If you've been lucky enough to exit your job with a couple
of extra bucks in your pocket from severance or other payments, the
Canada Revenue Agency (CRA) stands ready to kick you when
you're down by taxing that extra cash when you need it most.
Fortunately there are a few strategies you can use to fend off the
taxman's assault on your dwindling bank account.
Under the tax rules, any money you get from an employer (or
ex-employer) as a so-called "retiring allowance"
(that's tax talk for severance or other types of payments made
on leaving a job) will be taxable as income to you. However, the
CRA does offer a tax break if the funds received as a retiring
allowance are transferred to a Registered Retirement Savings Plan
(RRSP) or Registered Pension Plan (RPP) for certain years of
employment. In both cases, contributions of qualifying retiring
allowances will enable you to make additional contributions to the
plan, over and above the standard annual limits for certain years
(see more about this below); however, the additional contributions
cannot be made to a spousal RRSP.
If a direct transfer is not made by your employer to your RRSP
or RPP, sadly, the employer paying the retiring allowance must
report the amount paid on Form T4A Supplementary and must deduct
tax at source. So it might be beneficial to instruct your employer
to make the payment directly to your deferred plan to avoid that
On the other hand, if your retiring allowance was received as a
result of duking it out with your past employer, any legal fees
incurred are deductible to the extent that the retiring allowance
itself is not sheltered by transfers to a deferred income plan
– that is, the deduction is limited to the amount on which
tax is paid.
So in order to get a full deduction in this case, it may be a
good idea to "pass up" transferring some payments into an
RRSP or pension plan for that year because even if these payments
are "rolled in" to these plans, you will eventually have
to pay tax on them when they are received from the plan (although
they will earn tax-sheltered income in the meantime). Note: If the
legal fees are reimbursed to you, there is a corresponding
inclusion in income.
Transfers to RRSPs or RPPs
If you worked with your employer before 1995, any amounts you
receive on termination as a retiring allowance will allow you to
enlarge your normal RRSP or RPP contribution limit and thus enhance
your tax deferral.
For years of service before 1989, the maximum deferral available
for a retiring allowance through a contribution to an RRSP or RPP
is limited to $3,500 multiplied by the number of years during which
you were employed. However, the annual deferral is decreased by
$1,500 – that is, to $2,000 – for years when your
employer made contributions to a pension fund or plan, or to one of
their deferred profit-sharing plans, and those funds have vested
with you at the time you receive the retiring allowance. Note: For
years of service between 1989 and 1995, the tax-deferred ceiling is
limited to $2,000 in all instances.
In order to be eligible for the offsetting deduction, the
contribution to the RRSP or RPP must be made within 60 days after
the end of the year in which you include the retiring allowance as
Note: The February 1995 Federal Budget eliminated the
opportunity to enlarge RRSP and RPP contributions for retiring
allowances for years of service after 1995. However, the
opportunity to make contributions for retiring allowances for years
of service before 1996 was not affected.
Next time: The many definitions of a "retiring
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