In Part I we discussed how to prepare for job loss and what to anticipate in your termination package. Today I would like to address the options your termination package typically includes.
Retiring Allowance (Severance Pay)
A retiring allowance is the amount you receive on or after retirement from your employer in recognition of long service. You may also receive a retiring allowance if you lose your job, whether you are dismissed or resign on your own terms.
Generally, this benefit is fully taxable. In other words, the entire amount of the retiring allowance becomes your income in the year you receive it. If your employment is terminated close to the end of the year, your total annual income could jump substantially, thereby increasing your marginal tax rate. That is why it makes sense to discuss with your employer the possibility of receiving the retiring allowance (or at least a part of it) in the following tax year.
You may be able to shelter part or even all of your retiring allowance into your registered retirement savings plan (RRSP) or registered pension plan (RPP). There are two ways of doing this. Your entire retiring allowance could be divided into two parts:
- Eligible Part
- Ineligible part
The eligible part may be transferred to your RRSP without affecting your RRSP deduction limit. This is how you calculate the eligible part:
- $2,000 for each year or part-year of service before 1996 in which you were employed by the employer or a person related to the employer from whom you received the retiring allowance.
- You can also transfer an additional $1,500 for each year or part year of service before 1989 in which you had earned no pension or DPSP benefit from employer contributions that either vested in you at the time of payment or that were previously paid to you.
No tax is withheld if your employer directly transfers the eligible part of your retiring allowance into RRSP or RPP. However, transfer to RPP may result in pension adjustment (PA), that will affect your RRSP deduction limit in subsequent years.
Despite its name, the ineligible part could also be transferred to your RRSP. There is however one condition: you must have sufficient RRSP deduction room. Even if your RRSP deduction limit is lower than the ineligible part of your allowance, you can shelter that amount and pay taxes on the remaining portion only. For example: your RRSP deduction limit is $23,000.00. The ineligible part of your retiring allowance is $30,000. You ask your employer to transfer $23,000 directly to your RRSP, pay 20% withholding tax on the remaining $7,000 (which is $1,400), and receive $5,600 net as a cheque.
Based on my experience, in most cases you can negotiate with your employer’s HR department so that they don’t take the withholding tax on the ineligible portion directly transferred to RRSP.
There is a way to decrease your family taxation even further! Your spouse may have eligible RRSP contribution room. Example:
After transferring both eligible and ineligible portions into your RRSP, you have $37,000 of retiring allowance left. Your employer took 30% withholding tax in the amount of $11,100 and transferred the remaining $25,900 to your chequing account. What if your spouse has $19,000 in eligible RRSP contribution available? Then he/she can deposit $19,000 as their own RRSP contribution and receive their own tax refund. Eventually, the family gets more tax money back.
In the upcoming Part III we will go over your remaining financial options in your termination package.
VLAD SOLOKHINE, CFP®