Settlement agreements: a guide for employees

What a settlement agreement is

A settlement agreement is a legally binding contract between you and your employer. In return for a payment and other agreed terms, you give up the right to bring the claims listed in the agreement. Most settlement agreements end the employment, but they can also resolve a dispute while you stay in the job, such as a disagreement over a bonus. They used to be called compromise agreements.

Signing one is voluntary. You do not have to take part in discussions, and you do not have to accept the first terms you are offered. Employers usually propose a settlement agreement when they want a quick and certain exit, for example in place of a long performance or disciplinary process, as part of a redundancy, or where they think you may have a claim. If you turn an offer down and your employer later starts a performance or disciplinary process, it cannot rely on the offer or the settlement discussions as part of that process.

A settlement can also be reached through Acas conciliation. The terms are then recorded in a conciliation agreement known as a COT3, which is binding without the independent legal advice described below.

What makes the agreement legally binding

As a general rule, an agreement cannot take away your statutory employment rights or stop you bringing a claim in the employment tribunal. Section 203 of the Employment Rights Act 1996 makes an exception for a settlement agreement, but only if every one of these conditions is met:

• the agreement is in writing;
• it relates to particular complaints or proceedings, which in practice means it lists the claims being settled;
• you have received advice from a relevant independent adviser on its terms and effect, and in particular on its effect on your ability to pursue your rights before an employment tribunal;
• when the advice is given, the adviser is covered by insurance or a professional indemnity against a claim by you arising from that advice;
• the agreement identifies the adviser; and
• the agreement states that the statutory conditions regulating settlement agreements are satisfied.

A relevant independent adviser can be a qualified lawyer, a certified official or member of an independent trade union, or a certified advice centre worker. A person who is employed by your employer, or who is acting for your employer in the matter, cannot be your independent adviser. The Equality Act 2010 sets out almost identical conditions for settling discrimination claims, so agreements normally deal with both Acts.

Wording such as "in full and final settlement of all claims" is not enough on its own. The Acas Code of Practice on settlement agreements makes the point that the agreement has to state the specific claims it is intended to cover. If one of the statutory conditions is missed, the agreement does not stop you bringing those statutory claims.

What your solicitor's advice covers

The law requires advice on the terms and effect of the agreement and on how it affects your ability to go to an employment tribunal. In practice we go through the agreement with you clause by clause and look at the circumstances that led to the offer, because the most important question is often what you would be giving up by signing.

That means looking at the claims you might have and what they could be worth. If the offer follows a flawed process, a grievance you raised, a pregnancy, a disability or a disclosure you made about wrongdoing, your position may be stronger than the offer reflects. If you do not have the qualifying service for unfair dismissal and there is no other claim, it may be weaker. We also check the money: salary and holiday pay up to the leaving date, notice pay, any bonus or commission you have already earned, what happens to share options and pension contributions, and whether the tax treatment set out in the agreement is right.

We then look at what the agreement asks of you, such as confidentiality, not making derogatory comments, warranties that you have not committed gross misconduct or accepted another job, repaying the settlement money if you break the agreement, and restrictions on working for competitors or approaching clients. Some of these may need narrowing.

A confidentiality clause cannot stop you making a protected disclosure under whistleblowing law or reporting a crime to the police. Since 1 October 2025, a clause also cannot stop a victim of crime, or someone who reasonably believes they are one, telling a lawyer, a regulated professional, a victim support service, a relevant regulator, or their child, parent or partner about it for the purposes set out in the Victims and Prisoners Act 2024.

When you are satisfied with the terms, we sign the adviser's certificate or confirmation that your employer will ask for, and the agreement names us as your adviser. We act for you throughout, including where your employer is contributing to our fees.

Who pays for the advice

Your employer does not have to pay for your advice, although Acas guidance encourages employers to consider offering to pay. Because the agreement cannot settle your statutory claims without independent advice, employers often offer a contribution towards your legal fees. Where they do, the amount is usually set out in the agreement as a fixed sum paid directly to your solicitor after the agreement is signed.

Paying the contribution directly to your solicitor matters for tax. HMRC does not tax an employer's payment of your legal costs if three conditions are met: the money goes straight to your solicitor rather than to you, it pays for legal costs you incurred only in connection with the end of your employment, and it is made under a specific term of the settlement agreement. The exemption covers legal costs, not other professional fees such as an accountant's.

If the work is likely to cost more than the contribution, for example because there is a lot to negotiate, you can ask your employer to increase it. Before we start, we agree with you in writing what the work covers, what it will cost and how much of that the contribution is expected to meet.

How the payments are taxed

A settlement package is usually made up of several types of payment, and each is taxed differently. The agreement should show the breakdown and any deductions for tax and National Insurance. Check it carefully, because settlement agreements commonly make the employee responsible for any further tax that turns out to be due on the payments.

