Retirement and Unused Leave
When approaching retirement, one of the key considerations for many employees is how to handle unused leave entitlements, such as annual leave and long service leave. Whether you’re ready to retire immediately or want to delay your retirement for a bit, understanding the tax implications, superannuation benefits, and Centrelink rules is essential. Here, we’ll break down the options and explore how they can impact your retirement plans.
Options for Managing Unused Leave
As you near retirement, you generally have two options regarding unused leave:
- Take a Lump Sum Payment at Retirement:
You can choose to receive your unused leave as a lump sum when you retire. This payment, however, does not attract employer superannuation contributions (currently 11.5%, increasing to 12% in July 2025), which could be a significant drawback. - Delay Retirement by Taking Paid Leave:
Another option is to extend your working life slightly by taking your unused leave before formally retiring. This allows you to continue receiving your salary (which includes superannuation contributions) and can provide tax benefits as the leave payments are made over time.
Let’s look at how these options differ from tax, superannuation, and Centrelink perspectives.
Superannuation and Unused Leave
Employer contributions to superannuation are made on regular salary payments, which include any paid leave. However, if you opt for a lump sum payment for your unused leave, these contributions are generally not made. This could significantly affect your superannuation balance and your retirement savings, so it’s an important factor to consider when deciding whether to take paid leave or a lump sum.
Tax Implications
The tax treatment of unused leave can vary depending on how the leave is taken:
- Lump Sum Payments:
Lump sum payments for unused leave are taxed based on when the leave was accrued. For leave accrued after August 1993, the normal marginal tax rate applies, and the payment will be taxed at your payroll withholding rate. - Paid Leave:
If you take the leave as paid leave, the payments will still be taxed at the regular marginal tax rates, just like any other salary. However, taking the leave over two financial years could spread out your taxable income and potentially reduce your overall tax liability.
Centrelink and Age Pension Considerations
For those aged 67 and above, delaying retirement could help with the Age Pension application process. Paid leave is considered as income for Centrelink’s income test, while lump sum payments are treated as an asset. This means that if you delay retirement and take paid leave, you may be able to delay your Age Pension entitlement, as your income may be assessed differently, potentially allowing you to claim the Age Pension sooner.
Satisfying the ‘Work Test’
For individuals aged 67 to 74 who wish to make a personal deductible superannuation contribution, you must meet the ‘Work Test’. This requires you to work at least 40 hours within a 30-day period in the same financial year as the contribution. Paid annual leave counts toward the 40-hour work requirement, but a lump sum payment does not. Delaying retirement to take paid leave may allow you to satisfy this requirement and make a deductible super contribution.
Accruing Further Leave
Another consideration when taking paid leave is that long service leave and annual leave will continue to accrue. While this might be a minor point, it’s worth noting that you can continue to accumulate more leave while using up your current entitlements.
Case Study: Matilda’s Retirement Decision
To better illustrate the impact of these options, let’s look at the case of Matilda, a teacher planning to retire at age 67. She was due to receive an $80,000 lump sum payment for eight months of unused leave. Her taxable income for the 2024/25 financial year would be $170,000, which would result in significant tax obligations.
By opting to take her paid leave before retiring in December 2025, Matilda could spread her income across two financial years, significantly reducing her tax liability:
2024/25 Taxable Income:
- Employment Income: $120,000
- Unused Leave: $0
- Tax Payable: $29,188
2025/26 Taxable Income:
- Employment Income: $50,000
- Unused Leave: $0
- Tax Payable: $6,538
This strategy would save her nearly $12,000 in taxes. Additionally, she would receive extra super contributions (approximately $8,000 after tax) from the employer for the leave taken. This approach also allows her to satisfy the ‘Work Test’ in the 2025/26 financial year, enabling her to make tax-deductible super contributions if necessary.
Final Considerations
When deciding how to handle unused leave, it’s important to review your workplace policy and consider any specific rules around leave entitlements upon retirement. Additionally, if you have a defined benefit or public sector superannuation, check how taking paid leave may impact your retirement benefits.
You may also want to negotiate with your employer to determine the best strategy for your final working days. This could help you maximize your superannuation, minimize your tax, and even boost your retirement income.
Planning for retirement is a personal and strategic decision. If you find yourself facing similar scenarios with unused leave or need assistance in making these decisions, feel free to reach out for expert guidance.
Shaun Jones MAppFin (FP)
Financial Planner at About Retirement
