Retrenchment is an emotional and financial shock for those who experience it and those closest to them.
Knowing what to expect and what decisions you will need to make can help you avoid feeling overwhelmed. Making well-considered financial decisions can also reduce your stress.
The retrenchment offer
In terms of the Labour Relations Act, you are entitled to a severance package of at least one week's pay for each full year of completed service with your employer. However, this is negotiable and you can ask to be paid more than a week for each year you have worked.
You are also entitled to be paid for your notice period. Your notice period should be stipulated in your employment contract, but you can negotiate for a longer period.
You should also be paid out for any leave you are entitled to, but have not taken, and any other amounts to which your employer agreed in your contract. An example, is an annual bonus that your employer has agreed to pay. This should be pro-rated in line with the number of months of the year you have worked.
You can also ask for contract employment or retraining as part of your package.
Your retirement savings
If you belong to an employer-sponsored retirement fund, the fund will preserve the amount you have saved until you decide what you need to do.
You should aim to preserve this money if possible in order to provide an income in your retirement.
Withdrawing any of it may incur tax and will drastically reduce the pension your savings will provide.
If you do have to withdraw from your retirement savings, you will have to make a call on how much you will need, bearing in mind that it will be best to preserve as much as you can. You also need to consider the tax-free amount you can take and what your options are to withdraw more at a later stage should you still not be earning.
You can make a partial withdrawal from your retirement savings, transfer the balance to a preservation fund, and then at a later stage, if you are still not earning, make one further withdrawal before retirement.
However, if you make a second withdrawal from a preservation fund, it will be regarded as a withdrawal benefit. It may then be taxed at rates from 18% to 36%, depending on how much you withdraw and how much you have drawn before and when.
It may be worthwhile getting some financial advice on whether you need to withdraw from your retirement savings. This advice should take into account your personal circumstances, including how much you have in emergency savings, what access you have to other savings and what insurance cover you may enjoy.
A good adviser can also advise you on where to save any severance pay and retirement savings you withdraw until you need the money.
If you withdraw more than you need
If you withdraw more retirement savings than you eventually need to support yourself until you are earning again, earmark what remains as your retirement savings and don’t touch it until retirement. If you phase it into a tax free savings account you could enjoy tax free growth, as you would if your savings had remained in your retirement fund. Read more: What do I need to know about investing in a tax free savings account?
If you find a job or start earning an income again relatively quickly and your retirement savings are still in your former employer’s fund, you can then transfer those savings to either your former employer’s fund, your new employer’s fund, a preservation fund or a retirement annuity. Read more: What happens to my savings in an employer sponsored fund if I leave my employer?
Remember that savings transferred to an RA cannot be accessed until you reach age 55 (or later if you agree to invest for a longer term).
Tax on retirement savings and severance pay
If, on retrenchment, you are able to preserve your retirement savings in a retirement fund, you will not pay any tax on what you have saved.
However, if you do need to draw on your retirement savings, any amount paid out to you when you are retrenched will be added to your severance pay and taxed as if it was a lump sum paid at retirement.
The treatment of your severance pay in this way is conditional on the package being paid to you because your employer closed its doors, or because your role became redundant when your employer reduced staff numbers.
Another condition is that you must not own more than five percent of the shares in the business that retrenches you.
You have the choice to include any gratuities, such as additional notice pay you negotiate, in the severance package.
If you are offered voluntary retrenchment, the tax treatment of any severance pay will be the same as if you were retrenched involuntarily.
Tax free amount
The first R550 000 of your severance pay and any retirement fund lump sum you take could be tax-free.
This tax-free allowance will be reduced by any lump sums you have withdrawn from your retirement fund on:
To determine the tax you will pay on the severance and retirement savings benefit, add the lump sums you have taken previously on resignation, retirement or retrenchment after the applicable dates to the amount you plan to take now, and apply the tax rates as follows:
The tax on your retrenchment package
| If the lump sum taken on retrenchment (plus previous sums) is: | The tax you will pay is: |
| R1 - R550 000 | 0% |
|---|---|
| R550 001 - R770 000 | 18% of the amount taken above R550 000 |
| R770 001 - R1 155 000 | R39 600 + 27% of the amount taken above R770 000 |
| R1 155 001 and above | R143 550 + 36% of the amount taken above R1 155 000 |
Then deduct the tax you have paid previously when taking lump sums after the applicable dates on resignation, retirement and retrenchment.
Leave and notice pay
Leave and the contracted notice pay will be taxed as normal remuneration by your employer and the tax will be deducted before the amount is paid to you.
If you do not find another job or source of income for the rest of the tax year, the rate at which you have been taxed may have been too high. The South African Revenue Service (SARS) may then refund you some of the tax your employer deducted if you file a tax return.
However, if you do find another job, or start earning from contract work or a business, your income for the tax year may be higher than the averages used to calculate your monthly tax, and you may owe SARS more tax.
There are a number of other important financial steps to take when you are retrenched. Read: How can I minimise financial losses after retrenchment?
Group RA members take note