If I leave work due to a disability, will I be taxed on a lump sum payment?

3 July 2014


I'm a purchasing manager and I'm currently off work on full pay after having my leg amputated following a series of hospitalisations in May 2013. I have an interview scheduled with the occupational therapist to discuss a return to work, and the subject of a medical disability retirement has been raised. Under the scheme, I would receive an immediate pension, based on my 39 years of pensionable service, plus a separation entitlement lump sum, also service based, of around £80,000. How can I calculate how much tax will be levied on this lump sum payment - will any of it be paid tax free?


There are two tests that must both be satisfied for a taxpayer to receive his disability pay-off free of tax. Firstly there must be an identified medical condition that disables or prevents the employee from carrying out the duties of his employment and secondly the payment must be made on account of that disability and nothing else.  

If, for example, the employer is unaware of the disability when the employee leaves, then the payment cannot be made on account of disability.

You should keep any independent medical evidence confirming the precise nature of your disability, so that your occupational therapist will be well equipped to help you in this regard.  

Provided you are leaving work on the grounds of disability, then the full amount will be paid tax-free. If it is found that you are not, and the payment represents a payment for terminating your employment early, then the first £30,000 will be free of income tax, provided the payment is not contractual.

David Wesley-Yates, chartered tax adviser at Red & Black Accountancy