Getting laid off is a concern many employees face, but the possibility of losing your stable company income is even more anxiety-inducing when living in a foreign country. Fortunately for residents of Japan, many companies offer retirement payment packages and severance payment in Japan (“retirement allowances”) to employees who are forcibly retired. However, these packages come with tax obligations, and many people misunderstand the way retirement income is charged, and the effect that this will have on their taxes in the year that they receive the payout.
How Retirement Allowances In Japan Work
The concept of a retirement payment packages in Japan represents a significant aspect of the country’s employment culture. These payment packages serve as a financial cushion and a token of appreciation for an employee’s years of service upon the termination of their employment. Looking at the system more skeptically, Japan’s labor laws offer some of the strictest protections to employees in the world, meaning that it is almost impossible for a company to “fire” and employee. The solution? Offer them money to leave the company in the form of “early retirement”. Traditionally, Japanese companies awarded retirement allowances as a lump-sum payment upon an employee’s retirement. This payment served as a reward for lifetime employment and financial support during retirement. While this tradition continues in some companies, many now offer diverse retirement benefit plans, including defined contribution plans.
Japanese companies opting to provide retirement allowances beyond the statutory requirements must integrate these provisions into their work rules, as mandated by the Labour Standards Act. These rules must clearly outline who is eligible for the retirement allowance in Japan, how it will be calculated, and when it will be disbursed. The documentation, accompanied by an opinion letter from a representative of the employees, is then submitted to the Labour Standards Inspection Office for approval. Smaller companies (those with fewer than ten employees) are exempt from preparing formal work rules but must still include retirement allowance provisions in individual employment contracts if they choose to offer them.
Taxation of Retirement Income in Japan
Retirement income is treated separately from other forms of income for tax purposes. While income tax in Japan is levied on personal income (which includes retirement benefits), retirement income is taxed separately. As such, the tax is calculated distinctly from other forms of income such as salaries. This special treatment allows for a more favorable tax calculation, reflecting the unique nature of retirement pay as compensation for years of service.
The calculation starts by determining how much of your retirement income is taxable through the following formula:
- Taxable Retirement Income = (Retirement Allowance – Retirement Income Deduction) x 1/2.
Starting January 2022, significant changes were introduced to the taxation of retirement income in Japan, affecting employees who retire on or after this date under specific conditions. These changes primarily concern employees who meet the following conditions:
- Retired on or after January 1, 2022
- Had 5 years of service or less
- Received retirement income exceeding 3,000,000 yen
For these employees, the applied formula changes to:
- Taxable Retirement Income = 1,500,000 JPY+ (Retirement Allowance − (3,000,000 yen + Retirement Income Deduction))
The retirement income deduction is calculated through one of the following formulas, according to your years of service:
- For those with fewer than 20 years of service:
- Retirement Income Deduction = 400,000 yen/year x years of service (minimum 800,000 yen)
- For those with over 20 years of service
- Retirement Income Deduction = 8 million yen + 700,000 yen x (years of service – 20).
(Adjustments may apply based on specific scenarios, such as officer retirement or short-term service.)
Once the taxable amount has been determined, the applicable income tax is calculated according to Japan’s progressive income tax rates, which range from 5% to 45%. A special reconstruction income tax is also applied (currently at a rate of 2.1%, applicable until 2037). Finally, a flat 10% resident tax will be levied by your local municipality.
Considerations Foreign Residents With Retirement Allowances In Japan
Understanding retirement allowances in Japan and their tax implications requires navigating legal documents, interpreting nuanced changes, and considering international tax factors.
This can be a daunting task for anyone, let alone foreign residents who aren’t familiar with Japanese and international tax law. However, it’s also a critical aspect of effective financial planning.
Seeking professional advice from an international financial adviser experienced in working with foreign residents in Japan can be invaluable. Professional advisers can help navigate the intricate tax landscape, advising on how to optimize tax obligations related to retirement allowances and other income sources. This ensures that your retirement planning is robust, tax-efficient, and tailored to your unique financial situation, providing a solid foundation for your future.
