Making the right decisions can reduce the impact of redundancy says Steve Davis.
Redundancies occur as a result of rapidly changing work practices, the impact of technology and a range of other social and demographic issues. Consequently, it is very likely that any employee in Australi
a has faced, or will face, the issue of redundancy at some time during their working lives.
It is important to note that being made redundant no longer reflects unfavourably in any way on a person’s resume. Nevertheless, it can still be a traumatic and difficult time for the people involved. Despite the personal turmoil at this time it is also critical that people being made redundant make the right decisions in regard to dealing with any redundancy payments, superannuation and other benefit entitlements.
Making the right decisions can mean the difference between living comfortably in retirement or until the next role comes along - or finding oneself and your family in financial hardship. Consequently, it is absolutely essential to get good advice that focuses on your specific circumstances.
However, there are some common themes that do emerge. There are five fundamental principles to consider when dealing with a redundancy:
- Rolling over eligible payments to save tax
- Managing your cash flow
- Paying off appropriate debts
- Applying for Centrelink benefits
- Employing other tax saving strategiesRolling over to save tax
Several types of payment may be received on being made redundant and they are subject to a range of different tax treatments. From a tax treatment perspective these payments can be broken down into Eligible Termination Payments (ETP) and "ordinary" money. The fundamental difference between these is that ETPs can be rolled over and "ordinary" money cannot.
In the case of the actual redundancy payment or voluntary early retirement (VER) payment a portion of this is treated as ordinary money and the balance above set thresholds is treated as an ETP. Table one sets out an overview of the types of payments that fall into each category.
In relation to the tax treatment of the ordinary money, the main benefit is that the first part of the redundancy payment is received completely free of tax. In the majority of circumstances the balance of the ordinary money payments will ultimately be taxed at your marginal rate.
The more complex area is the tax treatment of ETPs. Depending on your circumstances, these may be divided into three main components:
- Undeducted contributions,
- Pre-July 1983 and;
- Post-June 1983.
(There are other components but these tend to relate to very few people).These components are then further broken down into taxed and untaxed elements. In summary, if a benefit has accumulated in a normal employer superannuation fund, the fund will have paid contributions and earnings tax along the way and payments from these funds are "taxed components". Where the employer makes a golden handshake payment or in the case of a redundancy payment that is higher than the tax free threshold, there have been no contributions or earnings tax paid on these amounts. Consequently they form "untaxed components".
The tax treatment of the various amounts is set out in table one. It is very important to note that your age when receiving these benefits is critical in regard to the tax treatment. If received after the age of 55, the tax treatment is much lighter than if you receive the benefits prior to age 55.
We can look at the case of a person who is entitled to receive their super-annuation on being made redundant at 54 years of age. If their super was worth $150,000 and they took the benefit in cash they would pay 21.5 per cent tax on the full amount or $32,250 in tax. If they rolled the money over for a year until they were age 55, they would only pay $7,286 in tax - resulting in a saving of $24,964.
In most cases, rolling over your benefits and waiting to receive them until you are over age 55 can result in a substantial reduction in the tax payable. But again it is very important that you get advice specific to your circumstances.
This is because there are restrictions on the amount of benefits that you can receive at a concessional tax rate. These restrictions are known as your Reasonable Benefit Limit (RBL). The benefit components above do not all have the same treatment from an RBL perspective. So if you are close to your RBL you need to very carefully consider the best way to receive these payments.
The way in which you roll over your benefits is also very important in helping you to manage your cashflow, particularly if you are uncertain of your future employment prospects.
When you are selecting a rollover fund, if you may have short term income needs and you have benefits that you can access, you should initially roll these into a short term cash based rollover account until such time as you recommence work. That way you do not have the risk of having markets move against you in the short term and you need to sell out of the rollover fund at a loss.
Once you recommence work you can look at longer term investment approaches that are likely to provide higher returns albeit with an increase in the level of risk.
With your preserved superannuation benefits, which cannot be accessed, you may want to consider adopting a more long term investment approach immediately, depending on your tolerance to risk and long term financial goals. Diagram three summarises this approach.
Importantly, what you do with your termination payment has a big impact on the other issues such as debt reduction, cash flow management and applying for Centrelink benefits.
Debt management
While it is very important to reduce debt to help reduce the drain on cashflow, if you are not certain about your future employment prospects you should consider reducing debt facilities that allow you re-draw funds if required. Repay credit cards and if you have a mortgage facility that allows you to re-draw funds, this is another good way to utilise monies. In doing so, you can be sure you have available funds in the event of an emergency.
Applying for Centrelink benefits
Debt reduction strategies and cash-flow management all interact with the roll-over scenario as well as the ability to qualify for Centrelink benefits. Where you do have other available cash or savings you should consider using these to reduce debt prior to leaving your employment. In this way there is a smaller amount of cash that is assessed under Centrelink’s liquid assets waiting period. This means that you may qualify for Centrelink support sooner than if you wait to pay these debts off after you leave employment.
The rolling over of benefits to superannuation is also an important consideration in maximising your Centrelink entitlements. This is because recent changes to Centrelink rules mean that the value of superannuation benefits is not counted as an asset, nor is there any income deemed on the value of the superannuation. This means you can have fairly significant values in superannuation and still receive Centrelink benefits.
Let’s look at the case of a person who is entitled to receive their super
annuation on being made redundant at 54 years of age. If their super was worth $150,000 and they took the benefit in cash they would pay 21.5 per cent tax on the full amount or $32,250 in tax. If they rolled the money over for a year until they were age 55, they would only pay $7,286 in tax - resulting in a saving of $24,964.
What is very important is that every action that you take at the time of receiving a redundancy can have a significant impact on both your short and long term financial security. It is also very important to understand that every individual is different. Consequently, the right answer for one person may be completely the wrong answer for another person.
Do not rely on what your colleagues at work tell you or on the suggestions of a friend. Often the decisions you make initally cannot be reversed. Seek professional advice that properly addresses your personal circumstances.
Redundancy, although often traumatic, is a critical time in your life to carefully consider and plan for your future financial security.
It can also be an opportunity to embrace new challenges and change your life for the better.
Contact: Steve Davis, National Manager – Financial Planning, Perpetual Private Clients Ph: 1800631381 .
Web: www.perpetual.com.au
These article and many more,
were in the
(15th edition) of Your
Retirement, Your Life.
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