The pandemic has greatly slowed many economies and unfortunately, some companies have been forced to cut staff due to loss of revenue. As an alternative to layoffs or terminations, some companies are offering retiring allowances (also called severance payments) to employees nearing retirement age, as an incentive to leave voluntarily while still reaping a financial benefit. For those who might find themselves being offered a “package” to retire, there are important items to consider.
What is a ‘Retiring Allowance’?
A retiring allowance is an amount paid to officers or employees when or after they retire from an office or employment, in recognition of their many years of service and to compensate them for the loss of employment.
Retiring allowance payments generally include the following:
- Payments for unused sick-leave credits on termination
- Amounts individuals receive when their office or employment is terminated, even if the amount is for damages (for wrongful dismissal, which occurs when a person is terminated without sufficient notice under the law)
Retiring allowance payments do not include:
- Salary, wages, bonuses, overtime, and legal fees.
- A superannuation or pension benefit.
- An amount an individual receives as a result of an employee’s death (these payments may be treated as death benefits).
- A benefit derived from certain counselling services.
- Payments for accumulated vacation leave not taken before retirement.
- Wages in lieu of termination notice.
- Damages for violations or alleged violations of an employee’s applicable human rights awarded under human rights legislation, to the extent these amounts are not taxable.
Options for Transfering a Retirement Allowance
You may be able to contribute (transfer directly or indirectly) part or all of your retiring allowance to your registered retirement savings plan (RRSP), registered pension plan (RPP), pooled registered pension plan (PRPP), or specified pension plan (SPP).
The conditions for such a transfer are as follows:
Employees with years of service before 1996 may be able to directly transfer all or part of a retiring allowance to a registered pension plan (RPP) or a registered retirement savings plan (RRSP). This part is commonly referred to as the eligible portion or the amount eligible for transfer. A retiring allowance may include an eligible portion and a non-eligible portion. The portion that does not qualify, the non-eligible retiring allowance, can only be contributed to your RRSP if you have unused RRSP contribution room.
A retiring allowance may be paid to the recipient over one or more years. The amounts paid in any particular year may be transferred to an RRSP or an RPP. The amounts transferred cannot exceed the employee’s eligible portion of the retiring allowance, minus the eligible portion you transferred in a prior year.
The amount that is eligible for transfer under paragraph 60(j.1) of the Income Tax Act (the Act) is limited to:
- $2,000 for each year or part of a year before 1996 that the employee or former employee worked for you (or a person related to you), plus
- $1,500 for each year or part of a year before 1989 of that employment in which none of your contributions to a pension plan or deferred profit-sharing plan (DPSP) were vested in the employee’s name when you paid the retiring allowance. To determine the equivalent number of years of vesting, refer to the terms of the particular plan. The number can be a fraction.
A rollover of a retiring allowance under paragraph 60(j.1) of the Act involves amounts an employee receives for services rendered before 1996. The amount the employee can rollover, tax-free, cannot be more than the amount shown on their T4 slip as Eligible Retiring Allowances. Only the eligible portion of a retiring allowance can be contributed to an RRSP if the contributor is also the annuitant. In this case, the rollover is completed regardless of the RRSP room available to the person receiving the retiring allowance.
For example, if an employee receives $60,000 payable in instalments of $10,000 per year over 6 years and has an eligible amount of $40,000, the employee can choose how they want the eligible and non-eligible portions applied to the instalment payments in each year.
If you have been offered or given a retiring allowance to compensate you for the elimination of your employment, please contact the Chartered Professional Accountants at Edelkoort Smethurst Schein CPAs LLP to make sure that you get the best advice on minimizing the income tax impact. You can reach us by calling 905-517-2297 or by contacting us online. Their consulting expertise will help you make the best decision for you and your family.