Holiday pay on termination of employment

Holiday pay on termination of employment will be one of the elements when calculating an employee’s final salary. The following guide for employers sets out the rules on holiday pay when an employee leaves your organisation, helping to minimise the possibility of any errors or complaints.

What are the rules on holiday pay on termination of employment?

Employers are legally required to pay an employee for any accrued statutory holiday that has not been taken by the time they leave. This is known as pay in lieu of holiday. Payment in lieu is permitted only on termination of the employment.

Where the contract of employment provides for more than the statutory minimum, the contract should also set out what will happen to any contractual holiday built up by an employee on termination.

An employee will only be entitled to any accrued contractual leave entitlement if the employment contract makes provision for this. If the contract is silent on this issue, and unless otherwise agreed, you are only required to pay the employee payment in lieu for any unused statutory annual leave.

How should holiday pay on termination of employment be calculated?

On termination of employment, employees are entitled to be paid in lieu of any unused statutory annual leave accrued up to the date the employment ends. The amount of holiday pay on termination will depend on the following.

The amount of leave

Under the Working Time Regulations 1998 almost all workers are legally entitled to a minimum of 5.6 weeks’ paid holiday per annum, where annual leave will begin to accrue as soon as they start work, without any qualifying period.

For a full-time employee working fixed hours 5 days a week, this equates to a total of 28 days, although you can include bank holidays and public holidays as part of an individual’s statutory leave entitlement. This paid holiday will initially accrue monthly in advance at a rate of 1/12 of their annual entitlement.

However, the way in which statutory holiday entitlement will accrue can differ depending on the nature of the employment contract. For example, for zero hours contract workers it may be easier to calculate their entitlement based on the number of hours worked. Adopting a calculation of 5.6 weeks of paid leave divided by 46.4 remaining weeks in the year, holiday for zero hour workers is accrued at a rate of 12.07% of the total hours worked in a year.

This would mean that where someone has worked 30 hours in a week, they would accrue 3.6 hours leave for that particular week, ie; 12.07% of 30.

The annual leave year

Many employers will specify the start and end of their annual leave year. Often this will run for a normal calendar year, from 1 January to 31 December, during which time individuals must take their leave entitlement.

If someone starts their job part way through a pre-set leave year, they will only be entitled to part of their total annual leave entitlement for that current year. If a leave year has not been set, this will start on the first day of their employment.

There is no automatic right to carry over unused leave into the following year, unless the employment contract allows for this or the COVID-19 provisions apply.

This means that any entitlement to holiday pay on termination of employment will generally depend on how much of the annual leave year has passed and whether or not the employee has been allowed to carry over any unused leave from a previous year under their contract.

The level of holiday pay

All workers are entitled to one week’s pay for each week of statutory leave that they take, whereby the amount of pay an individual receives will depend on the amount of days or hours they work and how they are paid for this time.

The principle is that pay received by someone while they are on holiday should reflect what they would have earned if they had been at work, although the way in which this is calculated can differ depending on the nature of the contract.

For example, for a zero hours worker, where their working pattern is not guaranteed or fixed, a week’s pay for the purposes of paid holiday entitlement will usually be based on the worker’s average pay from the previous 52 weeks prior to the calculation date. This is known as the holiday pay reference period, which was recently increased from 12 to 52 weeks.

Is there a formula for calculating final holiday pay?

In the absence of any contractual agreement that provides otherwise, payment in lieu of unused holiday on termination of employment can be calculated using the following formula: (A x B) – C, where A is the minimum period of leave to which the individual is entitled; B is the proportion of the annual leave year that expired before the termination date; and C is the period of leave already taken by the individual between the beginning of the leave year and the termination date.

When applying this calculation, if an employee has any spare holiday entitlement when they leave, you should pay them their equivalent daily pay rate for these days. The employee’s contract of employment or statement of written particulars should set out the way in which a day’s holiday is to be calculated. For example, this could be by taking the individual’s annual salary divided by the number of working days in the year, excluding periods of annual leave and weekends.

