Is Pay in Lieu of Notice Pensionable? UK Rules and Costs

PILON is not automatically pensionable in the UK. It depends on the employment contract and the scheme's definition of pensionable pay; the scenario table below shows the usual outcomes.

You may be checking a final payslip with a notice payment ready to release and a pension deduction that doesn't look right. Before approving it, bring together the signed contract, the scheme rules and the payroll record. Those documents should explain both what the employee is owed and how payroll will process it.

Whether PILON Counts as Pensionable Pay

The payslip label doesn't decide pension entitlement. A payment called basic pay isn't necessarily pensionable after employment ends, while a contractual notice payment may attract contributions where the governing documents include it.

Pensionable verdict by PILON scenario

The qualification in the basic-salary row matters. A calculation based on basic salary doesn't necessarily turn the resulting termination payment into basic salary for pension purposes.

Say different employers each make an identical hypothetical notice payment. One scheme includes contractual PILON, another accepts only its qualifying basic-pay element, and another excludes it altogether. The cash payment can look identical while the contribution calculation differs.

Apply the documents in the right order

Start with the employment contract to establish what the employer promised. Then check whether the scheme can accept contributions on that payment, before checking how the payroll software has been configured.

The payroll record is the implementation document, not permission to override either of the others. A pension tick box copied from ordinary salary can produce an incorrect employee deduction; an unticked box can leave an employer's contractual obligation unpaid.

Treat the table as a starting point, not approval to process. In particular, distinguish a right to pension contributions from a right to compensation for lost pension benefits. They may require different treatment.

What PILON Is and How It Differs from Working Notice

PILON is rather like buying out the remaining term of a gym contract: money settles the outstanding period, but the membership doesn't continue merely because that period has been paid for. With employment, the important distinction is between receiving money for notice and remaining employed throughout notice.

An employer using PILON ends employment on the effective termination date and pays for the unworked notice period, commonly as a lump sum. That termination date should come from the contractual arrangements and termination documents, not an assumption about when the bank transfer arrives.

The practical decision involves both money and employment status.

What the employee should receive

GOV.UK's notice-period guidance explains that PILON provides the basic pay the employee would have received during notice, with contractual extras, including pension contributions, payable where the contract includes them. It also explains that PILON can be offered without an existing contractual clause, but an employee who accepts should receive full pay and contractual extras.

That isn't a reason to put every contractual benefit through the pension contribution field. Payroll must distinguish the notice salary, any preserved benefits and any separate compensation before deciding how each component should be processed.

Working notice, garden leave and PILON compared

Say a business wants a departing manager to stop accessing customer records immediately. Garden leave achieves that while keeping the employment relationship in place; PILON brings that relationship to an end.

The trade-off isn't only whether to pay salary now or later. Garden leave normally retains ongoing employment obligations, while PILON requires a final settlement calculation and a clear assessment of which benefits survive termination.

Practical rule: Never use the payment date as a substitute for the confirmed employment end date.

Choosing PILON changes pension timing because the employee is no longer serving notice as an active employee. Paying an amount equivalent to notice salary doesn't, by itself, extend scheme membership through the notional period.

Contract, Tax and Scheme Rules Decide Pensionable PILON

The payslip is the receipt; the contract is the price list showing what was owed. The pension scheme adds another requirement: whether that particular payment qualifies for contributions.

Keep those documents together when reviewing the proposed treatment.

Taxable doesn't mean pensionable

HMRC's Employment Income Manual distinguishes contractual notice payments from damages arising from a breach of contract. But that legal distinction doesn't establish pension entitlement, and describing notice compensation as non-contractual doesn't safely establish a tax exemption.

For payroll, the questions must remain separate: what tax treatment applies, and what earnings definition does the pension scheme use? Operating PAYE and NIC is not sufficient justification for taking an employee pension deduction.

An express exclusion overrides a broad assumption

Regulation 20 of the Local Government Pension Scheme Regulations 2013, in the version effective 5 February 2025, includes salary, wages, fees and specified contractual benefits within pensionable pay, but expressly excludes untaken holiday payments and “any payment in lieu of notice to terminate a contract of employment.”

