Are you aware of the strategic considerations involved in the event your client gets a redundancy?
A person may receive a redundancy when their employer decides they no longer need the employee to do that job. Redundancy can be triggered by a number of factors, including business restructuring, streamlining or introducing new technology.
The components of the redundancy payment will vary depending on the industrial agreement or employment contract. However, a redundancy may include:
Payment in lieu of notice;
Severance payment based on a number of weeks’ pay for each year of service;
A ‘golden handshake’ – a lump sum usually provided to executives.
Wages owing or accrued annual and long service leave owing do not form part of a redundancy payment, even though they may be paid out to the employee at the same time.
Taxation of redundancy payments
Under current rules, no part of a redundancy can be rolled into super but must all be taken as cash.
A redundancy payment which qualifies as a genuine redundancy will be tax-free up to a limit based on the employee’s years of service – provided the person is (usually) aged under 65 at the time of dismissal. The tax-free amount is indexed annually and for the 2017/18 financial year is $10,155 plus $5,078 for each completed year of service. Any remaining balance will be treated as an employment termination payment (ETP).
A redundancy will not be classified as genuine in cases where the employee has their contract terminated or is dismissed for disciplinary reasons. An ETP may have a tax-free component if:
The payment relates to employment before 1 July 1983; or
Employment ceased because the employee sustained a permanent disability. The ETP will then have an invalidity segment, which is tax-free, and represents the time between cessation of employment and the employee’s ‘normal’ retirement age (usually 65).
The remaining ETP will be a taxable component. The taxation of the ETP will depend on the person’s age and whether the Whole of Income (WOI) cap needs to be considered. See Table 1.
Income component derived by your employee in the income year
Age of person at the end of the income year that the payment is received
Component subject to PAYG withholding
Rate of withholding
Cap to apply
Life benefit ETP – taxable component
Payment is because of:
* early retirement scheme
* genuine redundancy
* compensation for personal injury, unfair dismissal, harassment or discrimination
Under preservation age
Preservation age or over
Up to the ETP cap amount
Up to the ETP cap amountAmount above the ETP cap amount
Life benefit ETP – taxable component
* a ‘golden handshake’
* non-genuine redundancy payment
* severance pay
* a gratuity
* in lieu of notice
* for unused sick leave
* for unused rostered days off
Under preservation age
Preservation age or over
Up to the relevant cap amount
Up to the relevant cap amountAmount above the relevant cap amount
Smallest of ETP cap and whole-of-income cap
Source: ATO withholding rates for ETPs 2017/18 www.ato.gov.au. Note: Assumes tax file number was provided.
The ETP cap is $200,000 for the 2017/18 financial year and WOI cap (non indexed) is $180,000.
Tip: For ETP tax, preservation age is based on the age at the end of the financial year. For example, assume Nicky receives an ETP from genuine redundancy (after deducting the tax-free amount) of $100,000 in August 2018 when she is 56. She turns 57 in April 2019. As she had reached preservation age by 30 June 2019, the ETP component of her redundancy will be taxed at 17 per cent.
To receive the concessional tax treatment outlined in Table 1, an ETP must generally be paid within 12 months of termination. Payments outside this timeframe are generally included in the person’s assessable income and taxed at their marginal rate. There are a few exceptions to this rule. For example, if payment is delayed due to legal action, genuine redundancies or if the employer is now facing bankruptcy.
ETP cap or WOI cap?
The ETP cap will be applied to redundancy payments known as ‘excluded payments’. This includes:
Genuine redundancy and early retirement scheme payments in excess of the tax-free limit;
Payments that would have been a genuine redundancy, except that the employee has reached age 65;
Payments due to invalidity (excluding the invalidity segment which is tax-free);
Compensation payments; and
Death benefit ETPs.
Other ETPs are known as non-excluded payments and are subject to the lesser of the ETP cap and WOI cap. Examples of non-excluded payments are:
Non genuine redundancies;
Payment in lieu of notice; and
Payment for unused sick leave.
Tip: In the ETP Payment Summary provided by the employer, an ETP with a code of ‘O’ or ‘P’ will generally indicate it is a non-excluded payment and the WOI cap needs to be considered.
The $180,000 WOI cap is reduced by all ‘other taxable income’ earned in the same financial year that the ETP is received. However, if the person has a tax loss, their ‘other taxable income’ will be $0.
Example: ETP paid in instalments
Lily, age 59, receives a non-excluded termination payment of $100,000, with the first $50,000 received in December 2017 and the balance in May 2018. Her ‘other taxable income’ for the financial year is $90,000.
The lower of the WOI cap and ETP cap will apply to Lily’s termination payment. Her WOI cap is reduced to $90,000 ($180,000 – $90,000) and as this is less than the ETP cap of $200,000, the WOI cap applies. Therefore, the first instalment of $50,000 falls within her WOI cap and is concessionally taxed.
