Guide to Payment In Lieu of Notice (PILON)

what is payment in lieu of notice

For many new or smaller businesses, the following questions may be asked when the topic of terminating employee contracts arises: ‘What is payment in lieu of notice?’ and ‘What is PILON payment?’  

Well, we have created a guide to answer any uncertainty you may have around the process.  

Payment in lieu of notice (PILON) is a practice that is sometimes used by employers to terminate an employee’s contract with immediate effect. While it’s much less common than other ways of ending an employment contract, it’s important for employers to be aware of this option, its legal implications, and how it can be used to protect the business. 

Like any process that involves dealing with contracts, tax and pensions, there are many intricacies that you need to understand to ensure that you uphold the employee’s statutory rights. Although PILON usually falls under the responsibility of payroll, it’s important that all members of your HR team understand this form of dismissal so that they can better support employees. 

In this guide, we’re going to answer the question ‘What is a PILON payment?’, including the definition, legal aspects, and considerations related to tax and pensions. 

We’ll be covering the following topics: 

  • What is payment in lieu of notice? 
  • How does PILON work? 
  • How does PILON compare to other severance options? 
  • Employer guide to PILON 
  • Employee guide to PILON 
  • PILON & your effective offboarding strategy 

What is payment in lieu of notice?

Payment in lieu of notice (PILON) is when an employer chooses to end an employee’s contract immediately by giving them a lump sum payment instead of the notice period they are entitled to. It’s most commonly used in situations where there could be negative consequences of the employee seeing out their notice period. The possibility of PILON should be detailed in your employee contract to protect the rights of your business and the employee.

How does PILON work?

The process typically begins with reviewing the employee contract to determine if it includes a PILON clause. This outlines the conditions under which the employer can provide a payment in lieu of notice to terminate the contract with immediate effect. You will then need to make a decision whether to start the PILON process, or opt for another method of termination. 

There are several steps that employers need to follow in order to ensure that the process is carried out fairly and legally. Failure to do so could result in a breach of contract and legal action being taken against them by the employee. 

Here are the general steps involved in the PILON process, which we’ll look at in more detail below: 

  • Contract review 
  • Notice of termination 
  • Employee work period 
  • Lump sum payment 

Contract review

First of all, you need to check the employment contract for a PILON clause to determine how to proceed. This will outline the terms for employee termination, including when PILON can be enacted, and whether the lump sum payment will include additional extras such as pension contributions.

Notice of termination

If you decide to go ahead with their PILON process, you will need to provide the employee with a notice of termination. Rather than the statutory notice period, it should specify an earlier date of termination. This could be immediate, or could be for a shorter period, such as only working 1 week of a 4-week notice period.

Employee work period

Unless terminated with immediate effect, the employee will continue to work for your organisation until the date specified in the notice of termination.

Lump sum payment

On the agreed termination date, you will deliver a lump sum payment equivalent to the basic pay they employee would have earned during the notice period. It is at this point that their employment contract with the company officially ends. Depending on the terms outlined in the PILON clause of the employment contract, the employee may also receive extras such as pension contributions or private health care insurance for this period.

How does PILON compare to other severance options?

Garden leave

Garden leave is similar to payment in lieu of notice, in that the employee is not required to attend the workplace to serve their notice period. It’s often used to prevent the employee from being able to access sensitive information or data that could be used by a competitor.

The key difference between PILON and garden leave is that an employee who is put on garden leave legally remains employed by the company throughout the notice period. This means that they must be available to work during their normal hours, may be required to answer questions or return to work during the notice period, and can’t search for a new job. In contrast, an employee that is terminated via PILON is no longer employed by the company with immediate effect.

Standard redundancy

Standard redundancy occurs when an employer needs to reduce their workforce, typically due to business closures, restructuring, or a decreased demand for certain services. Employees must be selected for redundancy in a fair way, using criteria such as job role, skills, performance, or length of service. They are entitled to a notice period and, in most cases, redundancy pay.

While PILON focuses on reducing or removing the notice period, redundancy addresses the removal of the role itself. For a redundancy to be genuine, you must be able to prove that their job will no longer exist, and must try to find suitable alternative employment within the organisation for employees being made redundant.

Employer guide to PILON

With any dismissal, there are a lot of complex issues to navigate to ensure that the employee is treated fairly, and that the employer is acting lawfully. We’ve put together this handy guide to help SMBs get to grips with the legal considerations of PILON, including answering the common question ‘is PILON pensionable?’.

How to calculate PILON

Payment in lieu of notice is usually calculated based on what the employee would have earned if they had worked their normal hours during their notice period. As standard, this will only include the employee’s basic pay. However, if the employment contract has a PILON clause in place, the employee will receive all entitlements specified in the contract, such as pension contributions. 

