Redundancy Payments and Taxes: What You Need to Know
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Recent layoffs from companies in Ireland have left many individuals facing the challenging prospect of redundancy. This experience can be overwhelming, particularly when trying to navigate the financial implications and entitlements that come with it.
If you’ve recently faced redundancy, understanding the treatment of lump sum payments received upon job cessation and the tax benefits available under Irish law is crucial.
Whether you’ve been offered a redundancy package or are considering applying for one, it’s essential to educate yourself on all the options available to ensure you make informed decisions for your financial future.
Redundancy: When Does It Happen?
Redundancy occurs when you lose your job because your employer is either closing the business or reducing the number of staff. This also happens when your role within the company no longer exists, resulting in your being let go without a replacement.
What types of payments will I receive if I’m made redundant?
If you are made redundant, the types of payments you may receive can include Statutory Redundancy Payment and Ex-Gratia Payments.
Additionally, depending on your age and the type of pension plan you are in, you may be able to withdraw your pension early in the event of a layoff.
For occupational pensions, you usually can’t access funds until the normal retirement age, unless you’re over 50 and eligible for early retirement. For personal pensions and PRSAs, withdrawal is generally restricted until age 60, unless certain conditions are met, such as redundancy after age 50.
What is Statutory Redundancy Payment?
Statutory Redundancy Payment is financial compensation granted to employees who are laid off due to redundancy, which generally means their position is no longer required by the employer due to various reasons, such as business restructuring or downsizing.
In Ireland, the entitlement to a Statutory Redundancy Payment is governed by specific conditions set out in employment law.
Eligibility Criteria:
To qualify for a Statutory Redundancy Payment, you must:
- Have at least two years (104 weeks) of continuous service with the employer, from the age of 16 to 66.
- Be an employee under the legal definition, which typically excludes independent contractors and some other types of workers.
- Have been dismissed from their role, with the dismissal being attributable to redundancy.
Calculation of Payment:
The amount of the Statutory Redundancy Payment is calculated based on your length of service, age, and weekly pay, up to a certain limit. The formula used is:
- Two weeks’ pay for each year of service (and a portion of a year’s service).
- Plus one week’s pay.
The pay used in this calculation is limited to €600 per week before taxes (€32,200 per annum).
Example:
Martha has been employed for 15 years and 3 months with her employer and has now been made redundant. Her weekly gross earnings amount to €850. However, for the purpose of calculating her statutory redundancy payment, only €600 per week is considered. Therefore, her redundancy payment is calculated as follows:
(2×15.25+1) × 600 = €18,900
Do I pay tax on my Statutory Redundancy Payment?
Statutory Redundancy Payments are generally exempt from income tax. However, any additional payments you receive as part of your redundancy package, such as an Ex-Gratia payment, may be subject to tax, depending on the amount and specific circumstances.
Tax-free limits and exemptions may also apply to these additional payments, so it’s important to check your situation or consult one of our financial advisors to understand your full tax obligations.
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What Are Ex Gratia Payments?
Your employer might decide to pay you an amount above the statutory amount, known as an ‘ex gratia payment.’ These payments are voluntary and not required by law, but they are often made as a gesture of goodwill.
Do I pay tax on my Ex Gratia Payment?
Yes, Ex Gratia Payments (which are payments made in addition to your statutory redundancy entitlement) are generally subject to tax. However, there are tax-free exemptions and reliefs available that can reduce the amount of tax you need to pay on an Ex Gratia payment.
Tax-Free Exemptions:
Basic Exemption:
You are entitled to a basic tax-free exemption of €10,160, plus an additional €765 for each complete year of service with your employer.
Increased Exemption:
If you have not received a tax-free lump sum from a pension in the past, you may be eligible for an increased exemption of up to €10,000. This increased exemption is available on top of the basic exemption, but it may be reduced by any tax-free lump sum you are entitled to receive from your pension.
Standard Capital Superannuation Benefit (SCSB):
If you sign a waiver, giving up your right to a tax-free lump sum from your employer’s pension scheme, your SCSB payment won’t be reduced by that amount. The SCSB is calculated based on a fraction (N/15ths) of your average annual pay over the last 36 months before your job ends.
If you don’t sign the waiver:
- Your SCSB is reduced by any tax-free lump sum you receive if you take early retirement and start your pension immediately.
- If you choose not to take the lump sum right away and leave it in the pension scheme, your SCSB is reduced by the value of the lump sum you will get in the future.
You typically have two main options:
- SCSB1: Not signing the waiver, which means you get a smaller tax-free lump sum now but keep the option to take a tax-free lump sum from your pension later.
- SCSB2: Signing the waiver, which gives you a bigger tax-free lump sum now, but you lose the right to a tax-free lump sum from your pension either now or later.
What is the lifetime tax-free limit for ex gratia payments?
The maximum amount of Ex Gratia termination payments that can be received tax-free over a lifetime is capped at €200,000.