Her WOI cap is reduced by the first ETP and is now $40,000. Therefore, when she receives the second instalment, only $40,000 will be within her WOI cap and the remaining $10,000 will exceed her cap and be taxed at 47 per cent.
Example: ETP comprising excluded and non-excluded payments
Adrian receives a redundancy of $220,000, comprising a genuine redundancy of $170,000 and payment in lieu of notice of $50,000. His ‘other taxable income’ for the financial year is $30,000.
We first consider the excluded payment. With 10 years service, his tax-free amount is $60,935 and the balance of the genuine redundancy of $109,065 (taxable component) will be subject to the ETP cap.
Next, we look at the non-excluded payment of $50,000. This is subject to the lower of the WOI and ETP cap. His ETP cap has reduced to $90,935 ($200,000 – $109,065) and his WOI cap is $150,000 ($180,000 – $30,000). Therefore, the ETP cap applies and all of Adrian’s redundancy is concessionally taxed.
Annual and long service leave paid due to genuine redundancy will be taxed at a maximum of 32 per cent, with the exception of long service leave accrued pre 16 August 1978, which is taxed more concessionally (5 per cent taxed at the marginal rate). These concessional tax rates won’t apply if the person is age 65 or over at the time of dismissal.
Unused sick leave paid out on redundancy will generally form part of the ETP. The exception to this is if payment of unused sick leave was something that the employee would have received upon resignation from their position.
Division 293 tax
A client who has received a redundancy may get a nasty surprise when they receive notification from the ATO that they are liable to pay an additional 15 per cent Division 293 tax on their pre-tax super contributions in the year the payment is received. Division 293 tax is payable when a person’s income exceeds $250,000 per annum. Income is calculated as:
Income for surcharge purposes’ (excluding reportable super contributions); plus
Low tax (non excess) concessional contributions.
A client may never have been liable for Division 293 tax in the past. However, inclusion of the redundancy in their taxable income may increase their ‘income for surcharge purposes’ and potentially bring them over the threshold for that financial year. The additional 15 per cent tax is payable on the lesser of the low tax contributions and the amount above $250,000 per annum. This can be paid personally or deducted from super.
Ellie retires in March 2018 and receives a genuine redundancy and leave payment as follows:
Tax-free amount – $111,715;
Balance of redundancy (ETP) – $122,000;
Accrued long service leave – $30,000;
Accrued annual leave – $10,000.
Her taxable salary for the 2017/18 financial year is $110,000 and she has used up her concessional contribution cap of $25,000 ($11,000 employer super guarantee and $14,000 salary sacrifice).
For Division 293 tax, her income in the 2017/18 financial year is calculated as $297,000:
Income for surcharge purposes (excluding reportable super contributions) = $110,000 + $122,000 + $40,000 plus;
Low tax contributions = $25,000.
She is therefore subject to an additional 15 per cent tax on her $25,000 concessional contributions.
Contributing the redundancy to super
Although ETPs can no longer be directed into super via a directed termination payment, a person could still use part of their redundancy payment to make a concessional or non-concessional contribution to super, within their available caps and subject to other eligibility criteria. This may be particularly beneficial if they have no debt or large expenditure needs and are seeking to retire soon and commence a retirement income stream.
For persons who have yet to reach preservation age, caution needs to be taken when contributing funds into super, which may not be accessible. The funds may be required to meet any income shortfall whilst the person is seeking new employment.
Personal deductible contribution to minimise tax
From 1 July 2017, any person may be eligible to make a personal deductible contribution to super, regardless of their status as an employee or income earned from employment. Therefore, a person could potentially use part of their redundancy payment to make a contribution to super and claim a deduction. This would reduce their taxable income, which would in turn increase their WOI cap.
This strategy may be more effective when a person is made redundant early in the financial year and who intends not to work again in that income year. They would have minimal employer super contributions and therefore, a large portion of their concessional contribution cap available.
Receiving a redundancy can be stressful. With no future job lined up, a client may look for Centrelink benefits to assist with cash-flow in the interim. However, the redundancy will impose a waiting period on allowance payments, such as Newstart, known as an income maintenance period (IMP).
Any termination payment received will be treated as ordinary income and apportioned evenly across the period covered by the IMP. This is calculated by adding the number of weeks that the leave payments and termination payment represent. Where a portion of the payment is not related to the employee’s wage, then the payment will be divided by the weekly wage to get an equivalent timeframe. This is regardless of whether the funds are immediately spent or contributed to super.
The reasoning behind this is that Centrelink believes you should use your redundancy to meet your income shortfall initially, before relying on the Government.
Any IMP will be served concurrently with the liquid assets waiting period.
When a person is subject to an IMP, assessable income for the Low Income Health Care Card is determined by apportioning the lump sum payment over a 12 month period.
Josh has been made redundant and receives a redundancy payment of $68,600 consisting of:
5.5 weeks annual leave;
Eight weeks long service leave;
$50,000 golden handshake; and
Two weeks payment in lieu of notice.
