Be aware of tax you'll pay on severance package
Your final package may include notice pay, severance pay and a gratuity
Economists are predicting that between 350,000 and 1-million people could lose their jobs as a result of the Covid-19 pandemic and the subsequent nationwide lockdown to curb the spread of the disease.
If you are among the many who may be retrenched, it is good to know what tax you can expect to pay.
The Labour Relations Act says the retrenchment consultation process must include consensus about a severance package, says Annalise de Meillon-Muller, distribution manager at Glacier by Sanlam.
Your final package may include notice pay, severance pay and a gratuity. You will also be entitled to what you have saved in your retirement fund.
Do not offer to resign ahead of retrenchments as this will negatively affect your tax
Severance pay is governed by the Basic Conditions of Employment Act, which says you must get at least one week's remuneration for every completed year of service.
An employer does not have to pay it, however, if you unreasonably refuse an alternative offer of employment, says De Meillon-Muller.
If you work your notice period, you must be paid for it, but if you leave immediately, you should be paid for the notice period stipulated in your contract.
Any leave pay owed to you must also be paid out, as must any amounts your employer agreed to pay you in your contract, such as a bonus - pro rata in line with the number of months of the year you have worked.
A gratuity is something you can negotiate but it is beyond the realms of your contract, De Meillon-Muller says.
The notice pay, accrued leave pay and other contracted amounts form part of remuneration and will be taxed at your marginal tax rates.
But severance pay and any gratuity will be taxed like any lump sum you receive from your retirement fund, she says.
In order for a sum to be regarded as severance pay, however, it must be paid to you for termination of your service if you:
• Are over the age of 55;
• Are permanently incapable of working due to sickness, accident, injury or incapacity of mind or body; or
• Are retrenched because your employer closes its doors, or your role becomes redundant as your employer reduces staff numbers.
If you own shares in the business that amount to more than 5% of the issued shares, you cannot receive a severance package, De Meillon-Muller says.
Your employer may offer you a better package if you offer to be one of those who is retrenched - taking voluntary retrenchment. The tax treatment for voluntary or involuntary retrenchment is the same, but do not offer to resign ahead of the retrenchments as this will negatively affect the tax you will pay, says De Meillon-Muller.
If you belong to a pension or provident fund or umbrella pension or provident fund to which your employer contributes, and you are retrenched, you can no longer be an active member contributing to the fund. You can, however, leave your savings in the fund and become a deferred member.
Alternatively, you can draw your retirement savings from the fund in cash or you can transfer it to another retirement annuity or preservation fund or the retirement fund of a new employer.
If your employer has been contributing to a group retirement annuity on your behalf, the employer can stop contributing and the RA will belong to you, but you will not be able to withdraw unless you are over the age of 55 or retiring due to ill-health or emigrating.
The first R500,000 of the sum you receive as severance pay, as a gratuity or from your retirement fund is tax-free, De Meillon-Muller says.
Thereafter the sums you receive are taxed as follows:
• At 18% of the amount over R500,000 up to R700,000;
• At 27% of any amount between R700,001 and R1,050,000; and
• At 36% of the amount over R1,050, 000.
If this is the first time you have been retrenched and you receive, for example, R800,000 as severance pay and leave your retirement benefits in your fund, you will pay R63,000 in tax, says Daniel Baines, a tax consultant at Mazars.
If you have been retrenched before and taken a severance benefit or any amounts from your retirement fund, these must be added to your benefits before this table is applied. And remember, if you take a tax-free amount now, only the balance of the tax-free amount will be available to you at retirement. So, for example, if you take R300,000 now tax-free, only R200,000 is available to you tax-free at retirement unless the tax tables are adjusted before then, Baines says.
If you resign and withdraw money from your retirement fund it will be regarded as a withdrawal and the tax implications are very different. In this case only the first R25,000 is tax free – as long as you haven’t already used it for some previous withdrawal - and then the tax is applied as follows:
• 18% of any amount above R25,000 up to R660,000;
• 27% of any amount above R660,001 to R990,000; and
• 36% of any amount above R990,001.
This means that if you are, for example, earning R20,000 a month and you are offered R200,000 to resign, your tax will be R56,025, where as you could get the entire R200 000 benefit tax free if you were retrenched and assuming you did also not withdraw retirement savings that together took you over the R500 000 tax free, Baines says.
Jenny Gordon, head of Alexander Forbes retail legal, says when employers need to retrench a member who is over the age of 55, they often regard the termination of service to be early retirement.
If you reached your retirement age as defined by the rules of the fund you have to retire, she says.
But if you are between 55 and the normal retirement age set in the rules of your fund, your employer may offer you some additional benefits, such as a medical scheme subsidy, to encourage you to retire early, she says.
It may be worth accepting early retirement for this but remember when you retire you will not be able to withdraw your full benefit from the fund.
If you are a member of a pension fund and leave your employer on early retirement, like anyone retiring at their normal retirement age, you only have two options: You can take one third in cash and buy an annuity with the rest, or you can defer your retirement by leaving your savings in your employer-sponsored fund or transferring it to an RA or preservation fund.
However, if your exit from the company is labelled retrenchment, you will still be entitled to withdraw from the fund. You can choose to take a partial withdrawal and preserve the balance of your savings in a preservation fund where one further right of withdrawal is allowed, Gordon says.