Payment In Lieu Of Notice And KiwiSaver In New Zealand: Employer Guide

If you employ staff, chances are you’ll eventually deal with a resignation or a termination where the “notice period” becomes a real operational problem. Maybe you don’t want an employee on-site for the next four weeks. Maybe you’re restructuring and need the role to end sooner. Or maybe the employee wants to leave immediately, and you’d prefer a clean and professional exit.

That’s where payment in lieu of notice (often called “PILON”) comes in. But once you decide to pay notice out, one of the most common payroll questions we hear is how KiwiSaver applies.

This guide breaks down what small business employers need to know about your payment in lieu of notice KiwiSaver obligations, including practical payroll treatment, contract wording, and common traps to avoid.

What Is Payment In Lieu Of Notice (And When Can You Use It)?

A notice period is the amount of time required between giving notice and the employment ending. Notice can be:

• Contractual (e.g. 2 weeks, 4 weeks, 1 month) set out in the employment agreement; and/or
• Agreed between you and the employee at the time of exit (as long as it’s lawful and fair).

Payment in lieu of notice means you end employment earlier than the notice period would normally allow, and instead pay the employee an amount that represents what they would have earned if they worked that notice period.

In plain terms: you’re paying them to not work their notice period.

Common situations where PILON comes up include:

• Termination for performance or misconduct (where a fair process has been followed and notice applies).
• Redundancy, where you want to bring the end date forward (but still honour notice obligations).
• Resignation, where the employee wants to leave earlier and you agree (sometimes with a negotiated amount).
• Risk management, where you don’t want the employee to access systems, clients, or staff during notice.

It’s worth checking what your Employment Contract says about notice, termination, and whether you can direct the employee not to work out their notice.

Even when PILON seems simple, you still need to handle it carefully. In New Zealand, good faith obligations under the Employment Relations Act 2000 can still apply during exit discussions, and process matters (especially if this is a termination rather than a resignation).

If you want a deeper explanation of how PILON works in practice, payment in lieu of notice is a useful starting point.

Is Payment In Lieu Of Notice “Earnings” For KiwiSaver Purposes?

This is the key question behind most searches about payment in lieu of notice KiwiSaver treatment.

In many cases, yes - a payment in lieu of notice is treated like salary or wages and forms part of an employee’s “gross earnings” for KiwiSaver purposes. This is because PILON often represents what the employee would have earned as ordinary pay if they had worked their notice period, and it’s commonly paid through payroll and taxed as employment income.

However, you shouldn’t treat this as an automatic rule in every situation. The KiwiSaver position can depend on Inland Revenue’s “gross earnings” definitions and how particular payments are classified. For example, termination-related payments can be made up of several components, and different components may be treated differently.

In practice, the exact answer can depend on:

• How the payment is characterised (what it’s described as in writing, and what it actually relates to);
• What your employment agreement says about notice and payment in lieu;
• Whether you’re paying other amounts at the same time (e.g. holiday pay, bonuses, redundancy compensation, or settlement sums); and
• How your payroll system processes different termination payments.

As an employer, a sensible operational starting point is to check Inland Revenue guidance (or confirm with your payroll provider or accountant) before processing termination payments - especially if the exit involves multiple payments, a dispute, or anything that looks more like a settlement than “ordinary pay”.

If the exit is sensitive (for example, a negotiated departure, a dispute, or you’re concerned about future claims), it may also be appropriate to document terms properly (sometimes through a Deed of Settlement), because how payments are structured can affect payroll handling and tax treatment.

How To Calculate Payment In Lieu Of Notice (And What KiwiSaver Is Based On)

Before you can get KiwiSaver right, you need to calculate the payment in lieu correctly.

Step 1: Confirm The Notice Period

Check the employment agreement first. If it says “4 weeks’ notice”, that’s your starting point (unless you and the employee agree otherwise in writing).

If the agreement is unclear or silent, you may need to assess what “reasonable notice” looks like in the circumstances (which is a legal judgement call and a good time to get advice).

Step 2: Work Out What The Employee Would Have Earned During Notice

For a standard salaried employee, PILON is often straightforward: pay the salary they would have earned over the notice period.

For variable hours, commission-based arrangements, or fluctuating pay, it can get trickier. You may need to calculate based on:

• their normal weekly hours (or an average, depending on the arrangement);
• their ordinary hourly rate;
• any regular allowances that would have been paid during notice; and
• commission rules (whether it accrues during notice, and whether it’s “earned” or discretionary).

Be careful not to accidentally underpay by forgetting regular allowances, or overpay by including discretionary items that wouldn’t have been payable.

Step 3: Separate PILON From Other Final Pay Items

Your “final pay” often includes a bundle of different entitlements, for example:

• Payment in lieu of notice (the notice amount);
• Holiday pay for any untaken annual leave (under the Holidays Act 2003);
• Outstanding wages up to the termination date;
• Commission or bonus amounts (if applicable); and
• Any agreed payments (e.g. redundancy compensation or a settlement amount).

KiwiSaver treatment can differ depending on the type of payment, so it’s good payroll hygiene to itemise these clearly.

So What Is KiwiSaver Calculated On?

Generally, employer KiwiSaver contributions and employee deductions are calculated on the employee’s “gross salary or wages” (subject to the rules and any exceptions). Where PILON is treated as salary/wages, it will commonly form part of the base for KiwiSaver.

This is why employers often look up payment in lieu of notice KiwiSaver - if you treat a notice payout as a generic “lump sum” without checking its category, you can accidentally get deductions and employer contributions wrong.

