post-employment notice pay is offset (or reduced) by that amount. 

When the employment contract has no payment in lieu of notice clause, the post-employment notice pay formula is used to calculate how much of a lump sum settlement or severance pay should be taxed as notice pay. 

If an employer offers payment in lieu of notice without a specific PILON clause in the employee’s contract, the employee must agree to the payment – otherwise it is considered a breach of contract and could result in a wrongful dismissal case. Clearly, the time and cost involved in defending such cases mean that payments in lieu must be carefully handled.

The Employment Rights Act 1996 sets minimum notice periods for workers who have been continuously employed: 

• No notice, for employment of under one month.
• Not less than one week, for employment of between one month and two years.
• Not less than one week for each year of employment for employment of two years or more but less than 12 years.
• Not less than twelve weeks’ notice for employment of twelve years or more.

Notice of termination should be given in writing, stating that the employee will not need to work their notice period and will instead be paid in lieu. A payment in lieu of notice does not need to include other benefits on top of basic pay, unless specified otherwise in the contract. 

Often an employee is able to work through their notice period, with no ill effects on either the worker or the employer. Sometimes, however, immediate termination is preferred. For example: 

• To protect confidential information: If the employee has access to sensitive data, further access can be limited by terminating the employment contract immediately and making a PILON payment. Garden leave is also often used in these situations, to protect the company interests.

• To manage performance: When underperforming or toxic employees are negatively impacting the business or the team, a clean break can be preferable to further disruption. If an employee is dismissed for gross misconduct they are not entitled to a notice period, so there is no need for a payment in lieu. In less critical situations, the payment must be made. 

• To smooth a redundancy process: To avoid loss of morale and productivity among retained workers, redundant employees may be offered a payment in lieu of notice. This also helps both sides to make a clean break. Payment in lieu is made on top of, not instead of, redundancy pay. 

The redundancy point bears further consideration. A recent survey by Careerminds looked at redundancies as a result of AI implementation, and found that 52.1% of companies re-hired for these roles within three to six months. Worse, 30.9% found that re-hiring cost them more than they’d saved by cutting them, leaving them financially worse off than if they’d never made redundancies at all. 

Before jumping straight to redundancy, garden leave, or PILON, it’s worth considering whether the employee can be retained within the business. Outplacement firms can investigate internal mobility and place displaced employees into vacant roles elsewhere in the company or its subsidiaries. 

To calculate payment in lieu of notice in the UK, follow these four steps: 

1. Confirm the applicable notice period: This will vary from employee to employee, and contractual notice periods are often longer than the statutory minimums, so check employment contracts individually
2. Calculate pay: Gross basic pay is calculated as monthly (or weekly) gross salary multiplied by the number of notice months (or weeks). 
3. Add entitlements: Check PILON clauses in employment contracts to decide whether entitlements such as accrued holiday or commission need to be added. 
4. Deduct tax and National Insurance: PILON payments are subject to the same income tax and National Insurance obligations as the normal salary. 

If an employee is being dismissed or made redundant, they are entitled to their full, standard pay if their contractual notice is either the same as statutory notice, or less than one week longer. 

Additional entitlements paid as part of a payment in lieu of notice depend on individual employment contracts. 

The majority (and sometimes all) of a payment in lieu of notice comprises the employee’s basic pay, which is taxed at their normal rate. 

Annual leave accrued but not taken must be paid separately. For example, if an employee is entitled to 25 days’ leave per year but has only taken 20, they must be paid for the five they have not taken, on top of their PILON payment (pro rated). Holiday entitlement stops accruing on the termination date. 

Bonuses and commission are not automatically included in PILON, unless the employment contract guarantees these payments. 

Payments in lieu are not pensionable, unless the contract of employment states otherwise or the employer chooses to make pension contributions as part of the severance package. 

If an employee is sick during their notice period, they are not entitled to pay. Their employment ended on the date they received their PILON payment and the contract was terminated.

These are only payable as part of PILON if explicitly stated in the employment contract. Examples include health insurance, a company car, life insurance, gym memberships, and tuition allowances. 

For employees currently on family leave, their payment in lieu of notice must reflect what they would have received had they worked the notice period – as long as there is a PILON clause in their employment contract. 

Payment in lieu of notice is taxed as earnings, and therefore the usual income tax and National Insurance rules apply. This has been the case since April 2018, when all PILONs became fully taxable regardless of the employment contract.

At the same time, the post-employment notice pay formula was brought in, obliging employers to determine the exact portion of a severance package representing the employee’s basic pay that they would have received if the notice period was worked in full. That portion is then taxed as standard earnings.

Sarah is a 38-year old Data Manager earning £50,000 per year (£4166.67 per month or £961.54 a week). She has been a full-time employee for 10 years and has worked for 9 months of this financial year. When she is made redundant, she doesn’t work any of her three-month notice period.

She is offered a severance package including one week’s salary per year of employment (including statutory redundancy pay) and continuation of her healthcare benefits and pension payments for one month, totalling £350. 

Her PILON and PENP is calculated as basic pay for the last pay period, multiplied by the number of days in the unexpired notice period, divided by the number of days in the pay period. 

£4166.67 x 90 / 30 = £12,500

This payment of £12,500 is taxable as earnings. 

Her redundancy pay is calculated as weekly salary x 10 years.

£961.54 x 10 = £9615.40 

This payment of £9615.40 is tax free.

The additional health cover and pension payments are tax free. 

In addition to financial benefits, many employers also choose to support their redundant employees into new roles. Outplacement services provide help with job search strategy, CV and LinkedIn profile writing, and interview coaching. They also provide much-needed moral support at a time when they staff be mourning the loss of income and professional identity. 

Careerminds boasts a 95% placement rate for participants on its outplacement programmes, enabling businesses to protect their reputation, mitigate the risk of unfair dismissal claims, and maintain morale through a difficult phase. 

A payment in lieu of notice should be made on the last day of employment, or within a few days. It can be paid immediately on the employee’s final day, or as part of the regular payroll run. Employment contracts may specify payment deadlines. 

Payment in lieu of notice is paid as a lump sum due on the employee’s final day of employment. 

Holiday is not accrued during the leave period, as the employee is no longer employed by the company. Unused holiday prior to the departure must be paid separately. 

No, there must be a PILON clause in the contract of employment. Payment in lieu of notice may be given without a PILON clause by mutual agreement. 

Yes, employment terminates and the employee does not work for the business during their notice period if they receive payment in lieu of notice. They are free to take up employment elsewhere immediately. 

Payments in lieu of notice can be a useful tool, but their implementation relies heavily on clauses within employment contracts. Speak to your legal team or engage an employment lawyer to avoid costly and time-consuming mistakes. 

To ensure your redundancy process runs smoothly, it’s worth partnering with an outplacement provider. Their expertise means that they can alleviate some of the pressure, leaving your HR team to focus on delivering the project and returning to business-as-usual.