Termination payments 25 years ago were almost totally tax free ... the golden handshake was indeed golden. Even leave entitlements escaped the tax man. But times have changed.
These days, the effective tax rate on some termination payments can be more than 60 per cent. The message is clear-if you are facing a termination payment, be sure of your tax obligations so you can make the right decisions.
The tax you pay on termination depends upon years of service with the employer. If you are a long-term employee and started before July 1983, payment for pre-July 1983 service is virtually tax free. The rest is taxed at the flat rate of 31.5 per cent.
People who are terminated as genuine redundancies receive a portion of the termination pay tax free.
Your reasonable benefits limit (RBL) is the maximum amount of termination payment and superannuation you can receive at concessional tax rates. Above that, you will be taxed at the penalty rate of 48.5 per cent.
Eighty-five per cent of the amount you receive is counted towards your RBL, which eats into the amount of superannuation you can accumulate and makes it more likely you'll pay penalty tax for exceeding your RBL.
You can "roll over" a termination payment into a superannuation fund, which means you avoid income tax. But the fund must deduct tax at 15 per cent when you withdraw the sum.
Deciding on whether to roll over the Employee Termination Payment (ETP) or take it in cash depends on many variables and you should seek professional advice if you don't fully understand the benefits and implications of rolling over. A wrong decision can be costly.
The portion of a termination payment relating to service after August 1996 can be subject to a surcharge, which varies from 0-15 per cent and is determined by your adjusted taxable income.
If your adjusted taxable income is less than $95,000, the surcharge rate is nil. If greater than $115,000, the surcharge rate is 15%. There is a sliding scale for amounts in between.
The surcharge, assessed by the tax office, is often issued more than 12 months after you receive the ETP-by which time you might have spent the money. So be warned.
If you elect to roll over an ETP into a superannuation fund, you won't necessarily escape a surcharge. Your super fund will receive an assessment from the tax office and deduct it from your balance.
The timing of the termination payment can sometimes have a significant impact on resulting tax. If you are moving to a lower-paid job or to no job at all, receiving the termination payment at the start of the financial year would generally be better than receiving it at the end. For example:
Mr Sad is 63 and started work with his employer in 1997. He earns $80,000 a year. His employer wants to replace him with a younger person and has offered to give him a full year's salary in May 2004 as a golden handshake.
He plans to use the money to live on while he has a year off work, then return to the workforce for a year or two before retiring and taking his superannuation as a lump sum.
So what is Mr Sad's tax position?
He could have avoided this disaster simply by pushing back the date of termination to July so that it fell in the next tax year, the year he planned not to work. This would have enabled him to avoid surcharge. He also should have considered changing his plan for taking the superannuation to avoid exceeding his RBL.
But the most important thing would have been to understand the tax implications of the termination payment so he could have properly planned for it.