Redundancy – Take Time and Consider Your Options

No one sets out to be made redundant. However, the fact of working life today is that many will face this prospect over their working career. For many there is also the loss of employee benefits such as employer funded insurances and employee share schemes – sometimes these aspects are forgotten in the planning process!

A redundancy payment can provide a financial windfall for some, BUT it can also create complex tax situations for many. It is important that should you ever be offered a redundancy payment, you consider all aspects of this to enable you to navigate a course which is suited to your situation, BEFORE making any final decisions which cannot be undone.

Redundancy occurs when an employer decides that the job an employee has been doing is no longer needed. There are many reasons why a position is made redundant, including:

• The sale of a business i.e. employees are not kept on by the new owners;
• Technological changes;
• Restructuring of the workplace;
• An employer's inability to pay employees.

When your job is made redundant, you are usually paid a sum of money from your employer. If your redundancy is classified as a “genuine redundancy”, the payment you receive from your employer on termination is given special taxation treatment. This can result in significant tax savings, giving you more money to help you meet your costs or build your savings while you are looking for new work.

Genuine Redundancy

To be classified as a “genuine redundancy” there are certain conditions that must be met:

Genuine Redundancy

Conditions

Basic redundancy conditions

• The payment must be received in consequence of a termination;
• That termination must involve an employee being dismissed from employment;
• That dismissal must be caused by the redundancy of the employee’s position, and
• The redundancy payment must be made genuinely because of a redundancy.

Further redundancy conditions

• The dismissed employee is not older than the specified age limits (generally age 65 unless there is a younger age specified);
• The termination is not at the end of a fixed period of employment;
• Where the employer and employee are not dealing at arm’s length in relation to the dismissal, the actual amount paid is not greater than the amount that could reasonably be expected had the parties been dealing at arm’s length;
• There is no arrangement between the employer and the employee, or the employer and another entity, to employ the dismissed employee after termination, and
• The payment is not in lieu of superannuation benefits

Components of genuine redundancy payments

If a payment is classified as a genuine redundancy payment, it will have a number of components:

Redundancy Components

Tax free redundancy payment

Depending on how long you have worked at your employer, you can receive a portion of the lump sum from your employer tax free.

Employment termination payment

All lump-sum amounts received that are in excess of the tax-free limit.

Employment termination payment (ETP)

All amounts that you receive that are in excess of the tax free limit are classified as an employment termination payment (ETP).

ETPs commonly include:

• Payments for unrostered days off
• Payments in lieu of notice
• Ex-gratia or golden handshakes, and
• Payments for unused sick leave.

ETPs must be cashed (i.e. you cannot roll the money over to super) and are subject to tax depending on your age and the ETP components.

Depending on your circumstances, you may also receive part of your ETP tax free.

Redundancy ETP Components

Tax-free Component

Consists of any invalidity segment and any pre-July 1983 amount

Taxable Component

The remainder of the payment after the tax-free component is calculated

Tax-free Component

Invalidity segment

An ETP will contain an invalidity segment if:

• the payment was made to you because you can no longer work due to physical or mental ill-health;
• you stopped working before you reached your ‘last retirement day’ (usually 65), and
• two legally qualified medical practitioners have certified that it is unlikely you can ever work again in a role for which you are reasonably qualified by virtue of training, experience or education.
• The invalidity segment is calculated as the portion of the total termination payment that represents the period between termination and your ‘last retirement day’.
• In the absence of any ascertainable date, such as under the terms of employment or an award, the ‘last retirement day’ is when you turn 65 years old

Pre-July 1983 segment

The pre-July 1983 segment is calculated as the portion of the termination payment, less any invalidity segment, that represents your service period prior to 1 July 1983.

Taxable component of an ETP

The taxable component is the part of an ETP that is not the tax-free component, i.e. the remainder of the payment after the tax-free component is calculated.

Taxation of employment termination payments

The following table describes the tax treatment of ETPs that are called excluded payments.

Excluded payments arise in the following situations:

• Genuine redundancy and approved early retirement
• Invalidity or compensation for personal injury, or
• Payments as a result of an employment related dispute or unfair dismissal.

Taxation of Termination Payments*

Tax-free Components

Taxable Components

ETP cashed

Recipient is under preservation age at end of financial year

Tax-free

Up to $180,000 taxed at 31.5% Excess taxed at 46.5%

ETP cashed

Recipient is preservation age or older at end of financial year

Tax-free

Up to $180,000 taxed at 16.5% Excess taxed at 46.5%

*Rates shown include Medicare levy.

However where an ETP is not an excluded ETP and is not paid due to one of the reasons above, for example where it is a ‘golden handshake’ payment, the tax payable may be higher.

Taxation of Termination Payment (Golden Handshakes)

Component

Age

Amount

Tax

Tax-free

Any age

All of component

Tax free

Taxable

Under preservation age (currently 55)

Amount equal to the lesser of :

• the ETP cap ($180,000), and
• the whole of income cap ($180,000) reduced by other taxable income excluding this ETP

31.5%

Balance

46.5%

Preservation age or older

Amount equal to the lesser of :

• the ETP cap ($180,000), and
• the whole of income cap ($180,000) reduced by other taxable income excluding this ETP

16.5%

Balance

46.5%

*Rates shown include Medicare levy.

What Should I Do?

For some, redundancy can also create opportunities and these financial issues in their own right can be complex.

If you are expecting a redundancy, here are some of the issues that you will need to consider;

• When should I bank the payout – are there tax/timing considerations that I should be aware of?
• Should I take my unused annual leave and long service entitlements BEFORE I am made redundant? Can I do this?
• Based on my age, what should I do once I have the cheque – how should I best allocate the payout to maximise my personal financial position?
• What should I do with my super – should I contribute some of my payout to super, can I take a pension while I am looking for my next job?
• What should I do with my Salary Continuance Insurance – should I take up the continuation option within the 60 day limit and how flexible is this cover?
• Am I entitled to receive Centrelink Benefits while I am looking for my next role?
• What is the best strategy to deal with my need to be flexible while I am securing my next role?

Where you direct or allocate your payout is often the most important decisions to make. Getting this right is crucial to maximising your financial position in the short, medium and long term, given your changing circumstances.

There have been many changes to Employer Termination Payments relating to retrenchment in recent years. Understanding the rules and options is important. If you are in the top income tax bracket i.e. earn over $180,000 p.a. the decisions you make about where to direct your payout can have substantial tax effects. Whether you should direct this to repayment of debt, contribution to a superannuation fund, investment in long term investments, or parked in cash in the short term, depends on your circumstances.

Redundancy – putting it all together

As you will have gathered from the above information, understanding your redundancy payment is a complicated matter. To make this a little easier, your employer will provide you with a breakdown of the components.

To help eliminate some of the uncertainly, we recommend you seek advice from your accountant so you understand the taxation implications of your payment. We also recommend you meet with your financial adviser to discuss the best way to use the money to ensure you get maximum benefit for your financial situation.

For more information, please call Financial Keys on (02) 92 333 888.

Please note, this information is current as at 1 July 2013.