Magilton, 41, was dismissed in April 2009 with the club in ninth place in the npower Championship and was replaced by Roy Keane.
The club had refused to pay the former Northern Ireland international the compensation he was due and the case was to be heard in the high court later this week. But Ipswich have now paid Magilton the sum due to him as well as costs.
Magilton said in a statement: "It was disappointing and upsetting that a club I had served so loyally for so many years, as a player, club captain, and then manager, chose to try and deny me the compensation agreed in my contract, when we sadly parted company in 2009.
"I tried to obtain a sensible settlement, and even made an offer for less than the sum now agreed, but they still would not agree to my proposals. Instead, they continued to raise more unfounded issues, which they either then abandoned or have now withdrawn.
"It has been a long, tiring and unnecessary dispute but I am delighted that I have, with the support of the League Managers Association and its outstanding legal team, entirely cleared my name and put the record straight. I still have fond feelings for Ipswich Town, a club where I made many friends and I wish the club all the best for the future."
Source: PA
Source: PA