Check out the various options for your retirement allowance

The terms retirement allowance and severance pay are essentially the same thing.  Whether you are retiring or losing your job you may be offered some additional related amounts on top of your final employment income.

This additional pay is often confusing for people, especially if they are given options for how the amount is to be paid.   Most people are not familiar with the terms or the outcomes of different choices.  A time frame is often noted on the forms making the choice even more stressful during an emotional time.

One of the first items we review is the tax consequence of the different payments.  Don’t leave this to the last minute.  Spend the time to map out a tax smart plan with your accountant and financial advisor.  As your income may be about to change, a little planning can easily reduce the amount of tax you pay.

Income Tax Act

People who have worked for a company for a long period of time may be eligible to roll a portion of their retirement allowance into their RRSP without using your RRSP deduction limit.  The amount that may be eligible to transfer into your RRSP is outlined in the Income Tax Act and is limited to $2,000 for each year or part of a year before 1996.  For those employed prior to 1989 the limit is increased by $1,500 unless the employer vested the contributions to a company pension plan.  Simply put, if you began working for a company before 1996 you may have an eligible portion.  If you began working after 1995 then you will not have an eligible portion.

Taking advantage of contributing the eligible portion of a retirement allowance to an RRSP generally makes sense, especially if your income will be lower in future years.   Your employer should be able to tell you how much is eligible, in any.

Non-Eligible

If you began working after 1995 for your current company then you will not have an eligible portion.  You may still contribute the non-eligible portion to your RRSP, or to a spousal RRSP, up to your available RRSP deduction limit.   The company paying you the retirement allowance is required to withhold income tax unless you instruct them of your deduction limit and the portion you would like to contribute to your RRSP.

If you provide these instructions to your employer then they do not have to deduct income tax on the amount of the retiring allowance that you transfer to your RRSP.  Using your RRSP deduction limit at retirement is often prudent, especially if you do not have plans for further employment.

Lump sum payments made directly to you are subject to withholding tax.  If the amount is below $5,000 then 10 per cent withholding tax is applied.  If the amount is $5,000 to $15,000 then the rate is 20 per cent.  Amounts over $15,000 are subject to a withholding tax rate of 30 per cent.  The actual amount of tax will be calculated when you file your annual income tax return.

T4A

If you have received a retirement allowance during the year you should ensure you receive a T4A prior to filing your annual tax return.  The T4A will have the income amounts as well as the income tax deducted at source.  The non-eligible portion of a retirement allowance is fully taxable in the year the amount is received.   Both the eligible and non-eligible amounts are reported on a T4A.  The amount of retiring allowance paid in the year should be reported in either Box 26 (eligible amounts) or Box 27 (non-eligible amounts).  It is possible to have amounts in both boxes for the same year.

Timing

Some employers may provide the option for you to receive a retiring allowance as a lump sum payment or to be paid out over two or more years.  If you retire in January then the lump sum payment may be the best choice, as your employment income will be minimal.  Chances are you will have some RRSP deduction limit as well that may be used.

If you retire later in the year then you may be in a situation of high employment income plus a retirement allowance on top of this.  Deferring a portion of a retirement allowance may assist both you and the company.  The company benefits in that they do not have to come up with a lump sum immediately.

Deferring a portion of the retirement allowance may also make sense if you are moving the taxable income from a high marginal tax bracket (if taken immediately) to a lower marginal tax bracket if deferred one or more years.  Your retirement date, current income, future income, and specific details of these payments need to be reviewed.

If you are planning to look for work immediately you should ask how finding new employment might impact the retirement allowance if a deferral option is selected.  In some packages we have reviewed, the deferred retirement allowance is lost if you begin working again.

Retirement Package

Retirement packages should always be reviewed with your accountant and financial advisor.  In some situations, we recommend meeting with your lawyer to determine if the package being presented is fair given your situation.  Retirement packages typically have other important components, such as your pension plan, that also needs to be reviewed.  Planning retirement, or a sudden loss of a job, are two very important “life events” that should always involve your financial advisor.