Pay you have already earned

Salary up to the leaving date, holiday pay for leave you have not taken, and any bonus or commission you are already entitled to are earnings. They are taxed and subject to National Insurance in the normal way, even when they are paid under the settlement agreement.

Notice pay

Since April 2018 pay in lieu of notice has been taxed as earnings, whether or not your contract has a clause providing for it. Where you do not work your full notice, HMRC's formula works out your post-employment notice pay, which is broadly the basic pay you would have received for the part of your contractual or statutory notice period that you did not work. That amount is taxed in full and National Insurance is due on it, even if the agreement describes the whole payment as compensation.

The termination payment

The rest of the package is compensation for the loss of your job. The first £30,000 is free of income tax and anything above £30,000 is taxed as income. You pay no National Insurance on any part of it. Your employer pays Class 1A National Insurance, at 15% for 2026/27, on the amount above £30,000. Statutory redundancy pay counts towards the £30,000, and so does an enhanced redundancy payment made as compensation for losing your job through redundancy. All payments connected with the end of the same employment, or with employments with associated employers, share one £30,000 threshold.

For example, say you earn £60,000 a year, your contract gives you three months' notice, and your employer offers £50,000 on top of your salary and holiday pay to the leaving date, with your employment ending straight away. HMRC's formula would treat roughly three months' basic pay, about £15,000, as post-employment notice pay, taxed in full with National Insurance. The remaining £35,000 or so is the termination payment: the first £30,000 is tax-free, the balance is taxed as part of your income for the year, and you pay no National Insurance on it. The formula works in calendar days, so the figures in a real case will differ slightly.

Pension contributions and other payments

Your employer can pay part of the termination payment into a registered pension scheme instead of paying it to you. A contribution made that way is not taxed as a termination payment and does not use up any of the £30,000. It does count towards your pension annual allowance, which is £60,000 for most people in 2026/27 and lower for some high earners and for people who have flexibly accessed a pension. Salary, bonus or other earnings you are already entitled to are still taxed as earnings unless the entitlement has been properly given up before the contribution is made, so this needs care.

A few other payments have their own rules. Any part of the package paid in return for agreeing to a restriction, such as a non-compete, is taxed as earnings. Compensation for injury to feelings in a discrimination settlement is not taxable if it relates solely to discrimination that happened before the employment ended, and HMRC expects the amount to be in proportion to what a tribunal would award. A payment made because of an injury or disability that prevents you doing your job can be exempt, but medical evidence is required. Outplacement support that meets HMRC's conditions, which include having been employed for two years, can also be provided free of tax.

References and what people will be told

An employer does not have to give a reference unless it has agreed to, for example in your contract or in a settlement agreement, or the job is one of certain financial services roles regulated by the Financial Conduct Authority or the Prudential Regulation Authority. If a reference matters to you, negotiate the wording now and attach it to the agreement, together with a promise that your employer will use that wording when asked for a reference.

Any reference must be accurate and fair and must not be misleading, so an agreed reference cannot say things that are untrue. Within that limit, the content can range from a short factual reference confirming your job title and dates of employment to a fuller description of your role and strengths.

Agree what colleagues and clients will be told about your departure, and when. If the agreement has a confidentiality clause, check that it lets you tell your partner, close family and professional advisers about the terms, and that obligations run both ways where that is appropriate.

Negotiating the terms

Most terms in a settlement agreement can be negotiated. The amount of the payment is the obvious one, but the timing and structure of the package can matter as much. Points worth raising include the leaving date and whether you work your notice, go on garden leave or receive pay in lieu; bonus or commission earned to date; share options under the scheme rules; continued benefits; an employer pension contribution; outplacement support; the reference and announcement; confidentiality and restrictive covenants; and the contribution to your legal fees.

How much room there is to improve the offer depends mainly on the strength and value of the claims you would be giving up and on how much your employer wants certainty. If you have a strong claim that could be worth more than the offer, it makes sense to set that out to your employer, with reasons, in correspondence marked "without prejudice". Where there is an existing dispute and the correspondence is a genuine attempt to settle it, it cannot normally be used as evidence. If your potential claims are weak, the negotiation is more likely to focus on the leaving date, the reference and a modest improvement in the figures.

Protect your position while you negotiate. Do not resign before the agreement is signed, because resigning can change which claims you have and removes some of your employer's reasons to settle. Keep doing your job, keep copies of documents you are entitled to have, such as your contract, handbook, payslips and bonus or share scheme rules, and do not take confidential business information.

