Payment in Lieu of Holiday

When an employee leaves your business, one question always comes up: what happens to their unused holiday? Under UK employment law, payment in lieu of holiday means paying an employee for accrued but untaken annual leave, and it almost always applies when employment has ended. Payment in lieu is only permitted when employment has ended, so understanding the effective date of when employment ended is crucial for legal and financial compliance.

It’s worth getting this right from the start. UK workers are not usually allowed to swap their statutory holiday for cash while they’re still employed. Payment in lieu of statutory holiday during employment is generally illegal under the Working Time Regulations 1998, as statutory holiday is designed for rest and wellbeing. The law expects employers to let staff actually take their leave. Denying paid leave during employment can negatively impact employee health and increase employer liability. Payment in lieu only becomes lawful—and mandatory—when employment has ended. Employers cannot pay in lieu of statutory holiday while the employee is still employed, as it defeats the purpose of providing rest. If an employee is unable to take their statutory leave due to employer actions, this may have legal consequences.

For small and medium-sized employers navigating 2024–2026, this creates a clear obligation. Whether someone resigns, is dismissed, or reaches the end of a fixed-term contract, you’ll need to calculate and pay any outstanding holiday entitlement in their final pay. Denying the right to take paid leave can lead to claims for accrued leave backdated for several years in employment tribunals. That’s where clear records matter. A system like ScheduleLeave that tracks accrual and usage in real time can save hours of manual calculation and reduce the risk of costly errors.

Let’s break down exactly when payment in lieu applies, how to calculate it, and how to handle the tricky cases.

When Is Payment in Lieu of Holiday Allowed?

Under the Working Time Regulations 1998, payment in lieu of statutory minimum leave (5.6 weeks for a full-time worker) is generally only lawful when employment ends. During employment, employers must enable staff to take their paid leave rather than paying it out.

The key scenario is termination of employment. This includes:

• Resignation
• Dismissal (including for gross misconduct)
• Redundancy
• End of a fixed-term contract
• Retirement

Employers can stipulate that any remaining annual leave must be taken during the employee’s notice period. Employers can also refuse holiday requests during the notice period based on business needs.

In each of these circumstances, the employer is required to pay for any accrued, unused leave up to the termination date. This isn’t optional—it’s a statutory entitlement. When calculating final pay, both statutory notice and contractual notice periods may differ, and both should be considered when determining entitlements.

There’s an important distinction between statutory and contractual leave. If your employee’s contract offers enhanced holiday above the 5.6-week minimum, the rules for that additional untaken leave can be more flexible. Depending on how the contract is worded, enhanced days can sometimes be paid in lieu by agreement even if the worker stays employed. However, this must be explicitly stated in the employment contract or relevant agreement. Employees must check their contract to understand their rights regarding holiday during the notice period.

When requesting leave, the general rule is that the notice period for taking leave is at least twice as long as the amount of leave you want to take, unless your employee’s contract states otherwise.

Example: Sarah resigns from her job with a leaving date of 30 June 2025. Her leave year runs January to December, and she has a 28-day annual entitlement. By the end of June, she has accrued 14 days (half the year). She’s taken 10 days so far. Sarah is entitled to payment in lieu for 4 days of unused holiday in her final pay.

Example: Marcus works for a company that offers 33 days of annual leave (5.6 weeks statutory plus 5 contractual days). His contract states that contractual days not taken by the end of the leave year will be paid out. He can receive payment in lieu for those 5 extra days even while still employed, but not for his statutory 28 days.

How to Calculate Payment in Lieu of Holiday

Getting the calculation right depends on understanding what counts as a week’s pay under UK rules. This varies depending on whether your employee has a fixed salary, variable hours, or works irregular patterns.

Case law has established that employers must take into account regular overtime, commission, and allowances when calculating holiday pay. This ensures that payment in lieu of holiday reflects all elements of normal remuneration, not just basic salary.

Salaried Employees with Regular Hours

For regular full-time staff on a fixed salary, the calculation is straightforward. Divide the weekly pay by the number of days worked per week to get a daily rate, then multiply by the days owed.

Worked example:

• Weekly salary: £600
• Days worked per week: 5
• Daily rate: £600 ÷ 5 = £120
• Days of leave outstanding: 3
• Payment in lieu: 3 × £120 = £360

Variable Pay and Irregular Hours Workers

For workers with variable pay, including those on zero-hours contracts, part-time staff with fluctuating hours, or anyone earning commission, the calculation is more complex.

From April 2020 onwards, holiday pay for workers with variable pay should usually use a 52-week reference period. You look back at the previous 52 weeks where the worker received pay (excluding any weeks with no earnings) and calculate the average weekly pay.