If you have previously received tax-free termination payments and their total taxable termination payments will surpass €200,000, it may not be financially advantageous to sign a waiver. Doing so could result in the loss of the right to a tax-free pension lump sum without meaningfully increasing the tax-free termination payment—or potentially not increasing it at all.
Example
- Taxable termination payment: €115,000
- Previous tax-free termination payments from other jobs: €150,000
- Remaining tax-free termination limit: €200,000 minus €150,000 = €50,000.
- SCSB1 if the waiver is not signed: €60,000
- SCSB2 if the waiver is signed: €90,000 (where the tax-free pension lump sum is valued at €30,000).
In this scenario, the maximum tax-free termination payment from this job is €50,000, regardless of whether the waiver is signed. Signing the waiver offers no additional benefit.
Taxable Ex Gratia Termination Payment
If a portion of a termination payment is taxable, after accounting for the exempt amount, the remaining balance is subject to income tax and USC, but not to PRSI.
Will these payments affect my tax-free lump sum from my pension?
You can still get a tax-free lump sum from your pension, up to a limit of €200,000, according to the rules set by Revenue. However, there’s an option where you can choose to take a larger tax-free payment now as part of your redundancy package. This larger payment is sometimes called an “enhanced” tax-free lump sum. If you choose this larger amount now, it might reduce the amount you can take tax-free from your pension later.
So, if you don’t choose to take the larger payment now, you keep the full €200,000 tax-free limit for your pension. The exact amount you can get will still depend on your pension plan, how much you’ve saved, and your work history.
Tax-free payments from a pension scheme may influence the tax relief available against lump sums received from an employer. It’s advisable to keep this in mind when assessing your options.
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What Are Pension Scheme Refunds, and Are They Tax-Free?
If you have less than two years of qualifying service and are changing jobs or careers, you may opt for a refund of your own pension contributions (not your employer’s contributions).
However, this refund is subject to tax at the basic rate, which is currently 20% (as of August 2024). This option is only available if the pension scheme rules allow for refunds within the first two years of service.
Opting for a refund of your pension contributions means you forfeit any employer contributions, which could significantly impact your long-term financial future. Instead of taking a refund, you have other options.
For instance, you could keep your funds in the former employer’s scheme as a Deferred Member. If the scheme rules permit, this allows you to retain deferred benefits, including full entitlements from both your own and your employer’s contributions, for the duration of your service.
Alternatively, you can choose to transfer your own gross contributions to your new employer’s Occupational Pension Scheme or transfer them to a Personal Retirement Bond (PRB).
Each of these options has its own implications, so it’s important to understand them fully. To help with this, you can refer to our article, “What Happens to Your Pension After Leaving Your Job?” which provides detailed guidance on each option.
Can I receive both a €200,000 tax-free pension lump sum and a €200,000 tax-free ex gratia payment from the same employer?
The answer is yes, it’s possible because the maximum tax-free pension lump sum offset against the SCSB (Standard Capital Superannuation Benefit) is €200,000. Therefore, if the SCSB calculation results in at least €400,000, the individual may qualify for another €200,000 tax-free termination payment.
However, this “double” benefit is rare and typically only occurs in cases where the individual has both very high earnings and long service.
Example:
- Service duration up to termination: 20 years
- Average annual earnings over the last 3 years prior to termination: €400,000
- Value of tax-free pension lump sum: €200,000 (with no waiver signed)
- SCSB Calculation: 20/15 x €400,000 – €200,000 = €200,000
This example shows that while the “double” benefit is possible, it is uncommon due to the high earnings and extensive service required.
Additionally, the “double” can also occur if €200,000 of tax-free pension lump sums have been taken from other unrelated arrangements, allowing the individual to potentially receive a €200,000 tax-free termination payment from their current employment.
Can I put my redundancy payment into my pension?
Yes, you can usually put your redundancy payment into your pension. This is often done through an Additional Voluntary Contribution (AVC). Doing so can have potential tax benefits, as pension contributions are typically tax-deductible.
However, there are limits on how much you can contribute to your pension and still receive tax relief, so it’s important to check the specific rules and consult with one of our financial advisors to understand how this might affect your overall financial situation.
How can I effectively plan for my future and make the most of my redundancy payment?
Planning for the future after redundancy can be challenging, but it also presents a valuable opportunity to reassess your career goals and financial priorities.
It’s crucial to create a financial plan that aligns with your current situation and long-term objectives. Carefully considering what to do with the money you received from your redundancy is a key part of this plan.
You might want to set aside funds for immediate living expenses, fund your children’s education, buy a property, save or invest in funds or even enhance your retirement pot.
Consulting with one of our financial advisors can help you develop a strategy that balances your short-term needs with long-term financial stability, ensuring that your redundancy payment supports your future success.
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Our expert advisors are here to guide you through the complexities of redundancy, taxes, and creating the best plan of action for your financial future.
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