That's a concrete answer for that scheme, not a template for every workplace pension. Another scheme may expressly include notice payments or use a definition requiring further interpretation.

Scheme wording and its effect on PILON

The distinction between contractual entitlement and scheme acceptance is particularly important when drafting settlement documents. An employer shouldn't promise a contribution route that the scheme won't accept.

For additional context on the employment and pension questions, use the following video alongside the governing documents.

Automatic enrolment also requires a separate membership check. Use the employer auto-enrolment guidance to review the process, rather than treating a termination payment as an automatic extension of pensionable service.

Keep a written split identifying basic pay, bonus, benefits and compensation. Against each component, record the contractual entitlement, the relevant scheme wording and the payroll treatment authorised.

Sample Contract Wording for Pensionable and Non-Pensionable PILON

Clear drafting makes the payroll decision easier, but a sample clause isn't a substitute for employment-law advice. Check any proposed wording against the scheme rules and the rest of the contract before using it.

Version A preserving employer pension contributions

The employer may terminate employment immediately by making a payment in lieu of notice calculated by reference to basic salary for the unworked notice period. The employer will also make employer pension contributions on that basic salary at the applicable scheme rate, subject to the scheme permitting those contributions. No bonus, car allowance or other benefit is included unless expressly stated. Income tax and National Insurance will be deducted as required.

This version preserves an employer pension commitment while excluding unspecified extras. It also exposes a drafting question that must be resolved before signature: what happens if the scheme won't accept the promised contributions?

Agree that outcome explicitly with legal advice. Don't leave payroll to invent a cash substitute, particularly where its tax treatment or value may differ from a pension contribution.

Version B restricting PILON to basic salary

The employer may terminate employment immediately by making a payment in lieu of notice calculated solely by reference to basic salary for the unworked notice period, in settlement of the notice payment obligation. No pension contributions, bonus, car allowance or other benefits are payable in respect of that payment, subject to applicable law and the governing pension scheme rules. Income tax and National Insurance will be deducted as required.

This version expresses an intention to exclude pension contributions from PILON. It cannot override mandatory scheme obligations, remove benefits already owed under other contractual terms or settle unrelated claims merely by calling the payment full and final.

Check the whole clause, not just the pension sentence

• Right to pay in lieu: State whether the employer can elect to end employment immediately.
• Calculation basis: Specify basic salary and any included remuneration, with the notice period expressed clearly in weeks or months.
• Pension obligation: Identify employer contributions, employee deductions and any scheme conditions.
• Benefits treatment: Address allowances, commission, bonus and other benefits expressly.
• Tax deductions: Make clear that the payment is gross and subject to applicable deductions.
• Mitigation provisions: Obtain legal advice where instalments or replacement earnings may affect payment.

An existing contract without a PILON clause can't be rewritten unilaterally. Agree changes properly and keep evidence of acceptance.

The cheapest drafting shortcut can become an expensive termination dispute. I would resolve any conflict between the contract and scheme before offering revised terms, rather than relying on a payroll adjustment at departure.

Tax, NIC and Pension Costs on a Worked Example

Consider a hypothetical employee receiving a contractual notice payment where the scheme accepts the qualifying basic-pay element. The employer needs a gross-to-net calculation for the employee and a separate total-cost calculation for the business.

Don't use a flat percentage of the lump sum to estimate every deduction. PAYE needs the employee's tax information, NIC needs the correct earnings-period treatment, and pension contributions need the scheme's contribution basis.

Illustrative costs on a contractual PILON

The table uses calculation relationships rather than assumed tax rates or thresholds. It's a planning framework, not a payslip calculation.

Read the calculation in the right direction

First establish the gross contractual entitlement. Then calculate tax and employee NIC, followed by any permitted employee pension deduction.

Employee deductions reduce the amount transferred to the employee; they aren't additional employer costs. Employer NIC and employer pension contributions sit on top of gross pay, so they belong in the cash forecast separately.

PAYE can differ between employees receiving the same gross payment because their tax codes and payroll histories differ. A cumulative calculation also considers the tax-year position rather than treating the notice payment in isolation.

For packages containing other compensation, use a separate tax and termination payments review. Don't assume a non-contractual description gives notice pay the same treatment as a qualifying compensation payment.

