Quick take: A settlement agreement is a legally binding contract between you and your employer, usually offered when the employment relationship is ending. Most employees focus only on the payment amount. The clauses around tax treatment, restrictive covenants, and references are just as important.

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What a Settlement Agreement Does

In exchange for a payment, you agree to waive your right to bring certain employment claims: unfair dismissal, discrimination, breach of contract, and others. The agreement typically also includes confidentiality obligations and an agreed reference. For the agreement to be valid, you must receive independent legal advice from a qualified adviser.

1. The Scope of Claims Being Waived

Most agreements list every possible employment claim you might bring. Common claims covered include:

• Unfair dismissal

• Discrimination (age, sex, race, disability)

• Breach of contract (including notice pay and bonus disputes)

• Working Time Regulations claims (unpaid holiday, rest breaks)

• Unlawful deductions from wages

What matters is whether this list includes claims you may not yet be aware of. If you later discover your employer underpaid your pension contributions, you will have signed away your ability to pursue that claim. Read the list carefully, not just the payment figure.

2. Tax Treatment

The first 30,000 pounds of a genuine termination payment (not contractual notice pay or holiday pay) is typically exempt from income tax under section 401 of the Income Tax (Earnings and Pensions) Act 2003.

However, if the agreement does not clearly separate the termination payment from contractual entitlements, your employer may deduct tax from the entire sum. Check that the agreement specifies which elements are taxable and which are treated as ex-gratia termination payments.

3. Confidentiality and Non-Disparagement

Most agreements contain mutual confidentiality clauses preventing both parties from discussing the terms. Some also include non-disparagement clauses. Check whether these obligations are genuinely mutual. If only you are bound by non-disparagement, your former employer could make negative comments about you without consequence.

4. The Agreed Reference

An agreed reference is often included as a schedule. A minimal factual reference (dates of employment and job title only) may raise red flags with future employers. If possible, negotiate a more substantive reference that confirms your role, responsibilities, and performance in positive but factual terms.

5. Restrictive Covenants

Settlement agreements sometimes reaffirm or extend restrictive covenants from your original employment contract. If your contract had a six-month non-compete, the settlement may seek to extend it or restart the clock. Review this with your legal adviser.

FAQ

Do I have to accept the first offer?

No. Settlement agreements are negotiable. Your employer has made an offer because they want certainty and to avoid tribunal proceedings. You are entitled to negotiate the terms, including the payment amount, reference wording, and restrictive covenants.

Who pays for my legal advice?

Your employer will usually contribute towards the cost, typically 350 to 500 pounds plus VAT. This covers the cost of a solicitor reviewing the agreement and advising you on its terms. This is a legal requirement for the agreement to be valid, not an optional extra.

Disclaimer: This article is general information, not financial, tax, or legal advice.