What is a settlement or mutual separation agreement?

The employer calls a meeting, says the relationship is not working, and produces a document. It offers three months' pay. It says the employment ends by mutual agreement on Friday. It has a signature line, and there is a strong suggestion that it should be signed today.

This guide is part of our Your rights at work: pay, contracts, resigning and retrenchment, which links every guide on the topic.

Most people sign, because the alternative appears to be a disciplinary process or a retrenchment and the money is on the table. Some of them are right to. Almost none of them understand two consequences that are sitting in the document, unmentioned.

What it is

A mutual separation agreement, sometimes called a settlement agreement or a voluntary separation, is a contract in which employer and employee agree to end the employment relationship on stated terms. Typically:

• a termination date
• a payment, sometimes called an ex gratia payment or a separation package
• payment of what is owed anyway: notice pay, accrued leave, salary to the date
• a full and final settlement clause under which you waive claims against the employer
• confidentiality and sometimes a non-disparagement clause
• an agreed reference or wording for announcements
• occasionally a restraint of trade, or a confirmation of an existing one

The legal effect is that the employment ends by agreement, not by dismissal. That single characterisation drives everything else on this page.

What you give up

The right to claim unfair dismissal. Because you were not dismissed. An employee who signs a mutual separation and then refers an unfair dismissal dispute to the CCMA is met with the agreement, and the referral ordinarily fails on that basis. The Labour Court has also warned employers about dressing a dismissal up as a mutual separation, so the position is not absolute, but you should sign on the assumption that you are giving this up.

Everything in the full and final clause. A well-drafted clause waives all claims arising from the employment and its termination, known or unknown. That includes underpaid overtime you never raised, a bonus you believe you earned, and unfair labour practice claims. Read the clause, and if there is something specific you want to preserve, it has to be carved out expressly.

Severance pay under the BCEA, in the strict sense. Statutory severance is payable on dismissal for operational requirements. An agreed separation is not that, so whatever you receive is contractual rather than statutory. This matters for tax, below. Our guide on retrenchment without severance explains the statutory entitlement you are stepping away from.

The tax consequence

This is the one that costs the most and is explained the least.

A lump sum paid because employment ends is a severance benefit for tax purposes only if one of three conditions in the Income Tax Act is met: you are 55 or older, the termination is due to illness, injury or incapacity, or the employer is closing that business or you have become redundant through a general reduction in staff. It never applies to someone who held more than five per cent of the employer. A severance benefit is taxed on the retirement lump-sum table, under which the tax-free amount is R550 000, cumulative over your lifetime and shared with your retirement lump sums.

The label on the agreement does not decide this; the real reason does. A separation because the relationship has broken down, or to avoid a disciplinary process, meets none of the conditions for someone under 55, so the payment is taxed as ordinary income, at your marginal rate, in the year you receive it. A voluntary package offered because your job is genuinely redundant in a restructuring is different: SARS accepted in 2018 that voluntary severance packages in a retrenchment usually meet the definition. Our guide to how severance pay is taxed explains the definition and the tax directive.

The difference is large. On a package of R300 000, a retrenched employee with no prior lump sums may pay no tax at all on the severance portion. An employee whose separation does not qualify may lose a substantial share of the same amount to PAYE, and may be pushed into a higher bracket for the year. The severance tax estimator shows the figures for a qualifying payment.

Two practical points. Ask the employer, in writing and before you sign, to apply to SARS for a tax directive on the basis of the true reason for the termination, and to show you the directive. If you are leaving in a genuine reduction of staff, the directive should be requested as a severance benefit. And be very careful about an employer who offers to describe the termination as a retrenchment for tax purposes when it was not: that is a misrepresentation to SARS, and you are the taxpayer. If the true reason is redundancy, insist that the agreement says so and that the employer applies for the directive on that basis. Our retrenchment package calculator sets out the statutory minimums on a genuine retrenchment.

The UIF consequence

The second unmentioned consequence.

Section 16 of the Unemployment Insurance Act pays unemployment benefits only where the job ended for a listed reason, such as termination by the employer, dismissal, the end of a fixed-term contract or insolvency. Resignation is not one of them. A termination by agreement can be treated as voluntary, and a voluntary termination can disqualify you from unemployment benefits, in the same way that a resignation does, as our guide on claiming UIF after resigning explains.

