Retirement and unused leave advice opportunities

By Stuart Sheary, Senior Technical Manager

Retirement and unused leave checklist: Take paid leave or the lump sum?

Termination decisions at retirement

Employees approaching retirement can have significant annual and long service leave entitlements.

Retiring employees have a couple of options on how to receive their leave benefit. They may choose to take a cash lump sum on termination or take paid leave and terminate employment when their leave runs out.

Modelling the options can maximise your clients’ after-tax pay and social security entitlements.

The check list below summarises the benefits of each option where a client is contemplating retirement (not redundancy).

Superannuation Lump Sum Paid LeaveComment
‘Ceasing’ a gainful employment arrangement Terminating employment will ordinarily constitute a ceasing of a gainful employment arrangement. This is necessary to satisfy the retirement condition of release. Satisfying the retirement condition of release can allow a client to access their super as a lump sum or commence a retirement phase income stream such as an account-based pension.
Can help meet the ‘work test’ in a new financial year by delaying termination date Some retirees may wish to contribute to super beyond age 67. An individual seeking to satisfy the work test may prefer to take paid leave where it extends into a new financial year. If the leave in the new financial year equates to an equivalent of at least 40 hours over 30 consecutive days they will have met the work test. Further, if client has intentions of making further contributions to super in future years, then extending the work test, may also assist in meeting the working test exemption in the year following the year of retirement (depending on their total super balance).
Availability of super guarantee on leave Leave taken while employed attracts employer Superannuation Guarantee contributions. This is effectively a 9.5% before tax or 8.1% (ie 9.5% x 85%) after ‘contributions’ tax increase in remuneration.1 At the time of writing the SG rate is legislated to increase to 10% from 1 July 2021.
Taxation Lump Sum Paid LeaveComment
Availability of concessional tax rates on leave

Concessions apply to leave accrued before 18 August 1993 that is paid as a lump sum at retirement.

  • Annual leave accrued before 18 August 1993 is subject to a maximum tax rate of 32% (including Medicare Levy)
  • Long service leave accrued between 16 August 1978 to 17 August 1993 is subject to a maximum tax rate of 32% (including Medicare Levy)
  • Only 5% of long service leave accrued before 16 August 1978 is assessable at marginal tax rates

Unused annual and long service leave accrued after 17 August 1993 is taxed at marginal rates.

Splitting income can help manage tax over financial years

Remaining an employee and taking the leave as a paid break can delay receipt of part of the leave until the new financial year. Splitting income across financial years will allow the employee to utilise an additional tax free threshold and lower tiered tax rates.

This can also help avoid Division 293 tax where income for surcharge purposes may otherwise exceed $250,000.

Salary packaging arrangements such as employee novated car leases will end on termination. Remaining an employee and taking the leave as a paid break may allow the employee to continue some beneficial arrangements for longer. For example,  on terminating employment novated car leases will end.
Social security Lump Sum Paid LeaveComment
Exemption under the income test for Age Pension

Termination payments received as a lump sum are not assessed against the income test when calculating Age Pension entitlements.

Paid leave is fully assessable under the income test. Eligible employees may be able to reduce assessable income by taking leave on half pay.

Please note: Age Pensioners are automatically entitled to the ‘work bonus’ which exempts the first $300 of fortnightly employment income, including paid leave, from assessment.

Can the asset test assessment be delayed?

If the benefit is received as a lump sum it will be immediately asset tested by Centrelink.

By taking paid leave, the benefit will not be received immediately but over a period. During this period, leave benefits not yet received and banked are not counted towards the assets test.

Exempt under the income test for other (non-Age Pension) Centrelink payments

Taking a lump sum may reduce entitlements to Centrelink payments affected by the Income Maintenance Period (IMP). Please note the Age Pension and Carer Payment are not affected by the IMP.

Paid leave is fully assessable under the income test.

Other benefits Lump Sum Paid LeaveComment
Accrue additional leave entitlements while still taking leave Annual leave accumulates when an employee is on paid annual and long service leave.
Eligibility for other employee benefits such as, employee discounts and corporate offers such as discounts on private health insurance. Remaining an employee and taking paid leave may extend their eligibility period for staff discounts and may entitle them other benefits like employee share offers that they would not otherwise have received.
Keeping options open / flexibility to reassess intentions. Over the course of taking leave client’s desire to retire may change. Clients may change their mind and continue to work or perhaps in a reduced capacity. Terminating employment would potentially limit a client’s ability to exercise a change of mind.

1 This may be greater if eligible for the low income superannuation contribution.

More information

If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.

The information in this section of the website is intended for financial advisers only and is not to be distributed to clients. It has been prepared on behalf of Australian Executor Trustees Limited ABN 84 007 869 794 AFSL 240023, IOOF Investment Management Limited ABN 53 006 695 021 AFSL 230524, IOOF Investment Services Ltd ABN 80 007 350 405, AFSL 230703 and IOOF Ltd ABN 21 087 649 625 AFSL 230522 based on information that is believed to be accurate and reliable at the time of publication.