Work interrupted – Coping with an involuntary career transition

Severance planning options to help you through job loss

Job loss is a risk that all employees face. It can happen at any time, but can be a particularly widespread concern when the economy is in recession. In that case, you’ll need to be prepared that, despite your own conscientiousness, you could be displaced by events beyond your personal control.

While you may not be able to completely insulate against it happening, you can prepare yourself by establishing financial habits and obtaining tax knowledge to weather through it if it does, and emerge sooner and as intact as possible on the other side.

Having a bridge fund

As a type of emergency fund, this bridges the household until the primary or sole breadwinner can get back into financial production. Ideally, you’d have this in place well beforehand, but even if you don’t, it’s a habit and mindset that will serve you well if you’re beginning to get nervous about your workplace.

Generally, a three-to-six-month cushion is suggested. While this may serve the purpose, make sure it truly reflects your personal job outlook and spending habits. Without dwelling on it too much, ask yourself on an annual basis what your prospects would be if you had to look for work. And on the spending side, understand what goes respectively toward necessaries, discretionaries, and luxuries, and how you will place the latter two on hiatus when required.

Job loss in the moment

It’s an emotional shock, but you need to maintain a clear head in a compressed timeline. The decisions you make will have both immediate and long-term effects. Within that, tax is sometimes simply part of calculating what you have no control over, and in other cases it is a critical contributor to those decisions.

Nature of a payout

Without getting into the minutia of how each is calculated, your employer may owe you one or more of the following, all of which are subject to income tax:

- Severance pay — Based on length of your employment, when you are let go without any fault on your part
- Termination pay — In lieu of providing advance notice of the last day of employment
- Vacation pay — Earned but unused vacation entitlement
- Lump sum — Accrued benefits (e.g., banked sick days) that may be owed to you on departure

Withholding for income tax, Canada Pension Plan, and Employment Insurance will apply if severance pay is in the form of salary continuance. However, if it is paid as a lump sum, only the income tax is deducted. As well, if your employer agrees to spread payments over two or more years, that could ease the tax cost if you are in a lower bracket on each receipt.

Benefit continuation and replacement

Losing health and dental insurance can be an extra disruption, especially if you or your family have upcoming appointments. Ask if coverage could be extended for a time to relieve some of the burden.

For group life insurance, you are usually able to buy replacement coverage without medical underwriting from the current benefits company. That’s especially important if you’re no longer insurable, but otherwise you may be able to reduce your cost by shopping the market.

Retirement funds

Transfer to RRSP — When a large payment comes, you can direct some of that amount to your RRSP if you have room. This will protect against income tax, but be sure that you still keep enough cash on-hand to carry you through your expected unemployment time.

Registered pension plan (RPP) — Defined contribution plans can generally be transferred to a locked-in RRSP without any tax issues. Defined benefit plans are more complicated, with possibilities ranging from remaining in the plan, beginning the pension immediately, transferring to the plan of a new employer, or commuting into a locked-in RRSP. Your pension administrator will provide you with a package to review, so get out your reading glasses and fine-tooth comb.

Retiring allowance — Extra one-time RRSP room is available on severance pay to a longstanding employee. It is $2,000 for every year you’ve been with the same or related employer before 1996, plus $1,500 for each year before 1989 for which employer contributions to an RPP or deferred profit-sharing plan (DPSP) have not vested. Contributions must be to your own RRSP (i.e., not to a spouse), and the room cannot be carried forward.

Recovery to re-employment

On top of managing your spending, it’s important to keep your debt under control. At a minimum, make the minimum payments to keep your credit in good standing, bearing in mind that potential future employers will likely do a credit check before hiring.

If you are feeling overwhelmed, consult your financial advisor, a credit counselling service, or an insolvency trustee. They can advise on negotiating with creditors, and discuss whether debt consolidation may be appropriate.

Finally, when you do get resituated, understand and keep an eye on any probationary period you may be under. You should continue to operate with your streamlined spending rules until that period has passed, but in time things will normalize to a new routine, with your future back on track.

The information contained in this article was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. This material is for informational and educational purposes and it is not intended to provide specific advice including, without limitation, investment, financial, tax or similar matters. This document is published by Aviso Wealth and unless indicated otherwise, all views expressed in this document are those of Aviso Wealth. The views expressed herein are subject to change without notice as markets change over time.

