Unused leave at retirement – take leave vs lump sum

27 February 2023
When clients are approaching retirement, there are many things to consider when
assessing whether they should use the leave before retiring or take a lump sum
on termination.

Overview of options
Employees approaching retirement can have significant leave entitlements, including annual
leave or long service leave. Some employees may also receive an eligible termination payment
on retirement.
Retiring employees can usually choose how they receive their leave entitlements. They may
take a cash lump sum on termination or receive paid leave and terminate employment when
their leave runs out.
The best option for each client will depend on their circumstances and objectives. Modelling
the options can help you to maximise your clients’ after-tax pay, super contributions and Age
Pension entitlements.

Key implications
The table below summarises the pros and cons of both options

Lump Paid Comment

sum leave

Superannuation
Availability
of super   Leave taken while employed attracts SG contributions.
The current SG rate is 10.5%.
guarantee
(SG) on leave
Can help
meet the   Some retirees may want to make a personal deductible
contribution (PDC) beyond age 67 (and generally less than
‘work test’ age 75). Someone seeking to satisfy the work test may prefer
in a new to take paid leave where it extends into a new financial year.
financial year If the leave in the new financial year is equivalent of at least
by delaying 40 hours over 30 consecutive days, they will have met the
termination work test.
date

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 Lump Paid Comment
sum leave

Taxation
•
Can help with
income splitting   Remaining an employee and taking paid leave
can delay receipt of part of the leave until the new
over financial financial year. Splitting income across financial
years years may allow the employee to use an additional
tax-free threshold and lower marginal tax rate.
• Splitting income over financial years can also help
avoid Division 293 tax where income for surcharge
purposes may otherwise exceed $250,000 if taken
as a lump sum.

Age Pension
•
Exemption under
the income test for   Termination payments received as a lump sum
are not assessed against the income test when
the Age Pension calculating Age Pension entitlements.
• Paid leave as regular income is fully assessable
under the income test. Eligible employees may be
able to reduce assessable income by taking leave
on half pay.
• Age Pensioners are automatically entitled to the
‘work bonus’ which exempts the first $300 of
fortnightly employment income, including paid
leave, from assessment. The client may have
an income ‘bank’ amount that may be used to
offset employment income.
•
Can the asset
test assessment   If the benefit is received as a lump sum, it is
immediately asset tested by Centrelink (if held
be delayed? as an assessable asset, eg a bank account).
• By taking paid leave, the entire benefit will not be
received immediately but over a period. Accordingly,
the asset test impact is spread over time, in contrast
to a lump sum with immediate assessment.

Other benefits
•
Exempt under
the income test   Taking a lump sum may reduce entitlements
to Centrelink payments affected by the Income
for other Centrelink Maintenance Period (IMP). Age Pension and
payments Carer Payment are not affected by the IMP.
• Paid leave is fully assessable under the
income test.
Accrue additional
leave entitlements   Annual leave accumulates when an employee is
on paid annual and long service leave.
while still taking
leave
Eligibility for
other employee   Remaining an employee and taking paid leave may
extend their eligibility period for staff discounts and
benefits, such may entitle them to other benefits, such as employee
as staff discounts share offers they would not otherwise have received.
and employee
share offers

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Case study – comparison of options at retirement
Jane is a head science teacher and earns a base salary of $130,000 a year. Jane hopes to retire on
31 March 2023 at age 60. By then, she will have accumulated six months of combined long service
and annual leave accrued after 17 August 1993. Jane estimates she will receive roughly $65,000
(gross) if this leave is taken as a lump sum payment at retirement. Below are some options available
to Jane which are also summarised in the table at the end.

1. Receive lump sum payment

If Jane takes the lump sum on 31 March 2023 at retirement, the benefit will be taxed at marginal rates.
The leave does not contain any pre-18 August 1993 amount which would be concessionally taxed. Jane
has already received salary of $97,500 in the current financial year, so the lump sum will be taxed part
at 34.5% and part at 39% (including the Medicare Levy). Receiving this lump sum will result in additional
taxable income and additional tax. Jane’s personal tax liability will be approximately $48,442 for the
2022/23 FY. Her overall net benefit including net salary and net super contributions for the year will be
$122,760.

2. Receive lump sum and make catch-up concessional contributions

Jane may access any unused concessional contribution (CC) cap amounts in the previous four financial
years since 1 July 2018. From 1 July 2023 and in subsequent financial years, Jane may utilise unused
concessional cap amounts going back up to five financial years. To use the catch-up CC measure in
any given financial year, her total super balance must be below $500,000 at 30 June prior.
Her total CCs including employer SG contributions and salary sacrifice were consistently $15,000
a year. In the 2022/23 financial year, Jane will have accumulated concessional catch-up contributions
of $42,500 starting from the 2018/19 financial year. In the current financial year approximately $10,237
of CCs (SG only) will have been received up to ceasing employment on 31 March 2023.
Jane may choose to reduce her taxable income by making a PDC of $59,500 which consists of her
remaining concessional cap in the 2022/23 year and part of her unused ‘catch-up’ amount in prior
financial years. In this scenario, Jane’s overall benefit including net salary and net super contributions
for the year will be $136,275.

