Early retirement scheme

Early retirement payments are voluntary payments usually made as an incentive for some older employees to retire. Schemes which are approved by the Australian Tax Office have certain tax advantages which can flow to employees taking early retirement under the scheme.

 
Definition
 
Early retirement payments are a matter for individual businesses to consider. There is no legal obligation to pay them. However some employers may consider such payments as an incentive for some older employees to retire and this may fit the corporate strategy of a particular business.
 
If an early retirement scheme is approved as such by the Australian Tax Office then certain tax advantages can flow to employees taking early retirement under the scheme. The department requires that the schemes meet certain criteria and these should be investigated before any scheme is put in place.
 
Source of entitlement
 
 
Key issues
 
Long service leave
 
It is important not to assume that an employee who retires early is automatically entitled to be paid for any pro rata long service leave entitlement. It is important to check the relevant legislation. Some states specifically provide for this, In particular, the wording of the NSW legislation does not allow this — the employee must be retiring for reason of ill health, or another specified reason, for pro rata LSL to be paid out on retirement.
 
The situation in the various jurisdictions is summarised below:
 
Ill health: in NSW, Queensland, Tasmania, the ACT and the Northern Territory pro-rata leave after a qualifying number of years (see Long Service Leave for the particular situation in each State) is paid to an employee who leaves an employer’s service for reasons of ill-health, and/or incapacity.
 
South Australian legislation pays out pro rata long service leave where the employee lawfully leaves their employment after 7 years continuous service — this would include 'ill-health’.
 
Victorian legislation pays out pro rata leave on termination of employment after 10 years service, except for serious and wilful misconduct — this also would apply to a retirement on the ground of ill-health.
 
Retirement: in Tasmania, ACT and Northern Territory, an employee who leaves the employer’s service 'on retirement' is entitled to be paid their long service leave entitlement.  'Retirement' is not defined, but a straight-forward interpretation is the employee is leaving the workforce. ACT legislation doesn't refer specifically to retirement as such but provides for pro rata payment on termination for an employee who has reached the age of 65 years. Tasmania legislation defines 'retirement' as 65 years for males and 60 years for females.
 
South Australian legislation pays out pro rata long service leave where the employee lawfully leaves their employment after 7 years continuous service — this would include 'retirement'.
 
Victorian legislation pays out pro rata leave on termination of employment after 10 years service, except for serious and wilful misconduct — this would also apply to 'retirement'. 
 
See details on long service leave provisions in Employment topics A-Z.
 
Tax Issues
 
 
1. General
 
If an employee receives an early retirement scheme payment under a scheme approved by the Tax Office, part of the payment is tax-free. The amount of the payment that is not tax free is taxed as an employment termination payment.
 
2. Early retirement scheme approved for tax concessions
 
An early retirement scheme is only ‘approved’ if it satisfies all of three conditions (s83-180 Income Tax Assessment Act 1997).
 
1.   The scheme must apply to:
  • all employees of the employer, or
  • all employees who have reached a particular age, or
  • all employees who have a particular skill, or
  • all employees who have a particular skill and have reached a particular age, or
  • all employees who make up a particular class approved by the Tax Office.
2.   The purpose of the scheme must be to rationalise or reorganise the operations of the employer by:
  • the replacement of employees with a particular skill with those having a different skill, or
  • the replacement of employees of, or over, a particular age (not under 55 years) with those of a younger age, or
  • the cessation, or reduction in output, of the operations, or
  • moving the location of the operations, or
  • the introduction of new technology, processes or systems, or increases in productivity, or
  • any other change approved by the Tax Office.
3.   The Tax Office has approved the scheme before it is implemented.
 
3. Conditions of payment
 
A payment under an early retirement scheme only has a tax-free amount if:
  1. it relates to a termination occurring before age 65, and
  2. the payment comes from the employer, and
  3. there must not be an agreement between the employer and the employee, or between the employer and another person, to employ the employee after that time. 

Back to Tax issues

4. Tax treatment
 
Early retirement scheme payments are exempt from tax up to a certain amount (s83-170 Income Tax Assessment Act 1997). 
 
For 2014/15, the tax-free amount is $9,514 plus $4,758 for each completed year of service with the employer. For 2013/14, the tax-free amount was $9,246 plus $4,624 for each completed year of service with the employer.
 
Example
On 11 July 2014, Bill’s employment is terminated at age 56 under an early retirement scheme that has been approved by the Tax Office and he receives $130,000 (in addition to other termination payments to which he was entitled). Bill had worked for the employer for just over 16 years.

The tax-free amount is:
 
$9,514 + (16 x $4,758) = $9,514 + $76,128 = $85,642

The balance of $44,358 ($130,000 – $85,642) is taxed as an employment termination payment (ETP). Because Bill has reached preservation age (he is aged 56), the ETP is included in his assessable income and taxed at his marginal tax rates (but up to a maximum rate of 15%). 
The early retirement scheme payment must be taken by the employee in cash. It cannot be rolled over into a superannuation fund, but it may be paid to a superannuation fund as a personal contribution.

Back to Tax issues

5. Lump sum for unused leave payments on termination of employment
 
A lump sum payment to an employee for unused annual leave or long service leave in consequence of termination of employment receives concessional tax treatment if the termination is connected to an approved early retirement by the employee.
 
Whereas such a leave payment would generally be taxed at marginal rates, where it is tied to an approved early retirement scheme a maximum tax rate 30% applies.
 
6. Withholding by employer
 
An employer making an early retirement scheme payment to an employee must withhold tax from the payment. Withholding must be at the rate set out in the PAYG withholding schedules.
 
Sample documentation
 
For an extensive library of policies, agreements, forms, correspondence and checklists, designed to make human resources (HR) management easy for your business see our HR Advance website.
 

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