Whether a particular separation is treated that way depends on what really happened and how the termination is recorded on the UI-19 form the employer submits; our guide to the UI-19 and other UIF forms explains how to check it. And here is the trap for both parties: knowingly misrepresenting the reason for termination on the UI-19 is an offence under section 64 of the Unemployment Insurance Act. An employer who agrees to record a mutual separation as a retrenchment "to help you with UIF" is committing an offence and inviting you to benefit from one.

So before signing, work out what your position will be if UIF is refused. Our guides on claiming UIF after retrenchment and our UIF benefits calculator show what is at stake, and for many people the answer is that a separation payment needs to be large enough to cover the UIF they will not receive.

When it is a good deal

Mutual separation is not a trap by nature. There are situations in which it is plainly the right outcome.

The relationship has genuinely broken down and both sides want out cleanly.

A retrenchment is coming anyway, and the employer is offering more than the statutory minimum to avoid a process. Here, though, insist that the agreement records it as a retrenchment by agreement in the section 189 sense if that is what it is, because the tax and UIF consequences follow the substance.

You have a weak position in a pending disciplinary matter and the alternative is a dismissal for misconduct on your record.

You have another job, so UIF is irrelevant and the payment is a bonus.

The employer is paying for certainty, and the amount reflects that.

The question is not whether to sign but whether the number on the page compensates you for what the page takes away.

Before you sign

Take it home. You are entitled to reasonable time to consider it and to take advice. An employer who insists on signature in the meeting is telling you something about the document. If they will not allow time, that pressure is itself relevant later.

Get advice. A union representative or an attorney reading it for an hour is cheap relative to what is at stake.

Do the tax arithmetic. What is the payment worth after PAYE at your marginal rate, and what would a severance benefit have been worth?

Do the UIF arithmetic. How many months of benefit are you potentially forfeiting?

Check what is being paid in addition. Notice pay, accrued leave and salary to date are owed regardless. An offer that bundles them into the "package" is offering less than it appears. Our leave payout calculator and notice period calculator work out what you are owed anyway.

Read the restraint and confidentiality clauses. A restraint you are being asked to confirm may be worth more to the employer than the payment is to you. Our guide on whether your restraint of trade is enforceable explains the test.

Negotiate. The first draft is an offer. The payment, the reference, the termination date, the tax treatment and the carve-outs from the waiver are all negotiable, and employers routinely improve terms when asked.

Get the reference and the announcement wording into the agreement itself, not into a verbal assurance.

If you already signed under pressure

An agreement signed in a single meeting, with no opportunity to take advice, under threat of a worse outcome, is not automatically void. Contracts are generally enforced. But there is a real argument where the pressure crossed into duress or where the agreement is in substance a dismissal dressed up, and the Labour Court has been alert to employers doing exactly that.

Gather the record: the date and time of the meeting, who was present, what was said about the consequences of not signing, whether you asked for time and what the response was, and any messages before and after. Then take advice quickly, because referral periods run from the termination and are short. Our CCMA deadline checker works out the dates.

Worked example

This example is illustrative. An operations manager earning R45 000 a month is told her role is being restructured. Rather than a section 189 process, the employer offers a mutual separation: three months' salary as an ex gratia payment, plus notice and leave, signed this week.

She takes it home instead. Two things emerge.

Tax. The draft records only that the employment ends "by mutual agreement", and says nothing about her role. Paid on that basis, the R135 000 ex gratia payment would go through payroll as ordinary income, taxed at her marginal rate. If she is genuinely redundant, and it is recorded that way, it is a severance benefit and, with no earlier lump sums, falls within the tax-free portion of the retirement lump-sum table. The difference to her, after tax, is tens of thousands of rands.

UIF. A termination by agreement may be treated as voluntary. She has no other job. Several months of unemployment benefit are potentially at stake.

She goes back with two proposals. Either the agreement records the true reason, that her post is redundant in the restructuring, and the employer applies to SARS for a tax directive on that basis and records the same reason on the UI-19, so that the tax and UIF consequences follow the truth. Or, if the employer will not accept that the post is redundant, the ex gratia payment increases to reflect the tax she will pay and the UIF she may lose.

The employer, which is in fact abolishing the post, takes the first option and records the redundancy. She also has the reference wording written into the agreement and a carve-out preserving a disputed commission claim.

Change the facts: there is no restructuring, and the employer simply wants her gone after a disagreement with the board. Nothing makes her redundant, she is under 55, and the payment cannot honestly be called a severance benefit, so the only fair answer is a larger payment. The version that goes badly is the same manager signing in the meeting, discovering the PAYE deduction on her final payslip, being refused UIF as a voluntary termination, and finding that the full and final clause has extinguished the commission claim she meant to raise later.