Employment Termination Series: What Should You Do With the Severance Pay?

In the previous post, we’ve gone through the overall financial consideration upon employment termination. (To read the previous post, please visit: https://samuelconsultant.com/employment-termination/) This time, we will look into the treatments of severance pay more in depth.

 

Treatment of Retiring Allowances (Severance Pay)

When an employment is being terminated, usually a severance will usually be paid out to the employee as a result of voluntarily by the company, prescribed under by laws, or in some instances, may even due to a court settlement. Regardless of the cause, the severance may consist one or combination of termination pay, long service pay, unused sick leave credits, unused vacation pay, bonus pay earned but not yet paid. Under the Canadian rules, these payments may fall into different classification as “employment income” or “retiring allowance”. Employment income are taxable in the year they are paid, while there are some treatments that may be able deferred the tax for retirement allowance.  It is important to distinguish them when doing tax planning. For now, we’ll focus on the “retirement allowance”.

 

Retirement allowance consists of two portion: “Eligible part” and the “Non-eligible part”.

Before our discussion, my focus is to defer the immediate tax consequence. If you need to use the retirement allowances now, then there’s not much planning involved, the amount you received will simply be taxed.

As for the Retirement Allowance Transfereligible part, it may be transferred to your RRSP, but not to a spousal RRSP. If your employer directly transfers the eligible portion to your RRSP, then tax will not be withheld. The savings with the RRSP will be tax deferred until it is being withdrawn. To calculate the amount of eligible portion, it takes into consideration when you start working. However, from my understanding, the eligible portion are only available for those started their employment  before 1996. One interesting note is that the transfer will not used up any of your RRSP contribution room

On the other hand, the non-eligible portion can be contributed into your RRSP or to a spousal RRSP. In this case, transfer will be using your RRSP contribution room, so make sure to confirm that the amount will not exceed your RRSP contribution limit.  You will have to include the amount as income for tax purposes, but the RRSP contribution receipt will provide you an offsetting deduction effect. In other words, this will allow you to avoid immediate taxed consequence.

For more details about transferring retirement allowances, you may visit the CRA website at http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/trnsfrrng/rtrng-eng.html

 

Yet, there are many other considerations when handling with severance, to help you in having a better understanding of the different aspects, here’s the guide You and your severance — Put your money to work!”  from Mackenzie Investments.

 

 

[note] Of course, should you wish setup a meeting to discuss over the different strategies to plan for your severance, feel free to contact me. [/note]

 

Disclaimer: Image Courtesy stockimages/ FreeDigitalPhotos.net

 

 

Samuel Li

Hi, I'm Samuel Li. I started my financial advisory practice in 2005, assisting Canadians in growing their long-term wealth while protecting their assets. One area I specialize in is servicing families with disabilities. If you'd like to explore how I can assist you, feel free to email me at Samuel@SamuelConsultant.com

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