To calculate the amount of money the employee will receive as a lump sum payment on the agreed termination date, you need to multiply their daily rate by the number of days in the statutory or contractual notice period outlined in the employee’s contract. It’s important to clearly communicate the method of calculating PILON to the employee to mitigate the risk of legal dispute. 

The steps for calculating payment in lieu of notice are: 

  • Determine the contractual notice period 
  • Multiply the employee’s daily pay rate by the number of days in the notice period 
  • Include additional extras as outlined in the PILON clause of the employment contract 

Tax implications 

It’s often questioned whether PILON should be taxed. The lump sum payment is treated as an employee’s earnings. It’s therefore subject to the same deductions as a standard paycheck, such as tax and NI, and must adhere to all current payroll legislation. 

PILON in your contracts

t’s important to include a payment in lieu of notice clause in every employment contract to clarify the process and provide a legal backing for PILON proceedings. This also allows you to limit payments to basic pay only, or specify additional non-statutory contributions such as bonuses and health insurance that would be included in PILON calculations. 

If you don’t have a PILON clause in place, you still ask the employee to take payment in lieu of notice. However, this must be explicitly agreed by the employee, and enacting PILON without the employee’s consent would constitute a breach of contract. 

Is PILON pensionable?

The terms outlined in the employment contract, and the nature of the pension scheme in place will determine whether an employee receives pension contributions as part of PILON. While payment in lieu of notice is considered part of an employee’s earnings, employers aren’t legally obligated to include any pension contributions that they would otherwise normally pay during the notice period.

Clarifying the pensionable status is another important reason to include a PILON clause in employment contracts. If you’re not sure, it’s best to seek professional financial advice to make sure that any terms relating to PILON and pensions are legal and fair.

Employee guide to PILON

PILON is taxable, but doesn’t necessarily include additional benefits that you would receive if you were to work the notice period, such as pension contributions. Check your contract for a PILON clause, which will outline the specific terms that apply to your situation. If you’re unsure about how the payment in lieu of notice has been calculated, or you think there’s something wrong with the amount, it’s important to seek advice from an HR professional. 

As PILON means that you’re no longer an employee of the company, you’re able to apply for jobs during your statutory notice period. However, depending on the nature of the dismissal, you may need to consider how to approach the subject of receiving PILON during the interview process. Providing a clear and accurate explanation of the circumstances surrounding your departure from the previous company can help to manage expectations and ensure that potential employers have a full understanding of your employment history. 

Example of what PILON might look like for an employee 

If your employer opts to terminate your employment with payment in lieu of notice, they will first need to officially inform you of this decision. Where there is a PILON clause in your employment contract, this will determine the terms of the process, such as the length of notice period used to calculate PILON. If there is no PILON clause in place, your employer cannot legally force you to take it, and doing so could be grounds for unfair dismissal. 

For an employee, the PILON process usually involves the following steps: 

  • Notice of termination received from the employer 
  • Agreed period of work before the specified termination date 
  • Receipt of lump sum payment and end of the employment contract 

The payment in lieu of notice is calculated by multiplying your daily pay rate by the number of days you would work during your statutory notice period. As it’s treated like a salary, this amount is taxable and subject to National Insurance contributions. Whether or not you’ll receive additional compensation such as pension contributions depends on company policy. 

Say you receive a monthly salary of £3,000, and a company pension contribution of £300 per month. If your notice period is two months, this means a total gross pay of £6,600. However, tax and National Insurance contributions will be taken from this amount before the lump sum is paid to you. These will depend on your specific circumstances, but you can find more guidance on this on the GOV.UK website. 

PILON & your effective offboarding strategy 

PILON is part of an organisation’s offboarding process, which is one of the final stages of the employee life cycle. While it’s not the most common type of severance, it’s important for businesses to understand that it’s an option they can choose when terminating an employee.  

After reading this guide, you should have a clear answer to the question ‘What is PILON?’, understand of how PILON affects both employers and employees, what the process looks like, and why it’s important to include a clause relating to payment in lieu of notice in every employment contract. 

As an employer, the best way to manage employee contracts and the offboarding process is to implement a comprehensive HR software solution. As well as helping to streamline complete HR operations within your organisation, its built-in compliance tools make it easier to review contracts and ensure that your HR processes adhere to all relevant legislation. Access a free trial today to see how PeopleHR can support your offboarding strategy. 

Jack Tuhey
By Jack Tuhey Sales Executive

Jack Tuhey is a Sales Executive with 7+ years of experience at Access PeopleHR. Passionate about modernising internal processes for businesses and HR professionals, Jack aims to save customers valuable time and resources. With expertise in consultancy, direct sales, and SAAS product demonstrations, he tailors your demos for growth and efficiency.