If you receive a large severance payment from your employer, the tax payable can be significant. A long-time employee who receives a 12-month severance payment late in the calendar year, for example, can end up with two years worth of income in a single year. For many employees, this may be the year they have the highest tax bracket and pay the most tax in their entire career.
Some employers offer a severance as a salary continuance. This means your salary continues to be paid for a certain period of time. Many employers prefer to pay a lump sum payment. Some employers will be willing to defer the payment to a future calendar year or pay a large severance over multiple years. An employment lawyer can help you assess your entitlement and negotiate terms before you agree to sign off on a severance offer.
Taxes on lump sum severance pay in Canada
In the case of a lump sum severance late in the calendar year, asking your employer to defer the payment to January may result in less combined tax, Andrea.
As an example, an employee earning $75,000 of salary in British Columbia may pay about $14,000 of income tax. If they have a $75,000 salary and a $75,000 severance payment all in one year, they may pay nearly $41,000 of tax. If the $150,000 was split between two separate years, it would result in about $28,000 of tax, or around $13,000 of tax savings.
Consider RRSP contributions
A common tax reduction strategy with a severance is to contribute to a registered retirement savings plan (RRSP). An employee with a lot of accumulated RRSP room may be able to deposit some or all of their severance on a pre-tax basis. An employer can be instructed to deposit a severance directly to an RRSP.
If you receive the payment in cash first with income tax withheld, and then contribute to an RRSP, the drawback is that you will have less after-tax cash to make the contribution. You must then wait for a tax refund as well.
A long-time employee may be able to take advantage of an eligible retiring allowance if they worked for their employer in 1995 or earlier. This may allow extra RRSP contributions over and above an employee’s regular RRSP room.
According to Canada Revenue Agency, the eligible part of the retiring allowance is: