In short

When two qualified medical practitioners certify an employee is unlikely ever to work again in a role they're reasonably qualified for, the invalidity segment of their Employment Termination Payment is calculated using the days remaining to their normal retirement age and paid entirely tax-free. The rest of the ETP is still taxed under the standard concessional rates.

For Australian employees whose careers end on medical grounds — typically because two qualified medical practitioners certify they are unlikely ever to work again in a capacity for which they are reasonably qualified — the invalidity segment of an Employment Termination Payment (ETP) is the single most valuable tax concession available in the termination. An ETP is a payment made because your employment ends; the invalidity segment is the part of it that is converted into a fully tax-free amount, calculated by reference to the working life you would have had if you could have continued to your normal retirement age. The rules sit in section 82-150 of the Income Tax Assessment Act 1997. For a late-career employee terminated at 56 with 28 years of service and a $400,000 ETP, the invalidity segment can be around $97,000 — entirely tax-free, with the remainder taxed under the concessional ETP rules. The provisions are technical and the medical certification requirements strict, but getting the calculation right transforms the financial outcome of an otherwise unwelcome event.

The basic ETP framework sets the context. An Employment Termination Payment is generally a payment made in consequence of the termination of employment — covering payments in lieu of notice, ex gratia "golden handshake" amounts, and the taxable portion of a redundancy package above the genuine redundancy tax-free amount. The taxable component of a "life benefit" ETP is taxed at concessional rates up to the ETP cap of $260,000 for FY25-26. Crucially, the concessional rate depends on whether you have reached your preservation age — which is now 60 for everyone retiring in FY25-26. If you have reached preservation age, the taxable component is taxed at a maximum of 15% plus the 2% Medicare levy (an effective 17%) up to the cap; if you have not reached preservation age, the maximum is 30% plus Medicare (an effective 32%) up to the cap. Anything above the cap is taxed at the top marginal rate of 45% plus Medicare (47%). The invalidity segment sits entirely outside all of this: it is excluded from the ETP, does not count toward the cap, and is wholly tax-free. Because a younger, below-preservation-age employee would otherwise pay 32% rather than 17% on the taxable balance, the tax-free segment is worth even more to someone medically retired in their 50s than to someone in their early 60s.

The two-practitioner medical certification is the gateway condition. Section 82-150 requires that the employee stopped being gainfully employed because of ill-health (physical or mental), that this happened before the person's last retirement day, and that two legally qualified medical practitioners have each certified that, because of the ill-health, it is unlikely the person can ever be gainfully employed in a capacity for which they are reasonably qualified by education, experience or training. The "ever" qualification is strict — short-term incapacity, expected recovery, or temporary unfitness does not satisfy it. The "reasonably qualified" qualification is more flexible: it does not require an inability to do any work at all, only work the person is reasonably qualified for. A senior professional who could theoretically do basic clerical work, but for whom that would be a fundamental departure from their career capacity, can still meet the test. The certifications should be in writing, dated, and provided to the employer at or before termination — payroll departments routinely refuse to apply the segment without documentary proof, and certifications obtained well after the event are harder to rely on.

The calculation formula is mechanical. Section 82-150(2) sets the invalidity segment as the ETP multiplied by the ratio of "days to retirement" over the sum of "employment days" plus "days to retirement", where days to retirement is the number of days from the termination date to the person's last retirement day, and employment days is the number of days of employment the payment relates to. The "last retirement day" is generally the day the person would have had to retire under their employment contract — for most employees, age 65, though some occupations (military personnel, certain pilots, judges) have specific contractual or statutory dates. Worked through: an employee terminated at 56 after 28 years of service, with a $400,000 ETP and a last retirement day at age 65, has employment days of about 10,220 (28 × 365) and days to retirement of about 3,285 (9 × 365). The segment is $400,000 × 3,285 ÷ (10,220 + 3,285) ≈ $97,300, tax-free, with the remaining $302,700 taxed under the standard ETP rules.

The interaction with genuine redundancy can stack favourably where a medical exit coincides with a redundancy. The genuine redundancy tax-free amount under section 83-175 of the ITAA 1997 is a separate concession — for FY25-26, a base amount of $13,100 plus $6,552 for each completed year of service. It is applied first to the redundancy component; any excess flows into the ETP, and the invalidity segment is then worked out on the ETP. A useful point on the caps: both genuine redundancy excess and invalidity payments are "excluded payments", so only the $260,000 ETP cap applies to them — not the lower $180,000 whole-of-income cap (which is not indexed) that catches ordinary golden-handshake payments. Sequencing matters: applied correctly, a large medically-driven redundancy can see substantial portions escape full taxation under both concessions; applied incorrectly, the employee either overpays or invites an ATO query.

The post-receipt planning is often the second value-add. Once received tax-free, the invalidity segment can be retained, invested, or contributed to superannuation as a non-concessional contribution (NCC) — within the $120,000 standard NCC cap for FY25-26, or more under the bring-forward rule — so the money grows in the 15%-tax (or 0% pension-phase) super environment rather than at personal marginal rates. Where the medical incapacity also produces a personal injury settlement (workers' compensation, motor accident, or insurance payout), the structured settlement contribution provisions in section 292-95 of the ITAA 1997 give a separate, additional super contribution concession that sits outside the standard NCC cap. Centrelink timing also matters: leave and redundancy lump sums can trigger an Income Maintenance Period that treats the lump sum as income for a defined stretch, and for those moving onto the Disability Support Pension after medical retirement, the timing of the payment and the DSP claim should be coordinated.

What do worked planning examples show?

These two cases show how the invalidity segment applies in practice. Illustrative only — not personal advice — using FY25-26 figures.

Case 1 — Mark, 56, senior project engineer with 28 years of service. He has been diagnosed with a degenerative neurological condition, and two specialists have certified he is unlikely ever to work in his profession again. His employer offers a $480,000 package — an $80,000 genuine redundancy component plus a $400,000 ETP. On these facts, both concessions apply. The genuine redundancy tax-free limit is $13,100 + ($6,552 × 28) = $196,556, so the entire $80,000 redundancy component is tax-free. On the $400,000 ETP, the invalidity segment is $400,000 × 3,285 ÷ (10,220 + 3,285) ≈ $97,300, also tax-free. That is $177,300 tax-free in total. The residual $302,700 of taxable ETP is where Mark's age bites: at 56 he is below preservation age (60), so the first $260,000 (the ETP cap) is taxed at the higher 32% rate — not 17% — and the $42,700 above the cap at the top marginal 47%. This is precisely why the tax-free segment is so valuable to him: every dollar pulled into the segment escapes a 32% rate, not a 17% one. On these facts, contributing the $97,300 tax-free segment to super as a non-concessional contribution (within the $120,000 cap) and coordinating any Disability Support Pension claim is generally the rational plan.

Case 2 — Linda, 62, regional bank manager with 15 years of service. A serious mental health condition has been certified by her treating psychiatrist and a specialist occupational physician as making her unlikely ever to return to banking or similar work. Her package is a $250,000 ETP, with no genuine redundancy component (her role is filled internally). Only the invalidity segment applies here. Employment days are about 5,475 (15 × 365) and days to retirement about 1,095 (3 × 365 to age 65), so the segment is $250,000 × 1,095 ÷ (5,475 + 1,095) ≈ $41,700, tax-free. The remaining $208,300 is taxable ETP. Linda is 62 — above preservation age — so it is taxed at the concessional 17% (it sits under the $260,000 cap), giving roughly $35,400 of tax. Without the segment, the full $250,000 at 17% would cost about $42,500, so the segment saves her around $7,100 (that is, 17% of the $41,700 tax-free amount). On these facts, the rational steps are to confirm the certifications meet the legislative wording, independently verify the employer's calculation, and coordinate any DSP transition.

For employees facing medical retirement, the invalidity segment is the centrepiece of termination tax planning — and the area most commonly missed or miscalculated by employer payroll departments. The advice work is to verify the medical certification at the outset (two practitioners, the "ever" condition, the "reasonably qualified" wording), calculate the segment independently using the section 82-150 formula, sequence it with the genuine redundancy tax-free amount where both apply, plan the deployment of the tax-free money (typically into super), and coordinate the Centrelink interaction. For clients guided through this before termination is finalised, the outcome is often far better than for those who simply accept the payroll calculation — and the size of the gap grows the younger the employee, because below preservation age the taxable balance is taxed at 32% rather than 17%.

Sources

Key takeaways

  • The invalidity segment of an ETP is entirely tax-free and doesn't count towards the $260,000 ETP cap for FY25-26.
  • Two legally qualified medical practitioners must each certify the employee is unlikely ever to work again in a role they're reasonably qualified for — short-term or expected-recovery incapacity doesn't qualify.
  • The segment is calculated as the ETP multiplied by the ratio of days remaining to normal retirement age over total employment days plus days remaining.
  • The concession is worth more to employees below preservation age (60), since their taxable ETP balance would otherwise be taxed at 32% rather than 17%.
  • Where a medical exit coincides with a genuine redundancy, the redundancy tax-free amount is applied first, and the invalidity segment is then calculated on the remaining ETP.

Frequently asked questions

What is the ETP invalidity segment?

It's the portion of an Employment Termination Payment that's converted to a fully tax-free amount when an employee is medically retired, calculated by reference to the working years they would have had left before their normal retirement age. It sits outside the ETP cap and standard concessional tax rates entirely.

What medical certification do I need to access the ETP invalidity segment?

Two legally qualified medical practitioners must each certify, in writing, that because of ill-health it's unlikely you can ever be gainfully employed in a role you're reasonably qualified for by education, experience, or training. This doesn't mean you can never do any work at all — just that a fundamental departure from your qualified career capacity is unlikely to be reversed.

How is the tax-free invalidity segment amount calculated?

The formula multiplies the ETP by the ratio of days from termination to your normal retirement age, over the sum of your employment days plus those remaining days. Younger employees with long service tend to get larger tax-free segments, since they have more years left before their normal retirement age.

Is the invalidity segment more valuable if I'm younger than preservation age?

Yes. If you haven't reached preservation age (60), the taxable part of your ETP is taxed at up to 32% rather than the 17% rate that applies once you're past preservation age. Since the invalidity segment escapes tax altogether, it's worth more to someone who would otherwise pay the higher 32% rate on that amount.

A note on advice. This article is general information only and doesn't account for your personal circumstances. Everyone's situation is different — before acting, it's worth talking it through with a licensed adviser who knows your full picture.