Planning for a Loss of Employment in Canada
Losing your job is a dramatic and stressful life event that can have a profound effect on your finances. If you’re faced with the loss of employment, having a good financial plan and being familiar with the following tax strategies could be invaluable.
Deduct your legal costs
If you lose your job, any legal fees you pay to collect a severance or retirement allowance or a pension benefit are tax deductible on line 232 of your return. You can claim fees only up to the amount of the payment received in the year — minus any amount transferred to your RRSP (Registered Retirement Savings Plan). If you cannot claim all your legal fees in the year paid, they may be able to be claimed over the next seven years.
Roll over your pension
The funds in your Registered Pension Plan (RPP) are locked in so they will be there to provide you with an income on retirement. If you leave your employer you can’t simply receive a cheque for the value of your pension savings. You will need to choose one of the following three options:
Roll your existing pension into your new employer’s pension.
Leave it where it is and take your pension from that company when you retire.
Transfer your money into a locked-in retirement account (LIRA).
It’s advisable to consult with a qualified and experienced financial professional to help you decide which of these options is for you. Your future financial security could depend on you making a good decision.
Shelter your retiring allowance
Don’t be confused by the term retiring allowance — it doesn’t apply only to payments you receive when you retire. In fact, it also includes what people normally refer to as severance or termination pay, as well as to a court award or settlement for wrongful dismissal.
Portion of retiring allowance eligible for RRSPs
Retiring allowances are taxable. However, when you leave your employer and receive a retiring allowance, you might be able to pay a portion of your payment into your RRSP. This portion is called your eligible retiring allowance. If you choose to do this, you include the full amount of the allowance on line 130 of your tax return, but a deduction is given on line 208 for the amount paid to your RRSP. If those two amounts are the same, you will effectively receive the retiring allowance tax-free — at least until the time you make withdrawals from your RRSP.
Not all retiring allowances are eligible for transfer into your RRSP. In fact, the Income Tax Act sets limits on the amount of retiring allowance you can have paid into your RRSP. The limit is calculated as follows:
$2,000 per year or part year of employment service prior to 1996, plus
$1,500 per year or part year of employment service prior to 1989 in which you had no vested interest in any employer’s contributions to a registered pension plan or deferred profit-sharing plan.
So, if you worked for an employer from, say, 1997 to 2009, any retiring allowance paid to you would not be eligible for the special transfer into your RRSP. Too bad!
Suppose Alex left her employer in 2010 and received a $50,000 termination payment. She had started working there in 1985 and joined the pension plan in 1987.
The amount she can have paid to her RRSP is calculated this way:
|$2,000 x 11 years (1985 to 1995)||$22,000|
|$1,500 x 2 years (1985 to 1987)||$3,000|
|Eligible portion of retiring allowance that can be paid to her RRSP||$25,000|
The amount of a retiring allowance that can be paid to your RRSP and deducted on your personal tax return is over and above your regular RRSP contribution (or deduction) limit. You can still make your regular RRSP contribution in addition to this special contribution. It’s not critical that the retiring allowance be paid directly to your RRSP. However, you must contribute the funds to your RRSP within 60 days following the end of the year in which you receive the payment. For allowances received in 2012, this means the contribution must be made by March 1, 2013, or you lose your right to this special contribution.
The eligible portion of a retiring allowance can be rolled into an RRSP of which only you are the annuitant. It cannot go into a spousal RRSP.
Ineligible portion of retiring allowance
Any allowance received in excess of the amount you can have paid to your RRSP under the rules outlined above is considered an ineligible retiring allowance. In other words, the ineligible retiring allowance is any portion paid to you that relates to your employment from 1997 on. This amount is reported in box 27 of your T4A, and must be reported on line 130 of your income tax return. The ineligible portion of a retiring allowance does not open up new RRSP room for you.
A couple of tips may help ease the tax burden on any ineligible portion of a retiring allowance:
If you have regular unused RRSP contribution room, consider making an RRSP contribution with your ineligible retiring allowance. In fact, you can have your employer send the portion that you are going to contribute directly to your RRSP and avoid any withholding tax. To do this you must show your employer that you have the RRSP contribution room available.
Consider asking to receive the retiring allowance payment over a number of years. You don’t have to pay tax on a retiring allowance until it’s received, so this can help to defer tax to a year when you may be in a lower tax bracket. If any concern exists your former employer may run into financial trouble in future, take your money and run. Paying tax on income is much better than not receiving income at all.