When an employee’s employment is terminated without cause, the employee will typically receive some form of a termination/severance payment. All or part of this termination/severance payment may be considered a “retiring allowance” under the Income Tax Act, providing the employee with additional options in respect of the allocation of the payment.
Whether a payment qualifies as a “retiring allowance” will depend on the reason for the payment. Under the Income Tax Act, a retiring allowance is an amount paid to an employee on or after the date his or her employment terminates for the purpose of recognizing long service, or for the loss of employment. As a result of the definition of “retiring allowance”, a payment made pursuant to the applicable employment standards legislation may or may not qualify as a retiring allowance, depending on the circumstances.
Employees with service prior to 1996 may be able to take advantage of preferential tax treatment by transferring part of their retiring allowance to a registered retirement savings plan (RRSP) or registered pension plan (RPP) regardless of their “contribution room”, up to certain limits.
The portion that can be transferred directly to a RRSP or RPP regardless of the contribution room is commonly referred to as the ‘eligible portion’ of the retiring allowance.
Here is how to calculate the eligible portion of a retiring allowance:
- $2,000 for each year or part of a year of service before 1996 that the employee or former employee worked for the employer (or a person related to the employer); plus
- $1,500 for each year or part of a year of service prior to 1989 of that employment in which none of the employer’s contributions to a RPP or deferred profit sharing plan were vested in the employee’s name when the employer paid the retiring allowance.
Eligible portion of a retiring allowance:
The eligible portion of a retiring allowance must be transferred directly into the employee’s RRSP or RPP on a tax-free basis. It is not determined by, nor does it affect, the employee’s regular RRSP contribution room. The direct transfer of the retiring allowance to an RPP may result in a pension adjustment (PA) that will affect the employee’s RRSP deduction limit in subsequent years. Note that an employee cannot transfer any part of an eligible retiring allowance directly to a spousal or common-law partner RRSP.
Ineligible portion of a retiring allowance:
The non-eligible portion of a retiring allowance (i.e. amounts over and above the eligible portion) may also be transferred directly into the employee’s RRSP, or a spousal or common-law partner’s RRSP, if the employee has the available RRSP contribution room. If the transfer is made directly to the RRSP, tax need not be withheld.
Things to keep in mind:
- Contributions to an employee’s RRSP can only be made until the end of the year in which he or she turns age 71.
- Employers contributing remuneration directly to an employee’s RRSP on his or her behalf should have reasonable grounds to believe that the employee has sufficient RRSP contribution room and can deduct the contribution for the year.