A leave management system like ScheduleLeave can automate this by pulling data from timesheets or payroll exports, eliminating manual averaging and reducing errors.

What Must Be Included in the Calculation

Case law has established that certain payments form part of “normal remuneration” and must be included when calculating holiday pay:

• Regular overtime (whether compulsory or voluntary but regular)
• Commission payments
• Allowances that are regularly paid
• Shift premiums

If your staff receive bonuses or allowances on a regular basis, seek specialist advice on whether these should be factored into the holiday pay calculation.

Step-by-Step Example: Calculating Holiday Pay in Lieu

Let’s work through a more complex example for a part-time worker with variable hours.

Scenario: Emma works part-time with irregular hours. She’s leaving on 31 March 2026 with 6.4 days of holiday accrued but not taken. Her pay has varied over the past year.

Step 1: Calculate average weekly pay Looking at Emma’s last 52 paid weeks, her total earnings were £15,600.

• Average weekly pay: £15,600 ÷ 52 = £300

Step 2: Calculate daily rate Emma’s average working week is 4 days.

• Daily rate: £300 ÷ 4 = £75

Step 3: Multiply by days owed

• Payment in lieu: 6.4 × £75 = £480

Handling part-days: Your holiday policy should state how you round part-days—whether to the nearest half-day, the nearest hour, or some other method. Be consistent and document your approach in the staff handbook.

ScheduleLeave can produce an automated calculation and export the figure directly for payroll to process, creating an audit trail if the payment is ever questioned.

Accrual of Holiday and How Much Can Be Paid in Lieu

Statutory leave (5.6 weeks) accrues from the first day of employment. Most employers calculate this on a monthly or daily pro-rata basis through the leave year. Employees typically lose their statutory holiday if they fail to take it within the holiday year unless their contract allows for carryover. Employers must ensure employees take their full holiday entitlement within the holiday year to avoid negative impacts on morale.

Example of part-year accrual: Tom starts work on 1 October. His employer’s leave year runs 1 January to 31 December, and the annual entitlement is 28 days. By the end of December, Tom has worked 3 months out of 12, so he has accrued:

• 28 ÷ 12 × 3 = 7 daysThe holiday entitlement for part-time workers is also a minimum of 5.6 weeks paid holiday each year, regardless of hours worked.

If an employee is unable to take their holiday due to being on sick leave or family-related leave, employers must allow them to carry over untaken holiday entitlement into the next year. Workers can carry over their whole leave entitlement if they could not take it due to being on family-related leave or sick leave.

To work out unused holiday at termination, take the total entitlement for the leave year (including any contractual extra days), then subtract days already taken.

Edge Cases: Long-Term Absence

Holiday continues to accrue during certain types of leave:

• Maternity leave
• Adoption leave
• Paternity and parental leave
• Long-term sick leave

This can generate a significant balance. An employee returning from a year of maternity leave, for example, will have accrued their full annual leave entitlement during that period. If they then resign or are dismissed, the payment in lieu could be substantial.

Employers should keep real-time records of leave taken, carry-over, and accrual in a central system such as ScheduleLeave. This ensures final payments are transparent, evidence-based, and can be calculated in the same way every time.

Pro-Rata Holiday Calculation on Leaving

A simple formula approach works well:

(Annual entitlement ÷ 12 months) × months worked in leave year = accrued entitlement

Or use a daily accrual method:

(Annual entitlement ÷ 365) × calendar days employed in leave year = accrued entitlement

Worked example:

• Annual entitlement: 28 days
• Leave year: January to December
• Leaving date: 30 April
• Months worked: 4
• Accrued: 28 ÷ 12 × 4 = 9.33 days
• Days already taken: 5
• Days owed in lieu: 4.33 days

When an Employee Has Over-Taken Leave

Sometimes an employee leaves having taken more holiday than they’ve accrued. If your contract expressly permits it, you may reclaim the overpayment from their final wages.

Example: If the employee above had taken 12 days instead of 5, they would be 2.67 days “in deficit.” The employer could deduct the value of those 2.67 days from the final salary—but only if the employee’s contract explicitly allows this.

Spell out your chosen accrual method in the contract and staff handbook. Keep it consistent in your HR and holiday software to avoid confusion or disputes.

Gross Misconduct and Pay in Lieu

Gross misconduct is a serious breach of contract that can have significant consequences for both the employer and the employee, especially when it comes to pay in lieu of notice. If an employee is dismissed for gross misconduct, the employer is generally not required to provide notice or pay in lieu of notice, unless the employment contract specifically states otherwise. However, if a payment in lieu has already been made and gross misconduct is discovered afterwards, the employer may be able to recover the payment or withhold it, provided the contract allows for this.

