Severance savvy

How to ease the tax hit that follows job loss.

Deanne Gage 16 November, 2012 | 7:00PM
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You've just lost your job and the company is offering you a severance package. What can you do to minimize the amount of taxes you'll pay? That depends on the type of severance you receive, says Frank DiPietro, director of tax and estate planning for Mackenzie Financial.

The first order of business is to realize that the onus is on you to speak to the employer directly on how to best receive your severance. The employer is under no obligation to compromise but usually will try to accommodate, DiPietro says. He suggests meeting with a tax advisor to discuss your options.

If you worked for your employer before 1996, you'll be able to shelter part of your severance in your RRSP. Your employer will provide you with the summary of what portion actually qualifies for special tax treatment, known as the "eligible" portion of your severance or retiring allowance.

The best part of contributing the money toward your RRSP, besides the obvious tax benefits, is that there's no impact on your contribution room. "Even if you don't have any contribution room, the severance can still go into your RRSP," DiPietro notes. "Unfortunately, as time goes on, fewer people will receive an eligible portion of any severance." You won't pay tax on that money until it's withdrawn.

For those working years after 1996, some or all of your severance or retiring allowance will be classified as a "non-eligible" and is fully taxable. How you receive that amount varies from employer to employer.

Some may want to pay out one lump sum, which makes the tax hit that much greater since the whole amount will be taxable in the year you receive it. In this case, if you have RRSP contribution room, you could have your employer transfer the severance directly to your RRSP.

Frank DiPietro

This, in essence, means you'll pay no tax on the severance that year, assuming it stays in the RRSP. "If the employer can avoid having to withhold any tax on the payment, you'll get an RRSP slip that will offset the income inclusion you have on your tax return," DiPietro explains.

What if you don't have RRSP contribution room or need some of the money to survive until you land another job? "Addressing where cash flow is going to come from is going to be an important issue," DiPietro says. "Maybe having all the money go to the RRSP is not the best solution. You might need to keep some of it non-registered for personal use, but that's part of trying to analyze what sources of income you're going to be receiving over that transition period."

If you're laid off toward the end of the year, ask your employer to split the lump-sum payment over two years to lessen the tax burden, suggests Evelyn Jacks, president of The Knowledge Bureau and the Winnipeg-based author of Jacks on Tax. For example, if the layoff happens in December, you could take half at that time and the remainder in January.

Let's examine an example provided by Jacks. Betty loses her job and is entitled to a $100,000 severance. She has already earned $65,000 for the year. Had Betty simply taken the $100,000 over one taxation year, she would pay more than $42,000 in additional taxes, Jacks notes, depending on her combined federal-provincial marginal tax rate.

If Betty puts the money in her RRSP instead (let's say Betty's contribution room was also $100,000), she would eliminate those taxes until a later withdrawal, gaining the benefits of tax-deferred growth.

If she later withdraws the money at a lower marginal tax rate, she saves money. For example, if she needs to use the money over the next two years for cost of living, Jacks notes she could withdraw $50,000 each year, and assuming she had no other income sources, her tax bill would be about $8,700 a year (varying with provincial tax rates). The best thing about this strategy is that Betty controls the timing of when the income becomes taxable, Jacks says.

That said, Jacks recommends withdrawing from the RRSP only when other tax-preferred sources, such as tax-free savings accounts, or non-registered accounts have been drawn down first. But Jacks notes that Betty can make tax-free withdrawals from her RRSP under the Lifelong Learning Plan if she goes back to school.

If you're downsized earlier in the year, Jacks recommends asking the employer to annualize the tax on the lump sum. In this case, the payment would be added to income for the year and taxed based on the annualized tax bracket, rather than the spiked bracket that results from receiving the income in a two-week period.

The result is you avoid the highest marginal tax rate when the severance is paid. "You get to keep more of the total payment now rather than having to wait to file a tax return for your refund of overpaid taxes," she says. "However, if you are already in the highest marginal tax bracket, there is no benefit, unless an RRSP contribution puts you into a lower one.

Another tax-saving strategy applies to couples. If you're age 65 or over and laid off, you can split RRSP withdrawals with your spouse, Jacks says.

Some employers will forgo the lump sum and pay on a biweekly basis, similar to receiving a salary, which can make the tax hit more manageable. Others may just cut you a cheque for the full amount and won't budge on any changes. In that case, Jacks says take the lump sum and invest as wisely as you can.

"If an RRSP is not an option, I'd start with my tax-free savings account and then top up TFSAs for all family members because there's no attribution. All the money stays in that TFSA and you can then plan your next strategy to defer tax after that," she says.

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About Author

Deanne Gage

Deanne Gage  Deanne Gage is a Toronto-based writer who has specialized in personal-finance issues since 1999. A recipient of several journalism awards, including one from the Investment Funds Institute of Canada, she is also a former editor of Advisor's Edge and She can be reached at

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