Introduction
Retiring allowances, which have nothing to do with retirement, but can assist individuals losing their jobs to shelter much of their severance payments. They can also play a powerful tax-planning role in business succession planning for owner managed businesses.
Comments
These allowances include payments in recognition of long service or “in respect of” a loss of employment, as well as special damages that might result from litigation.
They do not, however, include payments for actual damages such as human rights violations, harassment, or personal injury. (See below for a list of other payments that do not qualify).
Employees hired before 1996 by an employer paying the retiring allowance can transfer some, or all, of the amount into a Registered Retirement Savings Plan (RRSP) or other registered plan, and defer paying taxes until the money is withdrawn.
For each year or partial year of employment before 1996 with a current employer, $2,000 can be transferred to a registered plan. For years of employment before 1989, an additional $1,500 per year can be transferred, as long as the employee was not a member of a registered pension plan with the employer.
The employer can deduct the allowance in the year it is paid, but the employee may not have to pay tax for several years. This is why retiring allowances are one of the best tax planning tools available for business succession in private corporations.
Let’s assume you own a business that you incorporated in 1976 when you were 35 years of age. You are now planning to retire at 65 and want to pass the business on to your children.
Because you were active in the business, and are a shareholder and director, the company may not have been paying actual wages to you for some years. Nevertheless, for tax purposes you are considered an employee.
Now let’s further assume you were an employee for 20 years before 1996 and 13 years before 1989. As much as $59,500 is eligible fortransfer to a Registered Retirement Savings Plan ($2,000 times 20 years [$40,000] plus $1,500 times 13 years [$19,500]).
You receive that money tax free, and can defer taxes on it for at least six years. When you turn 71 years of age, you will pay tax on the minimum withdrawal required from a Registered Retirement Income Fund (RRIF). However, it will be several years before you withdraw the full amount and in the meantime it grows tax-free.
What Doesn’t Qualify?
In addition to payments for actual damages in a lawsuit, other payments do not qualify as retiring allowances include:
- Superannuation or pension benefits.
- Money received as a consequence of the death of an employee.
- Salary or wages.
- Accrued vacation pay.
- Money received out of, or under, an employee benefit plan or a salary deferral arrangement.
- Retention bonuses for reporting to work until the termination date.
Amounts received upon or after retirement when a low (or no) salary was received before retirement may not qualify. This money is likely to be regarded as deferred compensation, which is taxable as income when received.
Conclusion
Joe Truscott has been advising his clients in the area of determining the amount of Retiring Allowances that qualify under the Income Tax Rules for over 30 years. He has also assisted former employees in correctly structuring their settlements with their former employers to minimize their personal income taxes. If you wish to engage Joe’s services with respect to structuring payments to a retirement savings plan, or minimize the taxation of amounts received from your prior employer, please do not hesitate in contacting Joseph A. Truscott, Chartered Accountant at 905-528-0234 ext: 224, or email Joe at [email protected].
November 2012
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