Understanding your severance pay

From: Financial Consumer Agency of Canada

Severance pay is money your employer pays you when you lose your job through no fault of your own.

Your employer may also offer you benefits when you lose your job. They may call it a severance package, severance agreement or retiring allowance.

How much severance pay you may receive

The federal, provincial and territorial governments make regulations about severance pay. In some cases, you may not be eligible for severance pay. For example, you may not be eligible if you’ve worked for your employer for only a short time.

To find out what severance pay to expect, review documents that outline your salary and terms of dismissal.

These documents may include:

  • a letter of offer you received when you first started your job
  • an employee handbook

The amount of money you’ll receive depends on the following:

  • regulations in your province or territory
  • your union’s collective agreement
  • your employment contract
  • how long you worked for your employer
  • why you lost your job

The federal government regulates certain industries, such as banks and air transportation. If you work in one of these industries, federal law will decide how much your employer may owe you.

Find out about labour regulations when you work in a federally regulated industry.

Review a list of federally regulated industries and contacts for provincial and territorial ministries of labour.

Consider your severance package options

Before you get your severance pay, you’ll need to sign an agreement that contains the details of the severance pay or package. Read the agreement carefully before signing it.

You’ll usually have time to review the severance agreement in detail. Speak with a lawyer if you have any questions or concerns.

Severance agreements

Your agreement should identify how much you’ll get in severance pay and how much you have in your pension.

Your severance agreement may include benefits. For example, your employer may offer you help finding a new job.

For every benefit your employer offers you, make sure you understand the following:

  • what your employer will cover as part of the severance package
  • how long coverage will last
  • what fees or premiums you’ll need to pay to get coverage

How you’ll receive your severance pay

Your employer will provide your severance pay in one of the following ways:

  • as a lump-sum payment
  • as a salary continuance. This means that your regular pay and benefits continue for a limited time after you lose your job
  • as deferred payments. This means that you’ll receive your severance pay over several years

In some cases, your employer will let you choose how you get paid.

How your employer pays your severance pay may affect Employment Insurance (EI) benefit payments.

Learn more about Employment Insurance benefits.

Paying income tax on your severance pay

You must pay income tax on severance pay.

How much tax you pay depends in part on how your employer pays your severance pay. For example, you may pay less tax if you get a salary continuance instead of as a lump-sum payment.

Paying income tax on lump-sum severance payments

If you get your severance pay as a lump sum payment, your employer will deduct the income tax.

The amount of tax depends on the province or territory you live in and the total amount of severance pay. Your employer won’t deduct Canada Pension Plan (CPP) contributions, Quebec Pension Plan (QPP) contributions and EI premiums.

Find out how much tax your employer must withhold from lump-sum payments.

Lump-sum severance payments transferred directly into a Registered Retirement Savings Plan

Your employer may give you your severance pay as a lump-sum payment. In that case, you may ask them to transfer it directly to your Registered Retirement Savings Plan (RRSP). They may also transfer it to your Registered Pension Plan (RPP).

This means your employer won’t deduct income tax from the lump-sum payment. Instead, you’ll pay tax on the money when you take it out of your RRSP or RPP.

You must have enough RRSP contribution room available to transfer your severance pay directly into your RRSP. However, there is an exception for severance pay that applies to years worked before 1996. For that period, you can transfer up to $2000 per year directly into your RRSP without affecting your deduction limit.  

Find out how to transfer your lump-sum payments to an RRSP or RPP.

Paying income tax when you get severance pay as a salary

In some cases, you’ll get your severance pay as a salary continuance. This means your regular pay and benefits will continue for a set period after you leave your job. You pay income tax on this type of severance payment like you would on regular employment income.

The usual income tax deductions apply, including:

  • CPP or QPP contributions
  • EI premiums
  • RPP contributions

Paying income tax on deferred severance payments

Some employers may allow you to spread your severance pay over 2 or more years. You pay income tax only on the income you make in a given year. Spreading out your severance pay over several years may lower the amount of income tax you’ll owe each year.

If you have more than one source of income

You pay income tax on all the money you earn each year. You may have another source of income. In that case, you may owe more income tax than what your employer deducts from your severance pay.

Try to set aside enough money to pay any additional income taxes when getting a severance pay.

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