What all older workers need to know about tax on redundancy payments

Redundancy payments can come in many different forms and, most importantly, with different tax rules. And in the current climate, in which the Australian Bureau of Statistics (ABS), in July recorded the highest unemployment rate in more than two decades at 7.5 per cent (it eased up to 6.8 per cent in August), understanding the rules around tax and redundancy is more important than ever.

This was at the top of mind for one Starts at 60 reader, who questioned why, when the government seemingly wants older Australians to continue working as long as they can, the Australian Tax Office (ATO) views redundancy payments as “bona fide redundancies” until Age Pension age but not afterwards.

“This has tax implications,” she wrote. “Do you think that’s fair? I don’t.”

Taxing pension-aged redundancies

According to the ATO, certain redundancy payments are tax-free up to a limit based on the number of years of employment. The only downside is that this rule applies only to what’s known as a ‘genuine redundancy’, and the ‘genuine redundancy’ only be applied if you’re under the age limit.

The age limit previously stood at 65 years old but in October 2019 the government changed the rules so employees over the age of 65 but under pension age (currently 66 years old) were also eligible for the tax-free threshold. And while this means more older Australians can now keep more of their redundancy payments – it begs the question: why can’t those who are over Age Pension age but employed do the same?

A Treasury spokesperson told Starts at 60 that the decision had to do outside factors. “A key part of the concessional tax treatment of genuine redundancy payments is a tax-free component,” the spokesperson said. “The tax-free component is not available to people at Age Pension qualifying age or over because they are more likely to have access to other forms of income or government assistance, such as concessionally taxed superannuation and the Age Pension.”

So, what defines a genuine redundancy?

A genuine redundancy is a type of employment termination payment (ETP) that comes about when an employer makes the decision that the job position no longer exists and the employment of a person in that position needs to be terminated. Depending on the employment conditions, these payments can include a payment in lieu of notice, severance payment of a number of weeks’ pay for each year of service or a gratuity that’s better known as  ‘golden handshake’.

Non-genuine redundancies include employees who are dismissed when they’ve reached normal retirement age, are pension age or older on the day of dismissal, leave voluntarily, have their contract terminated or are dismissed for disciplinary reasons. Payments for non-genuine redundancies are taxed as a part of the employee’s ETP, which means the sum will usually be taxed at a lower rate than the employee’s normal income, provided it doesn’t exceed certain caps.

How much tax do redundancy payments attract?

So what happens when working Australians who’ve reached the pension age receive a redundancy payment? As per the rules above and according to the Treasury spokesperson, where a payment would be a genuine redundancy payment except for the age of the person, the payment is then treated as a non-genuine redundancy payment and thus taxed as an ETP.

“Generally, for people at or above their superannuation preservation age [between 55 and 60 depending on birthdate], ETPs are concessionally taxed at 15 per cent up to the ETP cap ($215,000 in 2020-21),” the spokesperson said. “In comparison, ETPs for people below their superannuation preservation age are taxed at 30 per cent up to the ETP cap. Medicare levy may also be payable on these amounts.”

Those wondering if last year’s changes to the age limits affect their redundancy payments can check the ATO’s official site here, meanwhile all other information on the taxation of redundancy payments can be found here.

IMPORTANT LEGAL INFO This article is of a general nature and FYI only, because it doesn’t take into account your financial or legal situation, objectives or needs. That means it’s not financial product or legal advice and shouldn’t be relied upon as if it is. Before making a financial or legal decision, you should work out if the info is appropriate for your situation and get independent, licensed financial services or legal advice.