Ceasing Employment – Lump Sum Payments
General
There are special tax reliefs available where individuals receive lump sum payments from their employer when they are either being made redundant or retiring. There are certain minimum exemptions, which can then be increased depending on your length of service with the company. The position is further complicated by what happens to your pension rights if you are a member of a company pension plan.
Where a part of your lump sum is taxable then an additional special tax relief may be claimed based on your average rate of tax for the three preceding tax years.
Basic Exemption
First of all statutory redundancy payments are completely exempt from tax. Discretionary payments in excess of statutory redundancy paid by an employer are liable to tax subject to special exemptions for such lump sum payments.
Maximum exemption From the 1st January 2011 the maximum allowable tax free exemption is €200,000. Your tax free exemption will be calculated as per (A), (B) and (C) below. If any of these exceed €200,000 then the maximum exemption is €200,000.
Basic Exemption – €10,160 together with €765 for each complete year of service in respect of which the payment is made is completely tax free.
Increased Basic Exemption – The figure of €10,160 may be increased by an additional €10,000. This extra €10,000 is available where an individual is not a member of a company pension scheme, or irrevocably gives up the right to receive a lump sum from such a scheme and the individual concerned has not received a lump sum payment within the preceding ten years.
Long Service Exemption – Individuals who have a substantial number of years service with their employer may claim a higher level of exemption. This is known as the Standard Capital Superannuation Benefit (SCSB for short). A special formula is used to calculate the relief due as follows:
| A x N | L |
| 15 |
where
A = one years average of the Employees remuneration for the last three years of service.
N = number of complete years service.
L = any taxfree lump sum received or receivable under a company pension plan.
Application of PAYE
Where an Employer is making a lump sum payment to an Employee on retirement or redundancy, they will normally calculate the exemptions referred to above. These exemptions are then deducted from the lump sum payment and any excess is liable for PAYE at your normal tax rate. This can mean that a rate of 41% will be applied to the taxable element of your lump sum. In addition the USC Levy may also be charged on the taxable element of the lump sum.
Top Slicing tax relief for payments received before 1st January 2013
A special claim can then be made to your Tax Inspector for relief from taxation on the taxable element of your lump sum payment. A special tax rate is computed by reference to your average rate of tax over the three preceding tax years. If the application of this average rate of tax gives a lower tax liability than that deducted through the PAYE system you will be entitled to a refund.
Alternatively the taxable element of the lump sum can be treated as normal income for the tax year during which it is received if this gives a lower tax liability than paying tax based on the three year average rate of tax.
Summary
The application of the above rules can be best illustrated by way of example.
The most common decision that has to be made is whether or not to take a lump sum from your pension fund. While these are stated to be free of tax they can in effect be liable for tax. Each individual’s circumstances need to be examined bearing in mind the above rules to see what is best for them. We can provide this service for you at an extra charge.
Ceasing Employment Lump Sum Payments Example
- John has worked for 30 years with his current employer but is now being made redundant.
- His current salary is €50,000 per annum.
- His salary and tax deducted for the three preceding tax years is:
| Gross | Tax | |
| Year 1 | €45,000 | €15,000 |
| Year 2 | €40,000 | €12,000 |
| Year 3 | €35,000 | €10,000 |
| Total | €120,000 | |
| Average | €40,000 |
- He is receiving an exgratia lump sum payment of €50,000 plus his Statutory Redundancy.
- He is also receiving a tax free lump sum from the company pension fund of €40,000
Question – What tax will he have to pay on his exgratia lump sum?
Answer – Tax Due €2,000 calculated as follows:
Step 1
| Calculate the Basic Exemptions | €10,160 + (30 years x €765) | |
| Total Basic Exemption | €33,110 |
Step 2 – Calculate Long Service Exemption:
| Formula | ((A x N)/15) L | |
| Long Service Exemption | ((40,000 x 30)/15) 40,000 | €40,000 |
As the figure of €40,000 exceeds the basic exemption this is the figure for the tax free amount.
Step 3 – Calculate tax due on taxable element of lump sum.
Option A use 3 yr average rate
| Exgratia Lump Sum Payment | €50,000 |
| Less Long Service Exemption | €40,000 |
| Taxable | €10,000 |
| Average Tax Rate | 31% |
| Tax Due | €3,100 |
Option B Treat as normal income for year
| Normal Income | €30,000 |
| Add Taxable Element of Lump Sum | €10,000 |
| €40,000 | |
| Total Tax Due | €2,510 |
| Applicable to Lump Sum | €2,000 |
This option gives the lowest tax liability on the lump sum.
*Notes
- Initially the €10,000 taxable amount will be taxed at your normal PAYE rate. If this is the 41% rate then the benefit of the lower average rate has to be claimed from the tax office after the end of the tax year. This is only available for payments received before 1st January 2013.
- Also note here that if John reduced the lump sum from the pension fund to €30,000 instead of €40,000 he would not pay any tax on the lump sum payment. He immediately saves €2,000 in tax and will have an increased pension because of the lower lump sum payment
- The taxable element of a lump sum payment is also liable for the USC Levy which has been ignored in above example.