How should other aspects of final pay be calculated?

Other aspects of final pay could include the following:

Wages or pay in lieu of notice

The employee should be paid as normal when they are working their notice period. This includes if they are willing to work but you have asked them not to, up until the last day when their contract is officially terminated. This is known as pay lieu of notice.

Where the employee wants to leave without working some or all of their notice, they will need to reach an agreement with you to do so. If they leave without you agreeing to this first, they will usually only be entitled to be paid for the part of the notice they actually worked. This will include any accrued untaken holiday.

It may be open to you to bring a claim against any employee who leaves before or during their notice period, where not agreed, but only where their premature departure results in you incurring additional costs. This could include where you have had to hire a short-term replacement.

Deductions for costs

If you are looking to make a deduction to an employee’s final wage, for example, to cover the cost of training, this can only be done where permitted under their contract of employment or previously agreed in writing. This could be, for example, where prior agreement has been reached that the employee would pay back the costs of a training course if they left your employment within 6 months.

However, caution should be exercised here where making this deduction would take the employee’s wages below the National Minimum Wage. A deduction for training courses can only take someone’s pay below the minimum wage if they agreed to pay back these costs, and either they have chosen to leave of their own accord or they have been dismissed because of their conduct.

Redundancy payments

If an employee’s contract of employment has been terminated by reason of redundancy, they may be entitled to either a statutory or contractual redundancy payment. If you do not have an occupational redundancy pay scheme, the employee may be entitled to the statutory minimum, as long as they have accrued at least 2 years’ continuous service with you.

Statutory redundancy pay is determined by the employee’s age and length of employment, counting back from the date of the dismissal. The rates are set as follows:

Aged 18-22: half a week’s pay for each full year of employment
Aged 22-40: one week’s pay for each full year of employment
Aged 41 or older: 1.5 weeks’ pay for each full year of employment

The length of service is capped at 20 years, with weekly pay capped at £538. This sets the maximum statutory amount of redundancy pay at £16,140.

Do the rules on holiday pay differ if termination is with or without notice?

An employee is entitled to be paid for any unused annual holiday entitlement, up until the date of termination of their employment contract. This applies whether or not the employee has worked any notice or been paid in lieu of notice.

The employee may want to take whatever is left of their statutory or contractual leave as days off during their notice period, if you agree to this. The employment contract may also entitle you to demand that the employee takes their unused holiday when working through their notice.

Where the employee has left prematurely, without working their notice where required, any entitlement to holiday pay will only run up until their final day.

What if the employee has taken more annual leave than they accrued?

Where a departing employee has taken more annual leave than they have legally accrued, you can require them to repay the overpaid holiday or deduct money from their final pay packet to reflect this. However, this can only be done if there is contractual provision that this type of deduction can be made, or a written agreement has been reached with the employee in advance.

The rules on recouping holiday pay on termination of employment should usually be outlined in the employee’s contract of employment, the company handbook or on the staff intranet site.

If there is clear contractual or written agreement, this means that if an employee has taken more holiday than their entitlement for the leave year to date, they will need to recompense you for any paid holiday they have taken but not yet earned.

How can final holiday pay problems be avoided?

When you calculate an employee’s final pay packet it is important to be clear in their payslip what each payment or deduction is for. In this way, the employee can cross-reference your calculations against their own, hopefully providing them with the peace of mind that they have been correctly paid.

By law, employers are also required to provide sufficient information about holiday entitlement in the written statement of particulars of employment. This will allow for any accrued holiday entitlement on termination to be correctly calculated.

If an employee is unhappy with their final pay, including any holiday pay entitlement, you should try to resolve this on an informal basis and as quickly as possible. In the event that the matter cannot be resolved, it is open to the employee to bring a complaint. Legal action can be both costly and time-consuming and every attempt should be made to minimise any exposure to a claim against you, where at all possible.