Retrenchment packages can be complex when it comes to taxation. Misunderstanding SARS rules can result in harsher-than-expected tax liabilities for employees and unintended non-compliance for employers. This guide offers both employers and retrenched employees a clear framework for what portions of a retrenchment payout are exempt from tax and which are not, with up-to-date 2025 guidance.
1. Components of a Typical Retrenchment Package
A standard retrenchment package often includes some or all of the following components:
- Severance Pay (mandatory)
- Leave Pay (unused annual leave accrued)
- Notice Pay (if notice period is not worked)
- Bonus or Incentives
- Retirement or Pension-Pension Transfers
- Consultancy or Non-Disclosure Payments
- Medical or Insurance Scheme Payments
Each component is treated differently for SARS taxation purposes.
2. Tax Treatment of Severance Pay
2.1 What Is Severance Pay?
Severance pay is the payout for retrenchment, governed by the Labour Relations Act (Section 41). It must be at least one week’s remuneration per year of service with the employer. Many employers offer a more favourable package voluntarily.
2.2 SARS Exemption Rules
Since 2006, SARS allows a lifetime tax exemption for severance packages of up to R500,000 per employee. Any amount above this limit is subject to:
- A proportional tax for the excess
- Inclusion in the employee’s year-of-assessment income
Example 1:
A R300,000 package—fully exempt. No tax.
Example 2:
A R600,000 package—R500,000 is exempt; R100,000 is taxable and added to annual income.
2.3 Lump Sum vs Installments
The exemption applies only to lump-sum severance payments. If part of the payout is paid later or over a period, employees should request the full amount upfront to maximise exemption.
3. Tax Treatment of Leave Pay and Notice Pay
3.1 Leave Pay
Unused annual leave must be taxed as ordinary remuneration in the payout month. No exemption applies. It is taxed according to the employee’s normal income tax band.
3.2 Notice Pay
If notice is not worked, payment in lieu is taxable as standard income in the payment month.
Example:
Three weeks’ leave pay is taxed normally with PAYE in the month of payout.
4. Bonus, Incentive, and Performance Payments
Any performance-based incentive payout included in retrenchment is taxable in the same month and subject to PAYE, just like leave and notice pay.
5. Retirement Fund Transfers and Tax
5.1 Transfer to Another Pension Fund
If employees transfer pension or provident fund balances to another registered fund, the transfer is tax-free. However, taking withdrawal benefits as cash may trigger tax depending on the total amount and employer deductions.
5.2 Annuity After Retrenchment
Retrenchment may necessitate a lump sum from a retirement fund. If that sum is below R500,000, it may qualify for the same exemption category as severance pay. Above that amount, taxes apply on the excess.
6. Tax-Free Portion Breakdown
Here’s a quick summary table showing typical package components:
| Component | Tax Treatment | Tax Notes |
|---|---|---|
| Severance Pay | Partial Tax-Free up to R500,000 | Excessed portion taxed as ordinary income |
| Leave Pay | Fully taxable | Included in monthly PAYE calculation |
| Notice Pay | Fully taxable | As above |
| Bonus / Incentive | Fully taxable | PAYE applies |
| Retirement Fund Transfer | Tax-free if transferred in full | Tax applies if withdrawn |
| Collateral Payments (e.g. NDA) | Negotiable; may attract SETA or PAYE | Depends on contract and SARS view |
7. Structuring Packages for Better Tax Outcomes
7.1 Maximise Severance Pay Exemption
- Pay severance as a single lump sum
- Avoid splitting payments across tax years
7.2 Consider Fund Transfers
Direct retirement fund transfers are tax-free; cash withdrawals exceed threshold
7.3 Time Bonuses Carefully
Pay bonuses outside of retrenchment month to avoid additional taxable burden.
7.4 Monitor Cumulative Exemptions
If severance is paid over multiple retrenchment events, SARS uses aggregate exemption rules, not per event.
8. Why Structure Matters
8.1 For Employees
Proper structure means more take-home pay by reducing unnecessary deductions.
8.2 For Employers
Correct structuring avoids SARS penalties and ensures compliance with PAYE regulations—also fosters goodwill during difficult circumstances.
9. Real-Life Example: Thabo’s Retrenchment
- Salary: R40,000/month
- Years Service: 10
- Severance Pay: R250,000 (10 weeks’ pay)
- Leave Pay: R50,000
- Notice Pay: R30,000
- Bonus: R20,000
Tax treatment:
- Severance: R250,000 (exempt)
- Leave + Notice + Bonus = R100,000 taxable with PAYE deductions
- Net tax relief provided by exemption buffer
10. What Employers Must Do
Employers must calculate package tax implications, declare each component accurately on monthly payrolls, and prepare IRP5s reflecting severance and other payments.
Incorrectly coded severance in payroll may lead to disputes, penalty notices, or audits by SARS.
11. What Employees Should Beware Of
- Assuming all retrenchment components are tax-free
- Accepting payouts split across tax years
- Cash withdrawals from retirement funds above thresholds
Employees must seek clarity on what part of their payout remains after tax.
12. Labour Law with Luzan Can Assist
We provide in-depth support to both employers and employees by:
- Advising how to structure retrenchment packages to legally minimise tax
- Preparing payroll for accurate PAYE handling
- Reviewing and advising on retirement fund transfers
- Assisting with SARS interactions and relief matters
Conclusion
Understanding SARS tax treatment on retrenchment packages is essential. Not every portion is tax-free, but well-structured packages can use exemptions effectively. Employers and employees both benefit from compliance—they preserve more income and avoid penalties.
