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How to calculate holiday pay on termination of contract

6 min read | 25 August, 2021 By Andy Stewart

    

If you’ve recently had the unfortunate experience of terminating an employee's contract you should now be working out how much they are due to be paid before they leave. One part of the severance they are entitled to will be their accrued holiday pay.

This is a legal requirement, but the amount paid out depends on a number of factors. Make sure you get it right by learning how to calculate holiday pay on termination of contract.

What are the rules on giving holiday pay on termination of contract?

How is holiday pay calculated on termination?

What other aspects of final pay need to be calculated?

How to avoid any issues with final pay

Simple, stress-free holiday management

What are the rules on giving holiday pay on termination of contract?

At the termination of a contract an employee is entitled to any excess statutory holiday they have left as part of their final payment. As an employer you are legally required to do so. This is known as ‘pay in lieu of holiday’, and is applicable if the employee resigns or you ask them to leave.

If you offer employees more than the statutory minimum of holiday entitlement, an employee will only be entitled to ‘pay’ from these extra days if it is stipulated in the contract. If the contract does not mention that these days will be included, or there is no other agreement in place, you only have to pay the amount in lieu.

How is holiday pay calculated on termination?

An employee’s entitlement to pay in lieu entitlement consists of any unused statutory leave they have left, up to the date the employment ends.

For example, if the employee is due to leave halfway through a year but has only used a quarter of their holiday allowance over that time, they are likely to be eligible for pay in lieu to compensate them for not taking that leave yet.

The Working Time Regulations 1998 states that all contracted workers are legally entitled to a minimum of 5.6 weeks of paid holiday a year, so this gives you a basis to work from. However, it will depend on the type of contract your employee has for their position.

For a full-time employee

A full-time employee working 5 days a week will be eligible for a total of 28 days of paid holiday. However, this can include bank holidays and public holidays. For a standard full-time worker, this paid holiday will accrue in advance at a rate at one twelfth of their annual entitlement.

For example an employee leaving in June will only be entitled to 14 days holiday, as one twelfth of 28 is 2.33 and 2.33 multiplied by 6 is 14.

For zero-hours contracts

Calculating holiday pay on termination of employment is different for employees on zero-hours contracts. It may be less clear because of the nature of their working hours. In this instance it may be easier to calculate their entitlement by the amount of hours worked.

Holiday for zero hours workers is accrued at a rate of 12.07% of the total hours worked in a year. For example, if an employee on a zero-hours contract worked 40 hours in a week, they would accrue 4.8 hours leave for that week. 4.8 being 12.07% of 40.

If working out how much holiday someone is owed seems complicated, there are a number of holiday entitlement calculator tools available which can help you do the job.

How much holiday pay is my employee entitled to?

You should pay all your employees one week’s pay for each week of statutory leave that they take. The pay that is received when an employee is on holiday should reflect what they would have earned if they had been at work.

However, this isn’t the case when it comes to a zero-hours contract worker. The nature of the contract means their working hours are not guaranteed hours. Unlike a full time worker they do not have a standard set of hours to measure holiday pay on. Instead, a week's pay for the purposes of paid holiday entitlement will be based on the average pay from the previous 52 weeks to the calculation date. This is called the holiday pay reference period.

A simple formula to easily calculate your employees’ holiday pay

It seems a little complicated right now, but there is a formula that can be used to make working out holiday pay entitlement a whole lot easier.

As long as there are no other contractual agreements in place, this formula can be used:

(A x B) - C

  • A is the minimum period of leave to which the individual is entitled
  • B is the amount of annual leave that has accumulated before the termination date
  • C is the period of leave already taken by your employee between the beginning of the leave year and their termination date.

For example, if a part-time worker works 4 days a week, like all workers they are entitled to 5.6 weeks of paid annual leave.

They then leave the job 8 months into the leave year having only taken 7 days off. This is the equivalent of 1.75 weeks (7 days off ÷ 4 working days).

We can apply the formula here 5.6 [A] x (8 ÷ 12) [B] - 1.75 [C] = 1.96

This means the employee will be due 1.96 weeks in lieu.

When using this formula, if an employee has holiday left, you should pay them their equivalent daily pay rate for these days.

What other aspects of final pay need to be calculated?

Holiday entitlement is not the only consideration when terminating an employee's contract. You also need to make sure you calculate the following.

Wages or pay in lieu of notice

The employee should be paid normally when they work their notice period. They are due all that is owed to them up until the day on which their contracts will be terminated. This also includes if they are willing to work, but have been asked not to. This is all known as pay in lieu of notice.

If the employee wants to leave without working their full notice, you and the employee will need to reach an agreement. If they leave without an agreement, they will only be entitled to part of the notice they turned up for. You will also have to include any accrued untaken holiday into this payment.

Redundancy payments

If you have terminated an employee’s payment as part of a redundancy, they may be entitled to statutory or contractual redundancy payments.

If you do not offer a redundancy pay scheme as part of the job offering, the employee may be entitled to the statutory minimum. This comes with the caveat that they have worked for at least 2 years of continuous service with you.

If you are unsure about statutory redundancy pay, here is something worth remembering: Statutory redundancy pay is determined by the age of the employee and the length of their employment from the dismissal date.

  • 18-22: half a week’s pay for each full year of employment
  • 22-40: One week’s pay for each full year of employment
  • 41+: 1.5 weeks’ pay for each full year of employment.

You can quickly work out how much an employee is owed for redundancy using a redundancy calculator tool.

How to avoid any issues with final pay

To avoid any issues with final pay make it clear in the payslip what each payment or deduction is for. This will give the employee a chance to compare their final pay with calculation of their own, giving them reassurance that they have received the correct amount.

Make sure that in your written section 1 statement that you provide sufficient information about holiday entitlement. This will make it simpler to work out the correct calculation later on.

If the employee is unhappy with their final pay, or there are any discrepancies, try to resolve this on an informal basis first. If it goes further to legal action it can start to get costly.

Simple, stress-free holiday management

Keep your holiday management simple and stress free with a holiday booking system you’ll love. Make the most of our productivity boosting featings, such as setting holiday ‘blackout’ dates so your team knows when not to take leave. Set statutory holidays for multiple employees at the same time and easily filter time off by department, so everyone can be kept in the loop.

Get more done in less time with Breathe.

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Posted on 25 August, 2021

By Andy Stewart

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