Payroll, PAYE, And KiwiSaver: Practical Steps To Get It Right

When you’re paying someone out and ending employment, it’s easy to focus on the people-side and forget that the payroll side needs to be correct too. Here’s a practical checklist you can use.

1. Put The Arrangement In Writing

Whether it’s a termination or a resignation, confirm:

• the end date of employment;
• the notice period that applies (and whether it’s being worked or paid out);
• the amount of PILON and how it was calculated; and
• what other payments are included in the final pay.

This reduces misunderstandings and helps you defend the calculation later if there’s a dispute.

2. Process PILON Through Payroll (Not “Off-System”)

PILON is commonly processed the same way as wages. That generally means:

• deducting PAYE (and other standard deductions where applicable);
• deducting employee KiwiSaver contributions (if the employee is enrolled and deductions apply); and
• making employer KiwiSaver contributions (subject to the employer contribution rules and any applicable exemptions).

Trying to handle it as a cash “settlement” or a manual payment outside payroll is where employers often run into compliance issues.

3. Check How Your Payroll Treats Different Termination Payments

Some payroll systems allow you to select “termination pay” categories (ordinary pay, lump sum, holiday pay, etc.). Make sure you’re selecting the right categories so that KiwiSaver is calculated correctly.

If you’re unsure, it’s better to pause and confirm before processing. A small mistake at termination can create a long tail of admin later (amended filings, employee complaints, Inland Revenue queries, etc.).

4. Be Careful With Deductions And Offsets

Employers sometimes want to deduct amounts owed (e.g. overpayments, unreturned property, training costs). In New Zealand, deductions from wages are not something you can just do because you feel it’s fair - you need to consider the Wages Protection Act 1983 and any written consent requirements.

If you’re planning deductions, get advice first so you don’t turn a clean exit into a personal grievance risk.

5. Make Sure The Exit Process Is Fair (Especially For Terminations)

Even if you’re paying notice in lieu, you still need a fair process for a termination. PILON doesn’t “fix” a flawed process.

For example, if you’re ending employment for performance issues, you generally need to follow a fair process (clear expectations, opportunity to improve, good faith consultation, considering the employee’s response). If you’re unsure about the right approach, Performance management process guidance is often where employers start when they want to do this properly.

And if you’re considering redundancy, you should be thinking about consultation and process, not just payouts. Many employers get caught out by treating redundancy like a simple financial exercise. If you need support, Redundancy advice can help you work through the steps before you finalise decisions.

Common Pitfalls With Payment In Lieu Of Notice And KiwiSaver

Here are the mistakes we most commonly see when employers deal with payment in lieu of notice KiwiSaver calculations.

Calling It “Payment In Lieu” When It’s Actually Something Else

If you label a payment as PILON but it’s really compensation, a settlement amount, or a discretionary “go away” payment, you may create confusion about tax and KiwiSaver treatment.

From a practical perspective, you want the paperwork and payroll entries to match what the payment is actually for.

Forgetting That Holiday Pay Is A Separate Entitlement

PILON is about the notice period. Untaken annual leave is a separate statutory entitlement under the Holidays Act 2003, and it should be calculated and paid correctly as part of final pay.

A common trap is rolling everything into one figure and later struggling to explain what was paid (and whether KiwiSaver should have applied to each component).

Assuming KiwiSaver Stops Because The Employee Leaves Immediately

Even if the employee leaves the workplace right away, PILON can still be treated as earnings. The “work” part and the “pay” part are different concepts.

So, if you’re paying salary for the notice period as a lump sum, it’s still commonly subject to the usual payroll treatment, including KiwiSaver (depending on how it’s classified under the Inland Revenue rules).

Not Checking The Employment Agreement Wording

Your agreement should clearly cover:

• how much notice is required;
• whether you can elect to pay in lieu of notice;
• whether you can place the employee on garden leave (if relevant); and
• how final pay items are handled.

If your agreement is unclear, you may end up negotiating under pressure (and potentially paying more than you intended, or risking a dispute about notice).

Using PILON As A Shortcut Around Process

This one is important: paying someone out doesn’t automatically make a termination lawful or “safe”. The Employment Relations Act 2000 focuses heavily on process and good faith. If you skip steps and just pay notice, you can still face a personal grievance claim.

If you’re unsure about your position, it’s often cheaper to get advice early than to defend a claim later. Chatting with an Employment lawyer before you finalise the exit can save a lot of stress.

Key Takeaways

• Payment in lieu of notice is generally used when employment ends earlier than the notice period, and you pay the employee what they would have earned during that notice period.
• In many cases, KiwiSaver will apply to a notice payout because it’s often treated as salary or wages processed through payroll - but the correct treatment depends on Inland Revenue’s “gross earnings” rules and how the payment is classified.
• Separate and clearly itemise termination payments (PILON, holiday pay, outstanding wages, bonuses/commission, and any other agreed sums) to reduce payroll errors and disputes.
• Ensure your employment agreement is clear on notice and your ability to pay in lieu, and put any exit arrangement in writing.
• PILON isn’t a substitute for a fair process - if you’re terminating employment (for performance, misconduct, or redundancy), process and good faith still matter.
• If the situation is sensitive or complex, getting tailored advice early can help you avoid underpayment issues, KiwiSaver mistakes, or personal grievance risk.

Important: This article is general information only and isn’t tax, payroll, or accounting advice. For guidance on PAYE and KiwiSaver obligations (including what counts as “gross earnings” and how different termination payments are treated), you should check Inland Revenue guidance and/or speak with your accountant or payroll provider.

If you’d like help handling a termination or drafting the right employment documents so you’re protected from day one, you can reach us at 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.