Invest severance package in debt funds, use SWP to create cash flows

Part of this money should also go into creating an emergency corpus equal to 12 months of expenses

Layoffs are making headlines every few days, both in India and abroad. Around 2 lakh workers have been laid off worldwide in the technology sector alone, according to a media report. Several Indian tech companies and start-ups have also cut jobs in 2023. More cuts may follow. Employees who receive a severance package must deploy it judiciously. 

Size depends on contract
 

Some corporates offer their employees a compensation at the time of separation. Sandeep Bajaj, managing partner, PSL Advocates & Solicitors, says, “It is not a matter of right but a matter of practice and is contractually determined.” Its size depends on the length of employment and the terms of the employment contract.

Prioritise your spending
 

Begin by creating a household budget. Involve all family members in the exercise and cut costs wherever possible.

Next, create an emergency corpus. Dilshad Billimoria, board member, Association of Registered Investment Advisors (ARIA), says, “This fund should be able to take care of 10–12 months of expenses.” Besides regular household expenses, it should also be able to pay for expenses such as insurance premiums, children’s school or college fees, and equated monthly instalments (EMIs).

Loss of job is accompanied by loss of the health cover provided by the insurer. If you don’t already have a personal cover, buy one for your family. Purchase a ~15-20 lakh cover if you live in a metro and a ~10 lakh cover if you live in a smaller town. Billimoria says, “In addition, create a health corpus fund.” This corpus, which is in addition to the emergency fund, should be earmarked for health emergencies.

Next, pay off high-interest debt, like credit card outstanding. Col. Sanjeev Govila (Retd), a Securities and Exchange Board of India or Sebi-registered investment advisor and chief executive officer (CEO), Hum Fauji Initiatives, a financial planning firm, says, “This will free up money each month for meeting your living expenses.”

Billimoria adds, “Use money received in the severance package to reduce the loan outstanding so that your monthly outgo on EMIs comes down to below 30 per cent of your former gross income.”

If you have any money left, invest it in a debt fund. Govila says, “Use the systematic withdrawal plan route to generate a regular income for meeting household expenses.”

Invest any money left thereafter in a liquid fund. Use the systematic transfer plan (STP) route to continue investing in mutual funds for your future goals.

Divergent views on taxation
 

The rules regarding taxation of severance pay are not clearly established.  Ankit Jain, partner, Ved Jain & Associates, says, “This issue has been a bone of contention, leading to divergent views among the tax authorities and the courts.”
 

One view is that severance pay is taxable in the hands of the employee under the head “Salaries” under Section 17(3)(i) of the Income-Tax Act. Bajaj says, “Severance pay is currently considered to be a form of ‘salary’ and is hence taxable. It is not considered a compensatory relief. The employer will withhold appropriate tax while making this payment to the employee.”

The second view is that severance pay is an involuntary payment and hence is not taxable. Rulings from the Mumbai Tax Tribunal and the Gujarat High Court support this view.  
 

Jain says, “According to these bodies, severance pay is not part of the standard terms of employment. It is more of a voluntary exercise on the employer’s part. Hence, they argue that the amount received by the employee should be considered a capital receipt, and hence not subject to taxation.”

Seek expert help
 

White-collar workers don’t get any specific exemption for severance pay under Indian tax laws. Jain says, “However, given that the courts have deemed severance pay as non-taxable, one may potentially claim a deduction for it when filing tax return.”

Remember, the employer may view the severance pay as taxable and deduct TDS (tax deduction at source) on the payout. Jain says, “This discrepancy might lead to a dispute with the tax authorities if the employee chooses to exclude severance pay from her tax return.” It is advisable to seek professional guidance at the time of filing tax return.

Emergency corpus: Cushion against potential layoff

• Most people should have three-six months’ expenses in an emergency corpus

• If you are in the IT or start-up sector, have at least 10-12 months’ expenses
• If both spouses work in such sectors, have at least 12-18 months’ expenses (due to the risk of simultaneous layoff)
• If 40 per cent of your monthly income goes towards EMIs, set aside one year’s expenses as emergency funds
• If you are the sole earner of the family and have dependants, then have a year’s expenses
• Besides living expenses, include loan EMIs in this corpus
• Keep emergency funds in liquid instruments: cash, fixed deposits, and liquid funds