How long it takes and the deadlines to watch

The Acas Code of Practice says that, as a general rule, you should be given at least 10 calendar days to consider the formal written terms of a settlement agreement and to take independent advice, unless you and your employer agree otherwise. Acas guidance adds that a disabled employee may need longer as a reasonable adjustment. Not giving a reasonable time to consider the offer is one of the Code's examples of undue pressure, and improper behaviour of that kind can allow the settlement discussions to be used as evidence in an unfair dismissal claim.

The agreement should say when each payment will be made, and Acas guidance says it is good practice to pay as soon as possible after the agreement is signed.

Settlement discussions do not stop the clock on tribunal claims, so keep an eye on time limits while you negotiate. For most claims you must notify Acas for early conciliation within three months less one day of the dismissal or the act you are complaining about. Where that date falls on or after 1 October 2026, the period is six months. If negotiations are running close to a deadline, we can notify Acas to protect your position while discussions continue.

What to do when you receive an offer

Do not sign anything straight away. If Acas is involved, do not agree terms before taking advice, because an Acas settlement is binding once it has been agreed, even before anything is signed. Read the offer letter and the draft agreement, note the deadline for a response, and collect your contract, any handbook or policies it refers to, recent payslips, bonus, commission or share scheme documents, and any emails or letters about the issues that led to the offer.

Then contact us. We will confirm the cost and whether your employer's contribution is likely to cover it, go through the agreement with you, and handle any negotiation with your employer or its advisers. If you are an employer or HR adviser, see our guide to settlement agreements for employers.

Frequently asked questions

Do I have to sign a settlement agreement?

No. A settlement agreement is voluntary, and you do not have to accept the first terms offered or take part in discussions at all. If you turn an offer down, your employer can still follow its normal performance, disciplinary or redundancy procedures, but it cannot rely on the settlement offer or the discussions as part of that process. Before deciding, take advice on the claims you might be giving up and whether the offer reflects them.

Will my employer pay for my legal advice?

Your employer does not have to, but employers often contribute because the agreement cannot settle your statutory claims without independent advice. The contribution is usually a fixed amount set out in the agreement. It is not taxable if it is paid directly to your solicitor, under a specific term of the agreement, for legal costs incurred only in connection with the end of your employment. If the advice will cost more, you can negotiate a higher contribution.

Is the first £30,000 of a settlement payment tax-free?

The first £30,000 of a termination payment is free of income tax, and you pay no National Insurance on any of it. The threshold does not apply to pay you have already earned, such as salary, holiday pay or bonus, or to post-employment notice pay, which are taxed in full. Statutory redundancy pay counts towards the £30,000, and all payments connected with the end of the same employment share one threshold.

Is notice pay in a settlement agreement taxable?

Yes. Since April 2018 pay in lieu of notice has been taxed as earnings, whether or not your contract provides for it. If you do not work your notice, HMRC's formula calculates your post-employment notice pay, which is broadly the basic pay for the unworked notice period. That amount is taxed in full and National Insurance is due on it, even if the agreement describes the whole payment as compensation.

Can a settlement agreement stop me reporting wrongdoing?

No. Any clause that tries to stop a worker making a protected disclosure under whistleblowing law is void, and a confidentiality clause cannot stop you reporting a crime to the police. Since 1 October 2025, victims of crime also cannot be prevented from telling a lawyer, a regulated professional, a victim support service, a relevant regulator or their child, parent or partner about it, for the purposes set out in the Victims and Prisoners Act 2024.

How long do I have to consider a settlement agreement?

The Acas Code of Practice on settlement agreements says employees should generally be given at least 10 calendar days to consider the formal written terms and take independent advice, unless both sides agree otherwise. A disabled employee may need longer as a reasonable adjustment. An unreasonably short deadline can amount to undue pressure, which may allow the settlement discussions to be used as evidence in an unfair dismissal claim.

Can I still bring a tribunal claim after signing a settlement agreement?

Not for the claims the agreement validly settles. If the statutory conditions are met, including advice from an independent adviser who is insured and named in the agreement, you cannot bring those claims. You can still enforce the agreement itself if your employer breaks it, for example by not paying, and a clause that tries to stop you making a protected disclosure under whistleblowing law remains void.

Sources & further reading

• legislation.gov.uk — Employment Rights Act 1996, section 203
• Acas — Code of Practice on settlement agreements
• Acas — Settlement agreements: discussing and negotiating an offer
• HMRC — EIM13505: termination payments, the £30,000 threshold
• HMRC — EIM13876: post-employment notice pay
• HMRC — EIM13740: payments to meet legal costs
• HMRC — EIM13735: contributions to a pension scheme
• Acas — What employers can say in a reference

This article is general information, not legal advice. The law changes and depends on your circumstances — always take advice on your specific situation before acting. Last reviewed 17 September 2026. AD Solicitors is a trading name of AD Solicitors Limited, a recognised body regulated by the SRA (no. 8011228).