When it comes to leaving a PAYE job or winding up your own company, there are various types of severance payments you might receive, or give yourself! But what about the tax implications of these payments? In Ireland, the tax treatment of payments on cessation of employment can seem like pie in the sky for many people – I’m here to clear the air for you!
Firstly I will outline the 4 main types of severance payments that one may be entitled to. But be sure to read to the end which details an additional and potentially very lucrative type of payment a company can choose to pay you at the end of your employment. This is one that all company owners really need to be aware of as they approach retirement from their business.
As always – please do your own research on this and engage your accountant or tax advisor before taking action of putting a concrete plan in place – you don’t want to be fluffy about this one!
1. Statutory Redundancy Payments
Let’s start with statutory redundancy payments. If you’re made redundant, or making yourself redundant from your own company, the silver lining of this potential cloud is that statutory redundancy payments are tax-free up to certain limits.
You are entitled to get statutory redundancy once you have completed 2 years service with an employer. These payments are calculated based on your age, weekly earnings (to a max), and length of service with your employer.
Calculating the statutory amount you are entitled to get from your employer is pretty easy; 2 weeks pay for every year of service plus one additional week’s pay. And the max weekly amount of pay for the calculation is €600. MyWelfare.ie has a very neat calculator here that allows you to calculate it.
A quick example. If you were 10 years in a job, and earned average of €1000 per week (€52,000 per year), would be entitled to a minimum statutory redundancy of €12,000. This is arrived at 2 weeks per year (20 weeks) plus 1 extra week, giving a total of 21 weeks multiplied by €600 per week (600 being the max weekly figure allowed) giving you a statutory redundancy entitlement of €12,600.
One nugget worth noting around your salary level. If your salary or hours are reduced so as your weekly salary falls from say €600 to €400, and you are then made redundant more than a year later. If you ‘accept’ that salary reduction, you’re redundancy payment will be calculated on the €400. However, if you do not accept that salary reduction and keep asking for full hours/salary to be reinstated, your redundancy will be calculated on the €600!
2. Pension Scheme Refunds
Only if your tenure with an employer is less than two years, you have the option to request a refund of any personal pension contributions you may have made to the group pension scheme.
When the pension scheme trustees make this refund, it is subject to a 20% tax. There are no additional taxes owed on the received refund. It’s essential to be aware that if an employee chooses to receive a refund of their personal contributions, they forfeit the benefits associated with the employer’s contributions.
3. Pension Scheme Lump Sums
Pension scheme lump sums are taxed under the PAYE (Pay As You Earn) system. Of course, you can access up to 25% of the associated pension pot tax free, up to €200,000, with the balance going to an Approved Retirement Fund (Blog 147 for more on this) for you or you buying an annuity.
And income from those structures will then be taxed at your marginal rate when you draw it down. Interestingly, your marginal rate may be quite low when you do draw it down, so can be very tax efficient.
4. Ex Gratia Payments from Employers
Your employer may choose to pay you a top-up above the statutory amount, sometimes called ‘Ex gratia payments’. These payments are made without any legal obligation, and are subject to income tax and USC (Universal Social Charge), but not liable for PRSI (Pay Related Social Insurance).
Your employer is not under any legal obligation to provide additional compensation beyond the standard statutory entitlements, such as notice and statutory redundancy. However, your employer may choose to offer a voluntary supplementary payment, which is quite commonplace.
Furthermore, if your employment contract, a collective agreement, or your employer’s customary practices specify a right to receive a top-up payment, you may be entitled to such compensation.
Super-Mega-Bonus Item!…..Tax-Free ‘Severance’ Payments
Now, let’s talk about tax-free severance payments. And if you run your own business, you really need to be aware of this, particularly as you get to the final few years of your business. You might want to keep enough cash in the business to maximise any potential tax free severance payment your company might want to give you or any other cherished employee!
In Ireland, there are exemptions and reliefs that can make part of your severance payment tax-free. There are three relief exemptions, and the highest exemption may be claimed subject to you qualifying for it. And under current legislation, that can be up to €200k tax free severance payment, separate from any pension lump sum.
Now, this €200,000 is a lifetime limit and all previous exempt severance payments received are taken into account in determining this €200,000 limit. For example, if you received an exempt severance payment of €200,000 10 years ago from a previous employer, your limit is fully used and any future termination payment received is taxable.
There are 3 different calculations one can use to calculate the maximum tax free ‘severance’, and the components to consider:
‘Basic Exemption’
A basic exemption of €10,160 applies to ex gratia payments, which means the first €10,160 of your severance payment is tax-free.
Increased Exemption
An increased exemption is available for each year of service with an employer. The formula for this exemption is a bit complicated, but essentially, it allows for additional tax-free amounts based on your years of service.
Standard Capital Superannuation Benefit (SCSB)
If your employer operates an approved pension scheme, the SCSB formula can be used to calculate a portion of your severance payment that is tax-free.
According to Revenue “SCSB is calculated at 1/15 of your average annual pay for your last 36 months in employment. This is then multiplied by the number of full years you were working for your employer. Any tax-free lump sum payments you have received, or are entitled to receive from your work pension are subtracted from this benefit.”
The Standard Capital Superannuation Benefit (SCSB) is calculated using the formula:-
(A x B)/15 – C
A = 12 months average of the remuneration for the last 36 months
B = Number of completed years service
C = Any tax free lump sum received or receivable under the employer pension scheme
Imagine a scenario where your average yearly salary was €150k, number of years was 15, and the occupational pension scheme value was minimal (with the bulk of your funding in PRSA for example!). This could lead to you being potentially eligible to receive €150,000 severance for you, and potentially similar for any other family-member employees. And if you have PRSAs funded well, you are still entitled to 25% of the PRSA tax-free also. Not such a dark cloud after all!?
Final Thoughts
Navigating the world of severance payments and taxes can be confusing, but understanding the exemptions and reliefs available can help you make sense of it all. When it comes to tax planning severance payments, a good tax professional will pay for themselves many times over and could ensure it’s done compliantly and efficiently. Good luck, and here’s to a smooth transition to your next adventure!
Paddy Delaney QFA RPA APA
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