Payment ahead of retirement – Can that be a retiring allowance?

Our company’s information line has received a string of similar inquiries from advisors in the same locality in recent months. The issue is the potential tax treatment of certain employment-related payments anticipated by their clients.

A large employer in the area intends to make a current payment in lieu of what might otherwise be due upon retirement, with retirement itself still being a brief but undefined number of years away. The rationale for the employer appears to be a desire to crystalize the liability and take it off the books.

The question is whether under the Income Tax Act such a payment might constitute a “retiring allowance,” with its associated tax consequences.

Desirable tax treatment

The benefit of characterizing the payment as a retiring allowance is the recipient may direct a portion of the payment to her RRSP without having to reduce RRSP contribution room. The eligible amount for this purpose is:

$2,000 for each year or part year of employment prior to 1996, plus
$1,500 for each year or part year of employment prior to 1989 for which there were no vested or past-paid pension or deferred profit sharing plan benefits.

Payment on or after retirement

A retiring allowance is generally an amount that is received:

on or after retirement of a taxpayer from an office or employment in recognition of the taxpayer’s long service, or
in respect of a loss of office or employment of a taxpayer, whether or not received as, on account or in lieu of payment of, damages or pursuant to an order or judgment of a competent tribunal.

Where the amount qualifies under the first arm of the rule, the payment must be “on or after retirement,” and may in fact be significantly later than the actual retirement date. In one case, the Canada Revenue Agency argued it could be as much as eight years later.

Payment prior to retirement

Keeping with that first arm of the qualification rule, CRA has acknowledged that payment of unused sick leave could qualify as a retiring allowance. In one CRA technical letter, however, the Agency opined that payment five months ahead of time was too far in advance to be contemporaneous with retirement.

On the other hand, the second arm of the rule does not stipulate the time at which a payment must occur. In keeping with this, CRA’s administrative approach is to allow the possibility of a payment before retirement. To qualify, the termination should be certain to occur on a specific date, and the time frame must be reasonable.

Under either arm of the qualification rule, it would appear to be a challenge to be treated as a retiring allowance, but that remains for the client’s accountant or lawyer to advise upon, based on a closer examination of the nature of the payment and surrounding circumstances.

Saving when downsized – Choosing between RRSP and TFSA

An old friend was let go from her employment just before the summer. It came as a shock, even though the company warned staff about headcount concerns in the continuing sideways economy.

While her ego was bruised, her skill set remained intact and she had access to immediate outsourcing support. But with the summer ahead, she wondered how soon she would get back to work, assuming that the job market would be sluggish for the season.

Savings options for terminal pay

Meanwhile, she hadn’t even received her final paycheque. The company offered to have a portion of the terminal pay directed to her group RRSP, but needed her instructions soon. This only added to her stress.

She had three choices:

To allocate a dollar to RRSP, meaning a full payroll dollar was invested immediately.
She could invest in her individual RRSP using after-tax funds (though the contributed amount would be deducted from income when filing her taxes).
She could invest those after-tax funds in a tax-free savings account (TFSA). Then there would be no further implications at tax-filing time.

Funding an extended absence

What if my friend was right about the summer job market? What if she couldn’t find a suitable position as the fall months rolled on? Without an emergency fund, terminal payments earmarked for savings could be needed for current expenses.

Suppose she chose the RRSP route. As she would be subject to withholding tax (see table, “Withholding tax rates”) on a withdrawal from an RRSP, she would have to withdraw an amount greater than her specific need to net down to the necessary spendable cash. In the extreme, she would have to withdraw more than the original contribution to return to her initial cash position.

Even worse, she would still pay tax on that RRSP draw if the withholding tax fell short of the actual tax due when she files her tax return. And what if she continued to be on the job hunt into the new year? On top of that, the exhausted RRSP room is non-recoverable.

This situation is ideal for using a TFSA for at least a portion of the savings allocation. If unemployment continues, then a withdrawal is less complicated and less costly. There is no withheld or outstanding tax, and the withdrawal amount is a credit to future TFSA contribution room.

And if she is back on the job sooner than expected — as she is, by the way — she can transfer TFSA savings to her individual RRSP, once she’s comfortably settled into her new position.

Table: Withholding tax rates for RRSP/RRIF withdrawals

Amount General Quebec

Up to $5,000 10% 21%

> $5,000 to $15,000 20% 26%

> $15,000 30% 31%