In Ontario, you can legally avoid massive upfront withholding taxes on your severance pay by arranging for a direct rollover into your RRSP. By classifying your severance as a “retiring allowance,” your employer can send the funds directly to your financial institution, preserving 100% of your settlement for your retirement savings.
Finally settling a stressful wrongful dismissal lawsuit and securing a large severance package should feel like a victory. 😌 However, many workers in cities like Toronto, Kitchener, and London are shocked to discover that if their employer hands them a direct cash cheque, the Canada Revenue Agency (CRA) requires massive withholding taxes to be deducted immediately. For a large severance payout, the employer must legally withhold up to 30% right off the top. This means a $100,000 CAD settlement could quickly shrink to $70,000 CAD in your bank account.
Fortunately, Ontario employment law and federal tax rules provide a highly effective workaround. 📜 The CRA classifies severance pay and wrongful dismissal damages as a “retiring allowance.” Despite the word “retiring,” this applies to employees of any age. By utilizing your available Registered Retirement Savings Plan (RRSP) contribution room, you can direct your former employer to transfer the settlement funds straight into your RRSP without a single dollar being withheld for tax. This allows your money to continue growing tax-free until you eventually withdraw it.
Step-by-Step Process for an RRSP Severance Rollover
Executing an RRSP rollover requires coordination between your employment lawyer, your former employer, and your financial institution. 📋 If the money touches your personal checking account first, the tax advantages are temporarily lost. Here is the exact process to follow.
Step 1: Verifying Your RRSP Contribution Room
Before negotiating the settlement payout structure, you must know how much room you actually have. 🔍 Log into your “My Account” portal on the CRA website or check your most recent Notice of Assessment. If you have $40,000 CAD in available RRSP contribution room, you can shelter exactly $40,000 CAD of your non-eligible severance pay from immediate taxation. Any amount above your limit must be paid in cash and subjected to standard withholding tax.
Step 2: Drafting the Legal Settlement Documents
Your employment lawyer must explicitly include the RRSP rollover terms in your final Full and Final Release or settlement agreement. ✋ The legal document needs to instruct the employer to pay a specific portion of the “retiring allowance” directly to your financial institution. If the settlement agreement does not specify this, the employer’s payroll department will default to writing you a standard, heavily taxed cheque.
Step 3: Completing the Necessary Transfer Forms
To authorize the direct transfer, you will usually need to provide your employer with your RRSP account details. 💰 While the CRA officially uses Form T2151 for eligible retiring allowances, for modern (non-eligible) severance pay going into regular RRSP room, most Ontario employers simply require a direct transfer letter from your bank outlining the account number, institution number, and transit number.
Step 4: Filing Your Taxes the Following Year
When tax season arrives, your employer will issue you a T4 slip with the retiring allowance amount listed in Box 66 or 67. 📝 You will also receive an RRSP contribution receipt from your bank. When you file your return, these two amounts will offset each other, ensuring you do not owe any additional income tax on the rolled-over severance funds for that calendar year.
How Much Does it Cost to Structure a Settlement?
Handling the tax implications of your severance is usually built into the overall legal representation process. 💸 Here are the typical costs for legal and financial advice in Ontario:
- Employment Lawyer Fees: Most lawyers will negotiate the RRSP rollover language as a standard part of their contingency fee (which is typically 25% to 35% of your settlement).
- Hourly Legal Work: If you are just hiring a lawyer to review an already-offered severance package and draft the RRSP instructions, expect to pay $400 CAD to $800 CAD for a comprehensive consultation.
- Financial Advisor Fees: Consulting a fee-only financial planner to strategize your RRSP limits and tax brackets generally costs between $200 CAD and $400 CAD per hour.
How Long Does the Rollover Process Take?
Once the final settlement agreement is signed by both parties, processing the RRSP transfer is relatively fast. ⌛ Most corporate payroll departments in Ontario require 2 to 4 weeks to issue the funds. Because the cheque is being mailed or wired directly to a major financial institution, bank clearing times may add an extra 3 to 5 business days before the funds show up in your investment dashboard.
Direct Cash Payout vs. Direct RRSP Rollover
| Payout Method | Withholding Tax Rate (Federal & Provincial) | Immediate Financial Result (Example: $50,000 Severance) |
|---|---|---|
| Direct Cash Payout | 10% up to $5,000 | 20% up to $15,000 | 30% over $15,000 | The employer withholds $15,000. You receive $35,000 in your bank account. |
| Direct RRSP Rollover | 0% Withholding Tax applied at the source. | The full $50,000 is transferred directly into your RRSP to grow tax-deferred. |
Frequently Asked Questions (FAQ)
Can I rollover my severance to a Spousal RRSP?
Yes. If you have available RRSP contribution room, you can direct your employer to transfer your severance pay directly into a Spousal RRSP. This is an excellent tax strategy in Ontario if your spouse is expected to be in a lower tax bracket during retirement.
What happens if I take the cash first and put it in my RRSP later?
If you take the cash, the employer MUST deduct the 30% withholding tax. While you can manually contribute the remaining cash to your RRSP later and get a massive tax refund the following spring, you lose the ability to invest that 30% during the current year. Direct transfer is always better.
What is the difference between an ‘Eligible’ and ‘Non-Eligible’ retiring allowance?
An ‘Eligible’ retiring allowance applies only to years of service before 1996, which grants you bonus RRSP room that does not affect your regular limit. A ‘Non-Eligible’ retiring allowance applies to all employment after 1996. It can still be rolled over tax-free, but it uses up your standard, accumulated RRSP deduction limit.
Are my legal fees tax deductible in Ontario?
Yes. Under the Income Tax Act, you can generally deduct the legal fees you paid to collect or establish your right to a retiring allowance (severance pay). Your employment lawyer will provide you with an itemized invoice to present to your accountant at tax time.
Leave a Reply