Consider Your Retirement Allowance Carefully!
A retirement allowance (also known as severance pay, separation payment, or retiring allowance) is a sum an employee may receive from the employer (as a lump sum or in instalments) when leaving a job or retiring.
You may receive this type of allowance...
- To recognize many years of service
- To compensate for accumulated sick leave
- If your position has been eliminated
- For damages and interest in some circumstances
Retirement allowances do not apply...
- to accrued vacation paid at the time of departure
- to a retirement benefit or pension payable under a public or private pension plan
- To a sum received after an employee's death
Despite its name, a retirement allowance can be handed out even if an employee is not permanently retiring from the labour force—for example, if there is a change in employer.
Retirement Allowances and Taxation
- Maximum Transfer
Retirement allowances are taxable. However, by transferring them in full or in part to a registered retirement savings plan (RRSP) or supplemental pension plan (SPP), you can put off the tax bill. Be careful ! You can't transfer the funds to a spouse's RRSP or RRIF.
- Maximum RRSP or SPP Transfer
The maximum amount is $2,000 per complete year of service, or partial year before 1996, plus $1,500 per year of service before 1989, if no portion of it is included in the calculation of your SPP pension.
A retirement allowance is not part of the family patrimony, except any portions transferred to a family patrimony investment vehicle such as an RRSP and most SPPs.
- Amounts Exceeding the Transfer Maximum (if any)
If you can't transfer your full allowance to an RRSP, you can use the remaining amounts to make regular contributions to your or your spouse's RRSP for the year in progress if you still have any unused contribution room. It's best to contribute to your spouse's RRSP if you estimate that your retirement income will be higher. No prior authorization is necessary if the amount is within the prescribed limits.
- Sample calculations for an allowance transfer to an RRSP or SPP
Employment start date: December 6, 1981
Date the employee begins contribution to the pension plan: January 1, 1984
Employment termination date: June 30, 2008
Retirement allowance: $60,000
Amount transferable to an RRSP or SPP
- $2,000 × 15 years (1981 to 1995) = $30,000 plus
- $1,500 × 3 years (1981 to 1983) = $4,500
The excess of $25,500 ($60,000 − $34,500) will be taxable if it can't be transferred into an RRSP. You can transfer the balance to a tax-free savings account (TFSA) to avoid taxes on accumulated investment income.
Receiving Your Retirement Allowance: At Departure or Next Year?
These are the main points to keep in mind:
- Your income for the current year and how much you expect to earn next year
- The portion of the retirement allowance that can be transferred into an RRSP
- Your unused RRSP contribution room
It may be to your benefit to take your retirement allowance early in the following year, but be sure to consider any loss in yields. The loss will be minimal if you leave in December, but can be substantial if you leave at the beginning or middle of the year. Your employer, however, is at complete liberty to determine when to pay you your retirement allowance.
Other Factors to Consider
- A retirement allowance transferred to an RRSP or used for regular contributions to an RRSP or SPP is no longer subject to either the federal or provincial alternative minimum tax.
- When choosing between the transfer value and a pension, the non-transferable portion of a locked-in retirement account (LIRA) cannot be considered as a retirement allowance.
- Some types of severance pay may affect the amount your employment insurance benefits. Find out how!
For more information on taxation, Flash Retirement suggests the following Websites: