Oct 16, 2024
What is a retiring allowance?
A retiring allowance is a payment made by an employer to an employee when their employment is terminated. This payment is typically based on the employee’s length of service and their position within the organization. While the terms “retiring allowance” and “severance package” are often used interchangeably, they are not the same. A retiring allowance is just one part of a severance package, which may also include other forms of compensation, benefits, and incentives.
Qualifying payments for a retiring allowance include:
- Payment for unused sick leave credits upon termination.
- Amounts received when an employee’s office or employment is terminated, including damages (e.g., for wrongful dismissal) when the employee does not return to work.
Non-qualifying payments for a retiring allowance include:
- Salary, wages, bonuses, overtime pay, and reimbursement of legal fees.
- Superannuation or pension benefits.
- Payments received as a result of an employee’s death (which may be treated as death benefits).
- Benefits from certain counseling services.
- Unused vacation time.
- Pay in lieu of termination notice.
- Damages awarded under human rights legislation for violations or alleged violations of an employee’s human rights, which are not taxable.
Taxation of retiring allowances
A retiring allowance is considered taxable income for you, and your employer may need to withhold taxes on this payment. However, the withholding taxes are not your final tax obligation, and it’s your total taxable income that determines your overall tax liability. The withholding taxes serve as a credit toward your total tax liability. If the withholding taxes you’ve paid exceed your tax liability, you’ll receive a tax refund.
You might be able to defer the taxes owed on your retiring allowance by transferring or contributing it to an RRSP or a registered pension plan (RPP).
Eligible retiring allowance for RRSP transfer
You can transfer a portion of your retiring allowance – the “eligible” retiring allowance, to your RRSP without needing to use any unused RRSP contribution room. The eligible amount is determined as the lesser of the actual retiring allowance received and the sum of:
- $2,000 for each year or part of a year before 1996 that you worked for the employer.
- $1,500 for each year or part of a year before 1989 of that employment in which none of your contributions to your pension plan or deferred profit-sharing plan (DPSP) were vested in your name when the retiring allowance was paid.
This eligible portion can be paid to you, in whole or in part, or transferred directly to your RRSP. When it’s transferred to your RRSP, your employer doesn’t need to withhold tax. Your employer also doesn’t require confirmation of your RRSP deduction limit for this transfer.
If the retiring allowance is paid directly to you, you can still contribute the eligible amount to your RRSP without using contribution room, as long as you make the contribution within 60 days from the end of the year in which you received it. However, since your employer may need to withhold tax on a direct payment, you may need to add funds from other sources to contribute the gross amount to your RRSP, maximizing the contribution without using unused RRSP contribution room.
To qualify for a contribution that doesn’t use RRSP contribution room, you must contribute to an RRSP where you are the annuitant, not to a spousal RRSP.
Non-eligible retiring allowance
To defer taxes on the non-eligible portion of your retiring allowance, you can contribute that amount to your personal RRSP or a spousal RRSP, provided you have enough unused RRSP contribution room and you make the contribution within 60 days from the end of the year in which you received it. This contribution will reduce your unused RRSP contribution room.
Your employer might agree to contribute the full retiring allowance amount (without withholding tax) directly to your RRSP or a spousal RRSP, based on your available RRSP contribution room. The employer may also request reasonable proof of your available RRSP contribution room, such as a copy of your Notice of Assessment from the previous year showing your RRSP deduction limit. Alternatively, your employer might require you to complete CRA form T1213 – Request to Reduce Tax Deductions at Source and have it certified by the Canada Revenue Agency (CRA). Even with this proof, your employer has the discretion to withhold taxes instead of making a direct transfer to your RRSP. It’s advisable to contact your employer to explore your options.
If your employer withholds taxes and you contribute to your RRSP or a spousal RRSP, your tax liability for the year could be lower than the withholding taxes. In such cases, you would receive a tax refund for any excess withholding.
Tax reporting
When your employer first informs you of your retiring allowance, they may not specify the eligible amount. However, it is their responsibility to determine both the eligible and non-eligible portions for reporting on your T4 slip. This slip must be issued to you by the last day of February following the year in which the allowance is paid. Since the CRA will assess your tax return based on the information provided on the T4 slip, it’s important to ensure that both the eligible and non-eligible amounts are accurately reported. You must report the retiring allowance, including both eligible and non-eligible portions, as income on your tax return.
Pro tax tips – Transferring eligible allowance to RRSP is not the only option
You are not required to contribute your eligible retiring allowance to your RRSP as a transfer that doesn’t use RRSP contribution room. There might be other purposes for the funds or alternative tax planning strategies to consider.
For instance, if you need the funds immediately, you can request that all or part of the eligible retiring allowance be paid out in cash, subject to withholding tax. If you have a significant unused RRSP contribution limit that you may not otherwise be able to utilize and you wish to leverage a spousal RRSP, you may consider transferring as much of your retiring allowance as your unused RRSP contribution limit will allow directly into a spousal RRSP, even if some of your retiring allowance is eligible. For tax planning reasons, your employer might agree to let you defer receiving your retiring allowance to a future tax year. This could be advantageous if a portion or all of the retiring allowance is non-eligible, and you lack unused RRSP contribution room, or you decide not to contribute the payment to your RRSP.
Therefore, it’s highly advisable for a taxpayer to seek guidance from an experienced Canadian tax lawyer to determine the best option based on your circumstances.
FAQ
What type of payments qualify for retiring allowance?
The following payments may qualify for retiring allowance:
- Payments for unused sick leave credits on termination, and
- Amounts individuals receive for employment termination, including amounts for damages.
When a retiring allowance is paid to a taxpayer as income, how much withholding tax will the taxpayer’s employer charge?
| Retiring allowance | Province other than Quebec | Province of Quebec |
| $0-$5,000 | 10% | 20% |
| $5,001-$15,000 | 20% | 25% |
| $15,001 and over | 30% | 30% |
Disclaimer: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.
