Xero applies a flat 32% PAYG withholding rate on every Employment Termination Payment (ETP). If the employee has reached preservation age, the correct rate is 17%. That's a 15 percentage point gap - and Xero won't flag it for you

We process ETPs for clients regularly. And we've lost count of how many times a business owner or payroll person has come to us after the fact, having withheld 32% from an employee who should have been taxed at 17%. The employee doesn't lose the money permanently - they get it back when they lodge their tax return - but try explaining that to someone whose final pay is $7,500 lighter than it should have been

The fix takes about two minutes. But you have to know the problem exists first. This is one of several payroll processing errors that Xero won't catch for you

Why Xero Defaults to 32% on ETPs

When you add an ETP pay item to a payslip in Xero - whether it's a type O (golden handshake, gratuity, payment in lieu of notice) or type R (genuine redundancy excess) - Xero calculates PAYG at a flat 32%. Xero's own documentation confirms this: the system applies 32% and expects you to add a manual tax adjustment if a different rate applies

The 32% rate is the correct rate for employees below preservation age. But for employees who have reached preservation age, the ATO's Schedule 11 tax table specifies a maximum rate of 17%. Both rates already include the 2% Medicare levy (so 30% + 2% = 32%, and 15% + 2% = 17%)

Xero doesn't check the employee's date of birth against preservation age. It doesn't prompt you. It just withholds 32% and moves on

What Is Preservation Age (and Why It's Simpler Than You Think)

Preservation age used to be a sliding scale based on date of birth - anywhere from 55 to 60, depending on when someone was born. That created confusion because you needed to look up a table every time

Since 1 July 2024, the transitional period is complete. Preservation age is now 60 for everyone still in the workforce. Anyone born before 1 July 1964 has already passed their preservation age. Anyone born on or after 1 July 1964 has a preservation age of 60

So the check is straightforward: is the employee 60 or over at the time you're processing the ETP? If yes, the rate is 17%. If no, 32%

The Dollar Impact

Take a 62-year-old employee who receives a $50,000 taxable ETP component - maybe the excess of a genuine redundancy over the tax-free limit, or a gratuity on retirement

  • At 32% (Xero's default): $16,000 withheld

  • At 17% (correct for preservation age): $8,500 withheld

That's $7,500 over-withheld. The employee gets it back at tax time, but that could be 6 to 10 months away. For someone leaving a job - possibly retiring - that's real money they need access to now

On larger ETPs the gap widens fast. A $150,000 taxable component (not unusual for a long-serving employee made redundant) means $22,500 over-withheld. We've seen this happen

How to Process an ETP Correctly in Xero

Here's the actual workflow. Before you touch Xero, you need three pieces of information

1. Confirm the employee's date of birth

Check their Xero employee record. If they're 60 or over at the date of the ETP payment, preservation age applies and the rate is 17%. Under 60, the default 32% is correct

2. Determine the ETP type

This matters because the type determines which cap applies to the concessional rate

Type R (excluded payments) - the excess of a genuine redundancy or early retirement scheme over the tax-free limit, death benefit ETPs, and invalidity payments. Type R is subject to the ETP cap only ($260,000 for 2025-26)

Type O (non-excluded payments) - golden handshakes, gratuities, payments in lieu of notice, unused sick leave, unused rostered days off. Type O is subject to the lower of the ETP cap ($260,000) and the whole-of-income cap ($180,000 minus the employee's other taxable income for the year)

The whole-of-income cap is the one that catches people. If the employee earned $120,000 in salary before termination, their whole-of-income cap is only $60,000. Any type O ETP amount above $60,000 gets taxed at the top marginal rate of 47% - regardless of whether the employee has reached preservation age

3. Calculate the correct withholding

Work through the ATO's Schedule 11 Table A step by step. Determine which cap applies, compare the ETP amount against that cap, and apply the correct rate to each portion

  • For amounts within the applicable cap: 17% if at or above preservation age, 32% if below

  • For amounts exceeding the cap: 47% (top marginal rate of 45% plus 2% Medicare levy)

4. Process in Xero with a manual tax adjustment

Add the ETP earnings item to the employee's payslip. Xero will calculate 32% PAYG automatically. Then go to the tax section of the payslip and add a manual tax adjustment (ETP type O or type R) to bring the withholding to the correct amount

If the employee has reached preservation age, you're reducing the PAYG from 32% to 17% on the within-cap portion. If there's an amount over the cap, you'll need to account for the 47% rate on that portion too

A Worked Example

Maria is 63 and has been made genuinely redundant. She earned $90,000 in salary this financial year before termination. After calculating the tax-free component of her genuine redundancy, the remaining taxable ETP is $40,000 - classified as type R

Because it's type R, only the ETP cap applies ($260,000 for 2025-26). Maria's $40,000 is well within the cap. And because Maria is over 60 (above preservation age), the correct PAYG rate is 17%

  • Correct withholding: $40,000 x 17% = $6,800

  • If you let Xero's default run: $40,000 x 32% = $12,800

Maria would be $6,000 out of pocket until she lodges her tax return. Not ideal when she's just lost her job

The Checklist Before You Process

We run through this every time we process an ETP. It takes less time than fixing it afterwards

Before adding the ETP to the payslip -

  • Confirm the employee's date of birth in their Xero record

  • Determine if they've reached preservation age (60 or over)

  • Classify the payment as type R or type O

  • If type O, calculate the whole-of-income cap ($180,000 minus year-to-date taxable income)

  • Determine the applicable cap and compare it to the ETP amount

  • Calculate the correct PAYG using Schedule 11 Table A

After adding the ETP in Xero -

  • Check the PAYG Xero has calculated (it will be 32%)

  • Add a manual tax adjustment to correct the rate

  • Verify the net payment matches your manual calculation

  • Ensure the correct ETP code (O, R, S, or P) will be reported through Single Touch Payroll (STP)

What If You've Already Over-Withheld?

If you've already processed and filed the pay run with the wrong rate, you have two options. You can process an unscheduled pay run with a correction to update the STP year-to-date figures. Or the employee can claim the excess withholding back through their individual tax return

The unscheduled pay run is the cleaner fix - it corrects the STP reporting with the ATO and gives the employee their money sooner. But it does require you to reverse and reprocess correctly, and that means explaining to the employee what happened

Either way, it's more work than getting it right the first time

Key Numbers for 2025-26

For reference, here are the current thresholds from the ATO:

  • ETP cap: $260,000 (indexed annually)

  • Whole-of-income cap: $180,000 (not indexed)

  • Preservation age: 60 (for all current employees)

  • Within-cap rate (at or above preservation age): 17% (includes 2% Medicare levy)

  • Within-cap rate (below preservation age): 32% (includes 2% Medicare levy)

  • Above-cap rate: 47% (includes 2% Medicare levy)

  • Genuine redundancy tax-free base: $13,100 + $6,552 per completed year of service

These are indexed annually (except the whole-of-income cap). Check the ATO's Schedule 11 tax table for the current year before processing

ETPs aren't something most businesses process often - maybe once or twice a year. That's exactly why they're easy to get wrong. The rules sit outside your normal payroll routine, and Xero's default doesn't do the thinking for you on this one. Two minutes checking the employee's age against preservation age is the difference between a clean termination and a messy correction

Rates, thresholds, and withholding schedules referenced in this article are sourced from the Australian Taxation Office, current as at March 2026