Settlement Agreement vs Redundancy: Key Differences

The confusion explained

Many employees are confused when their employer offers them a settlement agreement during what they expected to be a redundancy. This is common — and important to understand. The two concepts overlap but are legally distinct. You can be made redundant via a settlement agreement, or you can receive a settlement agreement for reasons that have nothing to do with redundancy.

What is a standard redundancy?

Redundancy is a specific legal situation under the Employment Rights Act 1996. Your role must genuinely be eliminated — either because the business is closing, moving location, or no longer requires work of a particular kind. A proper redundancy process involves:

• A genuine redundancy situation
• Fair selection criteria (if selecting from a pool)
• A meaningful consultation period (collective consultation for 20+ redundancies requires 30–45 days' notice to the Redundancy Payments Service)
• Consideration of suitable alternative employment
• Statutory (or enhanced) redundancy pay

What is a settlement agreement in a redundancy context?

An employer can use a settlement agreement to implement a redundancy — particularly where they want to:

• Avoid a lengthy consultation process
• Ensure the employee cannot later claim the redundancy was unfair (e.g. the selection was discriminatory)
• Add an enhanced payment on top of statutory redundancy pay in exchange for a clean exit
• Include confidentiality clauses that a standard redundancy does not require

Key differences at a glance

Tax treatment comparison

Both redundancy pay and settlement agreement payments can benefit from the £30,000 tax-free exemption for termination payments — but the rules are the same whether you call it a redundancy or a settlement:

• Statutory redundancy pay: tax-free up to £30,000 (combined with ex-gratia)
• Ex-gratia payments: tax-free up to £30,000 (combined with redundancy)
• Notice pay (PILON): always fully taxable as earnings, regardless of how it's labelled
• Holiday pay: always taxable

The key point: the tax treatment is determined by the nature of the payment, not by whether the document is called a "redundancy letter" or a "settlement agreement".

Which is better for the employee?

Settlement agreements often result in better outcomes for employees who negotiate effectively, because:

• You can negotiate the financial terms
• You can negotiate the reference wording
• You can negotiate removal or narrowing of restrictive covenants
• Employers are motivated to settle cleanly, especially if there are any legal risk factors
• You get certainty about the outcome

A standard redundancy, while it may feel more "dignified," can actually result in a lower financial outcome if the statutory minimum is all that is offered — and it leaves all claims open (both ways).

Watch out: "redundancy" that isn't really redundancy

Some employers use the word "redundancy" loosely — sometimes to avoid calling a situation what it really is (a capability dismissal, a disciplinary matter, or a restructure that targets specific individuals unfairly). If your role is being eliminated but similar roles are being created, or if you believe you were selected unfairly (e.g. because of your age, pregnancy, or because you raised a grievance), the process may not be a genuine redundancy at all. This is exactly the kind of situation where a settlement agreement may be offered — and where you have significant negotiating leverage.