3. Take leave and make PDCs

Jane may take leave and delay her termination day until her leave is exhausted. Jane will continue to
receive employer SG contributions while on leave. This compares favourably to taking a lump sum
which does not attract employer SG contributions.
While on leave, Jane will continue to accrue annual leave (approximately $5,000 in entitlements based
on pro-rata annual leave entitlement of two weeks). We have assumed no additional long service leave
is accrued during this period. Long service leave entitlements may vary between states and territories.
We have assumed that Jane lives in NSW1. Her personal tax liability may be reduced by making a PDC
into super in 2022/23 and 2023/24.
Super contribution in 2022/23
In 2022/23, Jane can utilise her unused catch-up CC amount and make a deductible contribution of
$56,000. This $56,000 contribution would consist of her remaining concessional cap in the 2022/23
year and part of the unused ‘catch-up’ concessional amount accrued from prior financial years.
Super contribution in 2023/24
In 2022/23, Jane will receive approximately three months of leave entitlements, giving her taxable
income of $32,500. She can make a PDC of approximately $10,600, bringing her taxable income
down to $21,900. This is marginally above her effective tax-free threshold of $21,884 considering the
low-income tax offset (LITO). Note whilst a slightly larger PDC will eliminate any tax payable, Jane
may have other deductible expenses that she may also apply. In this scenario, Jane’s overall benefit
including net salary and net super contributions across both financial years is $151,152.

1
In NSW once an employee has completed 15 years of service, only completed years of service will count towards long service
leave. See https://www.industrialrelations.nsw.gov.au/employers/nsw-employer-essentials/long-service-leave-calculator/

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Summary of outcomes
Taking paid leave and making deductible contributions will maximise Jane’s after-tax remuneration.
Some points to consider on each of these strategy outcomes include:
• Taking the leave as a lump sum on termination will be the least tax-effective option. The lump
sum will boost taxable income in the 2022/23 financial year and be taxed at up to 39% (including
the Medicare Levy). The outcome may be different if Jane had leave accrued before 18 August
1993, as concessional tax rates apply on the lump sum.
• Taking the leave as a lump sum on termination and using catch-up CCs can assist in reducing
Jane’s personal tax liability. Unfortunately, there is not enough accumulated catch-up CCs
amount to fully absorb all the income from the lump sum, which means Jane will have a higher
tax liability.
• By taking paid leave, she will receive additional SG contributions on her entitlement. In addition,
Jane will receive a further two weeks in combined annual and long service leave entitlements
(approximately $5,000 in leave entitlements) that may be paid as a lump sum on terminating
employment. Furthermore, part of the leave will be received in a new financial year and Jane can
then take advantage of lower tax brackets and a new financial year’s CC cap.

Lump sum Lump sum Take leave plus deductible

plus deductible contributions
contribution
Financial year 2022/23 2022/23 2022/23 2023/24
Salary and paid leave $97,500 $97,500 $130,000 $32,500
Lump sum termination $65,000 $65,000 - -
payment
Total gross cash benefit $162,500 $162,500 $162,500
Less: PDCs - $59,500 $56,000 $10,600
Taxable income $162,500 $103,000 $74,000 $21,900
Less personal tax^ $48,442 $26,002 $15,997 $3
Total net cash benefit $114,058 $76,998 $58,003 $21,897

Superannuation guarantee $10,237 $10,237 $13,650 $3,575#

Less contributions tax $1,535 $1,535 $2,047 $536
Net SG contribution $8,702 $8,702 $11,603 $3,039

PDC $59,500 $56,000 $10,600

Less tax on deductible - $8,925 $8,400 $1,590
contributions
Net PDC $50,575 $47,600 $9,010

Total tax (over both FY) $49,977 $36,463 $26,444 $2,129

Net benefit for FY $122,760 $136,275 $117,206 $33,946

Total net benefit $122,760 $136,275 $151,152
^ Assumes 2022/23 tax rates
# SG increases to 11%

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Contact details
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Important information and disclaimer
This document is prepared by Actuate Alliance Services Pty Ltd (ABN 40 083 233 925, AFSL 240959), a member of the Insignia
Financial group of companies (‘Insignia Financial Group’) This is for financial adviser use only – it is not to be distributed to clients.
The document has been prepared to provide financial advisers with technical resources, support and knowledge. The information in
this document is current as at 24 February 2023 and reflects our understanding of existing legislation, proposed legislation, rulings
etc as at the date of issue, and may subject to change. In some cases, the information has been provided to us by third parties.
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