To protect their interests, employers should ensure that employment contracts include clear clauses regarding gross misconduct and the circumstances under which pay in lieu may be withheld or reclaimed. This contractual clarity is essential, as payments made under a contractual right are typically not recoverable, even if gross misconduct comes to light after termination. By carefully drafting employment contracts to address gross misconduct, employers can avoid disputes and ensure that payments in lieu are only made when appropriate.

Bank Holidays and Holiday Pay

Bank holidays are often a point of confusion when it comes to holiday entitlement and pay. In the UK, bank holidays can be included as part of the statutory annual leave entitlement of 28 days for full-time workers. There is no statutory requirement for employers to provide additional pay or extra days off for bank holidays beyond this entitlement, unless the employment contract states otherwise.

Employers can require employees to take annual leave on bank holidays, counting these days towards their statutory entitlement. Employees should always check their employment contract to see if it offers extra pay or additional leave for bank holidays, as this varies between workplaces. Understanding how bank holidays are treated in your contract is crucial for managing annual leave and ensuring both employers and workers are clear on their rights and obligations regarding holiday pay.

Relevant Agreement and Holiday Entitlement

A relevant agreement—such as a workforce agreement or a collective agreement incorporated into an employee’s contract—can play a significant role in shaping holiday entitlement. These agreements may provide for more generous holiday terms than the statutory minimum, or set out specific rules for how and when holiday can be taken, especially for workers with irregular hours or part year workers.

Employers must review any relevant agreements that apply to their workforce, as these can affect not only the amount of holiday entitlement but also how holiday pay is calculated. For example, a collective agreement might specify that overtime or certain bonuses are included in holiday pay calculations, or set out different accrual rules for part year workers. Staying informed about the terms of any workforce or collective agreement is essential for compliance with employment law and for ensuring that all workers receive at least the statutory minimum entitlement.

Tax, National Insurance and Payroll Treatment

Payment in lieu of holiday is treated as normal taxable earnings for PAYE and Class 1 National Insurance purposes in the UK. There’s no exemption or relief—it’s simply part of the employee’s pay.

This payment should appear on the employee’s final payslip and P45, clearly identified but processed through standard payroll. The same applies to any pension contributions that would normally be deducted.

When processing termination payments, be aware of how different elements are treated, especially in relation to statutory notice and the date employment ended:

Holiday pay in lieu is always separate and fully taxable, regardless of what other payments are made.

It is important to note that the effective date of termination for statutory purposes may differ from the date an employer states if they pay in lieu of notice. This can affect claims for unfair dismissal or redundancy, as statutory notice periods and legal entitlements are based on the statutory notice and the actual date employment ended.

Payroll teams can use exports from ScheduleLeave—showing remaining days and calculated amounts—to reduce errors and speed up processing when someone’s employment has ended.

Contract Clauses and Company Policy on Payment in Lieu

Every employer should include a clear clause in the employment contract and staff handbook explaining:

• When payment in lieu of holiday will be made (typically on termination only)
• How it is calculated
• The leave year dates
• The difference between statutory and enhanced entitlement
• Carry-over rules and any maximum limits
• Rounding rules for part-days
• Treatment of untaken leave on leaving

It now makes tactical sense for employers to include a pay in lieu of notice clause in the employee’s contract due to recent tax law changes. If an employer pays in lieu of notice without a contractual right in the employee’s contract, they may be in breach of contract, which could lead to potential claims for damages from the employee. Employees are entitled to be paid for any accrued holiday entitlement up to the date of termination, but not for any holiday that would have occurred during the employee’s notice period if they are paid in lieu of notice.

For enhanced contractual leave, you can set more generous rules. For example, you might allow staff to be paid for unused contractual days even during employment—provided you don’t reduce statutory rights below the minimum.

Align your written policy with how requests and balances are actually managed in your holiday planner. If your contract says one thing but your system shows another, you’re creating grounds for dispute.

Handling Over-Taken or Negative Holiday Balances

If an employee has taken more leave than they’ve accrued by their leaving date, you can usually recoup the overpayment from final salary—but only if the contract expressly permits this.

Worked example:

• Employee is 3 days “in deficit” at termination
• Daily rate: £100
• Deduction: 3 × £100 = £300

This deduction should appear clearly on the final payslip with an explanation. Before agreeing a leaving date, review negative balances in your leave management system so both parties understand any likely deductions in advance.

Any deduction must be:

• Reasonable in amount
• Clearly explained in writing
• In line with unlawful deduction from wages rules
• Authorised by the contract or a relevant workforce agreement

If in doubt, speak to an employment law specialist before making deductions.

