Is Severance pay taxable? Tax on your severance package in Canada will be information you will need to know to properly execute a financial plan. What is the tax rate on your severance package? If you receive the lump sum in one year you could jump into the highest tax bracket. Severance pay is taxable; however, there are thins you can do to minimize the tax. Tax planning for severance packages is an important issue because the amount of money is usually significant. The first thing to consider is the special rules that relate to retiring allowances. Retiring allowances can include severance payments or termination payments, settlements for wrongful dismissal and payments for long service on retirement.

Can you contribute your severance pay to an RRSP? The amount that can be transferred tax-free to an RRSP rather than being taxed as income when received is $2,000 per year for years of employment prior to 1996. You can also transfer an additional $1,500 a year for years of employment prior to 1989 for which pension plan contributions have not vested. The legal fees you pay to review or obtain the severance will usually be deductible against the retiring allowance, so keep your legal invoices. If you transfer the entire retiring allowance to an RRSP, the legal fees will not be deductible. Once the money is removed from the RRSP it is no longer considered a retiring allowance and the legal fees will not be deductible. So, you may not want to transfer the total amount of the retiring allowance to an RRSP if you want to deduct the legal fees.

Investing your Severance Plan outside your RRSP:

Another issue to consider is where you will invest the money. You will need some money to live on until you find a job. If you believe you will find work in three months, keep three months worth of the severance in a liquid investment. For the longer term investment plan, you may want to consider capital class mutual funds that are tax efficient.

Severance Pay and RRSP’s:

A spousal contribution should also be explored if you are married / common law. This will be an excellent income splitting opportunity if your spouse is in a lower tax bracket. You, the recipient of the severance payment, will have to have RSP contribution room, however. Check your latest notice of assessment to determine what your contribution limit is.

Severance Pay rules:

For severance pay rules consult your legal advisor. You will want to ensure you are getting the most from your severance plan.

Retirement Compensation Arrangements (RCA’s):

Retirement compensation arrangements are useful in some situations. You will have to start early with the RCA; your employer will have to agree with contributing to the RCA. The RCA will be beneficial to the employer because it will reduce employer payroll taxes. The benefit of the RCA is to defer income tax on the severance plan. If you receive a large severance, the tax rate on the severance may be steep.

Layoff and Severance:

You have just lost your job. This is a stress full time for you. Take a few deep breaths. With the severance package, you have a little breathing room to get yourself organized. Talk to a few advisors – a financial advisor and a lawyer. The financial advisor will help you manage your severance package and the lawyer can provide advice regarding how much is reasonable. In our experience, a weeks pay for each year of service is very common. View this time as an opportunity. Take some time and find a better job than the one had.

Retirement and Severance Pay:

View your severance pay as an opportunity. If you are able to get employment quickly after you have received the severance pay, you won’t have to use much of it. This extra cash can jump start your retirement plan. We would recommend well managed mutual funds for your retirement plan. It is not a get rich quick scheme, but if you earn 5% to 7% your money will double in approximately ten to fourteen years.

Contact or call GTA Wealth Management toll free 1 855 GTA WLTH (855 482 9584) to accelerate your ride to financial independence. A professional wealth management financial advisor is ready to serve your wealth management, tax return and planning needs. GTA Wealth Management Inc. has three convenient locations in Mississauga, Toronto and Markham to serve you.

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