Keep the accounting entry separate from the entitlement decision

When reconciling the ledger, the QuickBooks payroll posting examples from Bookkeeping and Accounting of Florida Inc. can help illustrate how gross wages, deductions and employer liabilities are separated. They aren't authority for UK tax or pension treatment.

Match the payroll journal to the actual liabilities: net wages payable, tax and NIC payable, and pension contributions payable. An accounting entry that balances can still contain the wrong pension deduction.

Use planning calculations to reserve cash. Release the payment only after the payroll software has applied the confirmed rules to the employee's actual record.

How to Process PILON Through Payroll Without Errors

A separate pay code helps reviewers identify PILON, but its settings must follow the documented decision. Copying the ordinary salary code and renaming it is a common route to an unjustified pension deduction.

Keep the supporting documents accessible beside the final payroll report.

Final payroll procedure

1. Confirm the departure facts. Record the employment end date, notice length and whether the arrangement is worked notice, garden leave or PILON. Resolve conflicting dates before entering the leaver details.

2. Pull the signed contract, amendments, termination letter and governing scheme rules into the payroll file. Use the documents applicable to the employee, not an unsigned template from the shared drive.

3. Build the payment split. List notice pay, outstanding salary, holiday pay, benefits and compensation separately. Record why each component is pensionable or excluded, rather than assigning a single treatment to the whole package.

4. Calculate PAYE and NIC on the relevant taxable elements. If the package includes non-contractual compensation, obtain a proper tax assessment rather than switching off deductions because of its description.

5. Calculate the pension liability. Apply employee and employer contributions only to the confirmed pensionable amount. Check for any outstanding membership or contribution corrections separately from the treatment of PILON.

6. Reconcile the termination date, final pensionable payroll, deductions, employer contributions and salary sacrifice. A net-pay pension arrangement reduces gross pay for PAYE, but not for NIC; don't confuse that mechanism with salary sacrifice.

7. Use a distinct, tested pay code. Inspect its tax, NIC and pension settings, then preview both the payslip and pension output. In Xero Payroll or other payroll software, the displayed name alone doesn't prove the underlying configuration is correct.

8. Give the employee a written breakdown showing gross components, deductions and the basis for pension treatment. Keep a matching employer-cost reconciliation so the bank payment, pension submission and ledger can be checked together.

Review membership corrections separately

The Pensions Regulator's automatic-enrolment guidance requires membership and contributions to be handled from the applicable enrolment date, including backdating where membership was established late. That correction obligation doesn't make every termination component pensionable.

A final payroll should resolve outstanding obligations, not hide them inside the notice payment.

Build these checks into your payroll management process and assign a named reviewer before release. Treating every PILON identically risks either underpaying contractual benefits or deducting pension contributions the employee never owed.

Pre-Payment Checks and Written Confirmation

Before authorising payment, isolate the unresolved question. Pay undisputed sums when due; don't withhold the whole final salary merely because the pension treatment needs clarification.

Nor should you assume you can retain a disputed amount indefinitely. Agree a lawful timetable for resolving and paying it, with advice where necessary.

Questions for the scheme administrator

• Contractual PILON: Does the governing definition include this payment, given the employment end date?
• Basic salary: Is only the qualifying basic-pay component pensionable, and which extras are excluded?
• Membership timing: How does the applicable automatic-enrolment date affect the final contribution period?
• Corrections: Is any backdating required, and how should it appear in the submission?

Ask for a written response identifying the relevant rule, ideally on scheme letterhead or through an authenticated administrator email. A generic helpdesk answer about ordinary salary isn't enough.

File the decision with the contract clause, termination documents, calculation and reviewer approval. If the contract is silent, obtain employment-law advice on the benefit entitlement as well as scheme confirmation on contribution acceptance.

Start today with the signed contract, current scheme rules and confirmed termination date. Prepare the payment split before producing the final payslip, while there's still time to correct the treatment without reversing deductions.

Stewart Accounting Services can help review the termination calculation, reconcile pension obligations and process the final payroll with a clear audit trail. Ask for a pre-payment review before the payment is authorised.