Record Keeping and Holiday Entitlement

Accurate record keeping is fundamental to managing holiday entitlement effectively. Employers should keep detailed records of each employee’s holiday dates, payments for holiday time, and any agreements that affect entitlement, such as the leave year, accrual rates, and carry-over of untaken leave. It’s also important to document any payments made in lieu of notice and deductions for overpaid holiday pay.

Employees are encouraged to keep their own records of holiday taken and pay received, so they can verify their entitlement and spot any discrepancies early. Good record keeping helps both employers and employees avoid misunderstandings, ensures compliance with statutory requirements, and provides clear evidence if disputes arise over holiday entitlement or payments in lieu.

Common Mistakes Employers and HR Teams Make

Even experienced HR teams can get payment in lieu of holiday wrong. Here are the most frequent errors:

When final holiday pay is wrong or missing, employees’ entitlements and pay can be directly affected, leading to disputes or claims. This is especially true for long-serving staff or those returning from long-term leave who may have accrued significant balances. Unreasonably refusing holiday requests could also lead to claims of constructive dismissal.

Manual spreadsheets increase the risk of incorrect balances compared with a centralised platform like ScheduleLeave that tracks accrual and usage automatically. Consider regular audits of holiday balances and policies, particularly when legal rules on holiday and pay calculation change.

Irregular-Hours and Part-Year Workers

Irregular-hours and part-year workers—including casual, seasonal, and education sector staff—are higher risk for mis-calculated holiday and payments in lieu.

For leave years starting on or after 1 April 2024, the rules for these groups have tightened. Employers need to ensure their policies and systems are updated to reflect current guidance.

Some employers have used percentage-based accrual (e.g., 12.07% of hours worked) as a shortcut. This method should now be used with caution and only where lawful under current guidance. Clear documentation is essential.

A specialist leave system can store contracted hours, work patterns, and historic pay and attendance data. This makes end-of-employment calculations more robust for these groups and provides evidence if a calculation is ever challenged.

Disputes and Resolution

Disputes over holiday entitlement can occur for a variety of reasons, including misunderstandings about the employment contract, errors in calculating holiday pay, or disagreements about when leave can be taken. The first step in resolving any dispute should be to follow internal procedures, such as discussing the issue with HR or a line manager. Clear communication and reference to the employment contract can often resolve issues quickly.

If a dispute cannot be settled internally, seeking external advice from an employment specialist or mediator may be necessary. In some cases, unresolved disputes may need to be taken to an employment tribunal. Employers should have clear, accessible policies for managing holiday entitlement and resolving disputes, while employees should be aware of their rights and the steps to take if they believe their entitlement has not been met. Taking early advice and following established procedures can help both parties reach a fair resolution and avoid escalation.

How ScheduleLeave Helps Manage Holiday and Payments in Lieu

ScheduleLeave is a cloud-based holiday planner for SMEs that replaces spreadsheets and manual forms with one central platform. For businesses dealing with terminations and final pay, it removes the guesswork from calculating payment in lieu.

Key features that support payment in lieu calculations:

• Real-time balances: HR and managers can see exactly how many days each employee has taken and has remaining, at any moment
• Configurable leave types: Separate statutory leave from contractual enhanced days, each with its own rules
• Custom leave years: Set your leave year to match your business (calendar year, April–March, or any other period)
• Pro-rata rules: Automatic calculation for starters and leavers based on their employment dates
• Multiple work patterns: Handle full-time, part-time, and irregular-hours staff with appropriate accrual settings
• Integrations: Sync with Outlook, Google Calendar, and Slack so approvals and dates flow into existing workflows

When someone leaves, reports and exports from ScheduleLeave show the exact outstanding holiday balance. Share this with payroll to calculate payment in lieu correctly, and keep the evidence on file if the calculation is ever questioned.

ScheduleLeave offers per-user pricing and a free 1-month trial, making it accessible for businesses with roughly 10–500 employees looking to tighten their holiday and final-pay processes. If you’re still managing leave on spreadsheets, the risk of errors on termination is one of the strongest reasons to make the switch.

If you have questions about payment in lieu of holiday or need help with complex scenarios, contact ScheduleLeave or an employment law specialist for further advice.

Getting payment in lieu of holiday right protects your business from claims and ensures your employees receive what they’re entitled to. Clear policies, accurate records, and a reliable system are the foundations. If you’re unsure about any calculation—especially for complex cases involving maternity, sick leave, or irregular hours—seek specialist advice before finalising final pay.

Ready to simplify your holiday management? Start your free ScheduleLeave trial and see how real-time tracking makes termination calculations faster, clearer, and audit-ready.