Voluntary redundancy - should I consider it?

Financial advice

i was contacted by an individual recently who told me that his employer announced a voluntary redundancy program and he wondered whether he should consider applying.

And there’s no doubt about it, you have to tread carefully when it comes to making a decision whether to leave a job or not especially when it’s of your own accord so without stating the obvious, it’s really important to have the facts and figures and the information to hand before you make any decision, so I was glad he reached out for help.

Our starting point was finding out a number of things like, what impact his leaving would have on his pension and his plans for retiring in the future, how much he’d need to earn when he joined a new employer, how long could he be out of work before he needed to return etc.

And the answers to a lot of the questions he had, could only be found out if he first knew:

What was his net severance payment going to be? And it’s here where I want to start before I tell you about the other areas we needed to figure out.

And there are two reasons why I’m starting here and the first is that most people are confused about how much tax they’ll pay on a redundancy payment.

The second reason why we need to figure this amount from the get-go is because people need to know how much will land in their account the day they exit, because should they leave, it impacts how long it would last before they have to return to work, how much is available to maybe pay off debt or a mortgage, how much can be invested and so on.

And I’m going to return to all of these areas in my follow up article next week and I’ll give you some numbers that related to the gentleman who contacted me, but first as I said I want to start with how much he was likely to receive and it was going to come from two sources and they were:

Statutory Redundancy
Everyone who is made redundant, be that voluntary or compulsory redundancy, is entitled to statutory redundancy.
To qualify for the statutory redundancy payment you must first have to satisfy three requirements and they are:
-Be over age of 16
-Be in incurable employment according to social welfare acts and if under 65 you must be paying Class A PRSI, and
-Have worked continuously with the same employer for a minimum of two years
The statutory payment is calculated with reference to, two weeks’ pay for every years’ service, plus an additional weeks pay. The payment is subject to a maximum earnings of €600 per week.
So, if you worked with an employer for 10 years and your income was €50,000 your statutory payment would amount to €12,600 i.e. 10 x €1,200 = €12,000 + €600 = €12,600.
Let me give you a couple more examples.
If you worked for 18 years and your income was €90,000, your statutory payment would be €22,200.
And if you worked for four years and your income was €35,000 your statutory payment would be €5,400.

Ex-Gratia Payment
This amount is dependent on your employer and they might offer you three weeks’ pay for every year worked, plus statutory, or it could be 6 including statutory. The amount will really depend on them and what might be negotiated on your behalf if you were part of a union.
Unlike the statutory payment the ex-gratia amount is subject to tax but there are three tax exemptions that you are allowed to avail of and you can choose the one which gives you the highest tax free amount.
And those three exemptions are:

Basic Exemption
This exemption allows the first €10,160 of your ex-gratia payment to be tax free along with €765 for every years’ service.
So, if you had 12 years’ service, your basic exemption tax free allowance would amount to €19,340 i.e. €765 x 12 + €10,160.

Increased Basic Exemption
This option allows you to get an extra €10,000 on top of the basic exemption calculation provided you haven’t received a tax free lump sum in the last 10 years and you are not getting a lump sum pension payment now or in the future.
So, 12 years with the same employer, under this exemption you are entitled to a tax free allowance up to the amount of €29,340.

Standard Capital Superannuation Benefit
This third option is more commonly known as the SCSB calculation.
And it’s said that this exemption typically benefits those most who are on larger salaries and especially those who have worked for a company for a long time.

And there are two formulas in this instance and both are related to your pension and whether you wish to waive or preserve your right to a future tax free lump sum from it.

If you preserve that right, it’s likely the severance payment you’ll be in receipt of will be smaller than if you waive your right.
If you waive your right to a future tax free lump sum, the calculation is as follows:
Your average salary for the last three years (in some instances the calculation is based on what your highest average salary for three cumulative years was over a ten year period) x years’ service, divided by 15.
So, if someone had an average salary of say €60,000 and 18 years’ service, their SCSB calculation is:
€60,000 x 18 / 15 = €72,000.

And that means they can receive up to €72,000 of an ex-gratia payment tax free, but they waive their right to a future tax free lump sum from their pension.

But they’re only waiving their right to a future tax free lump sum from the pension from the company they’re leaving. If they move to other companies they can take tax free lump sums from pensions accumulated with them, if they want to.
Okay, if someone wants to preserve the right to that future tax free lump sum, the SCSB calculation is:
(Average salary (3 years) x years’ service / 15) - net present value of their pension.
This net present value of their pension is commonly known as NPV and is worked out by the administrators of the pension scheme.

So, let’s use the same numbers for this calculation i.e. average salary is €60,000 and they have 18 years’ service, but let’s also assume the NPV for this person is €25,000.

Now their SCSB tax free amount is:
€60,000 x 18 / 15 - €25,000 = €47,000.
You can see the difference between both is:
Waive right to future tax free lump, tax free limit = €72,000
Preserve right to tax free lump sum, tax free limit = €47,000

The difference is €25,000 and the individual has to decide whether they want to receive up to €72,000 now without having to pay tax on their severance payment knowing they’ll receive no tax free lump sum in the future or receive up to €47,000 of their termination payment tax free, knowing that at a later date they’ll be able to take 25% of the value of their pension fund tax free.

And there’s no right or wrong answer here, it’s really down to a personal decision based on an individual’s circumstances. Some people may need that extra money now because they have a purpose for it i.e. it will help put a child through college, it will pay off debt or a portion of their mortgage, or they want more money in their account because they want to maybe re-train and they don’t want to rush back to work and that extra money gives them more time away from having to return to work. There could be any number of more valid reasons.

My advice to people in situations like this is that unless they really need the extra money now because they have a specific reason for it, I’d preserve the right to a future tax free lump sum. But again I stress that it’s very much down to an individual’s circumstances and their redundancy numbers. In some situations the amount they receive would be the same whether they waive or preserve their right to a future tax free lump sum from their pension and if this is the case they should always choose the preserve option. Okay that’s the first piece of the jigsaw so to speak when figuring out whether someone should apply for a voluntary redundancy package if offered one.

The next is applying it to your finances and knowing what impact it could have. When I worked out the numbers for the individual who contacted me, we knew his statutory payment was going to be €21,000 and his ex-gratia payment was going to be €90,720, so he was going to have €111,720 in total.

And he decided to preserve his right to a future tax free lump sum because the number between preserving and waiving his right to a future tax free lump sum was only €7,200 and it wasn’t big enough for him to give up that future tax free lump sum from his pension in the future.

So, that was Phase 1 i.e. we knew he had €111,720 if he applied and was accepted for voluntary redundancy, but what else did he need to know?

And I’m going to tell you that next week, which was Phase 2 of our conversation.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie or www.harmonics.ie