How to pay a tax-efficient golden handshake

Golden handshakes

It’s a classic “bloke down the pub says” scenario - golden handshakes up to £30,000 are tax free. In fact, that’s never been true. The £30,000 tax and NI-exemption for employment termination payments cannot usually apply to golden handshakes.

As a reward for past work, golden handshakes are taxable as additional salary through PAYE and subject to employees’ and employers’ NI in full in the same way as salary. The £30,000 exemption only applies to payments that relate solely to the termination of an employment, e.g. compensation for giving up your job. They must have no link to past or future service.

Ex gratia payments

It’s possible, but not easy, for an employer to pay a tax and NI-free golden handshake. If this is achieved the £30,000 exemption applies. The payment must be truly ex gratia (voluntary) and, as already mentioned, not in recognition of past work. There should be no indication that implies this in any letters to the director or employee leaving, or in other documents, e.g. a board minute confirming the payment. Instead, documents should make clear that the payment is not made under any obligation but is wholly voluntary.

Despite taking all the precautions, HMRC is generally reluctant to accept that a payment is truly ex gratia. The good news is that there’s a way to guarantee a termination payment can be tax and NI free, and with a larger amount than £30,000.

A golden handshake can be made entirely tax and NI free if it’s made in the form of an employer contribution to a registered pension scheme or employer-financed retirement benefit scheme, e.g. a small self-administered scheme for the benefit of a departing director or employee.

A cunning (retirement) plan

HMRC has no objection to the avoidance of tax and NI by following the advice above. When the director or employee is 55 or older (57 from 6 April 2028) they will be entitled to take part or all of their pension fund. 25% of this will be tax free and, of course, the whole amount will be entirely free of NI.

Example. Andrea is a higher rate taxpayer. She’s decided to retire after serving as chairperson of Acom Ltd for 20 years. The company makes a one-off contribution of £60,000 to Andrea’s registered pension plan. Andrea can immediately take £15,000 tax and NI free. She can choose when to draw the remainder, e.g. she can delay taking the money until she becomes a basic rate taxpayer and so avoid paying any higher rate tax.

There is no limit on the amount of pension contributions an employer can pay to a director or employee. However, to maximise tax efficiency the amount should be limited to their pension annual allowance. Taking advantage of any carry-forward of unused annual allowances from earlier years this can allow for a golden handshake in the form of a pension contribution of over £200,000.