Josh’s IMP will be calculated as outlined in Table 2.
Income Maintenance Period
5.5 weeks annual leave
Eight weeks long service leave
$50,000 golden handshake
Two weeks payment in lieu of notice
^$50,000/$1,200 (Josh’s gross weekly income) = 41.7 weeks rounded down to 40 weeks.
Josh’s total IMP will be 55.5 weeks and the redundancy of $68,600 will be apportioned as ordinary income over this period. For the Low Income Health Care Card, his assessable income must include $1,319.23 ($68,600/52) each week for the 52 weeks since receipt of the payment.
For Age Pension, a redundancy will not be assessed as income, as there is no continuing employment relationship. However, if the redundancy was placed in the bank account, the proceeds would be assessed as an asset and deemed under the income test.
For those ready for retirement, redundancy may be the starting point to commence a retirement income stream from super. Even for clients seeking to return to the workforce, it could still be beneficial to access their super at least in the short-term to provide additional cash-flow.
Persons over preservation age but under age 60 will generally only meet a condition of release if they have ceased work and intend never to be gainfully employed for more than 10 hours per week.
Therefore, for a client who has applied for Newstart Allowance, it may be difficult to argue they intend never to work again, when by definition Newstart Allowance suggests they are keen to re-join the workforce. That said, for persons age 55 or older, their ‘mutual obligation requirements’ can be met from voluntary work, which generally wouldn’t qualify as gainful employment.
Commencing a pension under transition to retirement may be possible, although tax-free earnings within a transition-to-retirement pension cannot be enjoyed.
Tip: A person applying for Newstart Allowance could consider leaving the super in Accumulation and making ad hoc lump sum withdrawals to supplement their income needs, if they have satisfied a condition of release. This would mean that whilst under Age Pension age, their super would not be assessed by Centrelink under the Income or Assets test, which may increase their benefit. However, caution should be taken if making regular lump sum withdrawals, as Centrelink could potentially construe this as an income stream.
There are limited circumstances where a person can access their super early. This includes:
Compassionate grounds. Application needs to be made to the Department of Human Services, and there must be evidence that the client needs the funds for things like medical treatment, to make a loan repayment to prevent home foreclosure, or to pay funeral expenses.
Severe financial hardship. Up to $10,000 can be accessed in a 12-month period if you have been receiving income support for 26 weeks and are unable to meet reasonable immediate family living costs.
Beware – the withdrawal and re-contribution strategy
For a client who has met a condition of release and can access their super, a withdrawal and re-contribution to super can be beneficial to increase the tax-free component of their super benefits. This strategy may reduce the amount of tax the client pays on benefits accessed prior to age 60 and also minimise ‘death benefits tax’ that may be incurred for any future super benefits passed to non-dependant beneficiaries.
However, for persons under age 60, the taxable component withdrawn, even if within their low rate cap (currently $200,000), will be included in their assessable income, with a rebate applied to ensure the client pays no tax, provided the withdrawal doesn’t exceed their low rate cap. This means that their taxable income increases, which would therefore reduce their WOI cap and may mean more tax is paid on the ETP.
For clients receiving an excluded ETP where the WOI cap is not applicable, this strategy will not impact the taxation of their payment. However, the inclusion of the withdrawal in assessable income may have implications for eligibility for tax rebates, government co-contribution and various Centrelink payments.
Clients receiving a redundancy generally benefit from financial advice to assist them in transitioning either to a new job or into retirement. Financial advice can assist with managing tax, optimising super and assessing any Centrelink benefits.
1. Which of the following is a non-excluded ETP payment and may be subject to the Whole of Income cap?
Compensation for personal injury.
Payment in lieu of notice.
Early retirement scheme.
Payments due to invalidity.
2. Bruna receives a non-excluded ETP payment of $50,000 in January 2018. Her ‘other taxable income’ for the financial year is $80,000. Which cap applies to her ETP?
ETP cap of $200,000.
WOI cap of $180,000.
WOI cap of $50,000.
WOI cap of $100,000.
3. Renee receives a redundancy comprising five weeks accrued annual leave, four weeks lieu of notice and a golden handshake of $30,000. Her weekly salary was $1,500. What is her income maintenance period before she can receive Newstart Allowance?
4. Damian, age 58, received a redundancy of $210,000 under an early retirement scheme in July 2017. He has completed 10 years of service with his employer. How will his redundancy be taxed?
$60,935 tax-free and the balance of $149,065 taxed at 32%.
$60,935 tax-free and the balance of $149,065 taxed at 17%.
$200,000 taxed at 17% and $10,000 taxed at 47%.
$200,000 taxed at 32% and $10,000 taxed at 47%.
5. Which of the following is not included in the definition of ‘Income for surcharge purposes’?
Net rental loss.
Employer super guarantee contributions.
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