Whether employment departure was voluntary on your part or not, there are many financial issues that should be reviewed and in some cases important choices need to be made.
Pay in lieu of actually Working
When your departure is involuntary, normally your employer will pay you in lieu of actually working throughout the notice period. This is “termination pay” and is employment income for tax purposes.
If you have been offered severance from your employer your first step should be to contact an employment lawyer. Contact us if you need a referral to an Employment Lawyer. You need to be assured that the amount offered meets the minimum severance requirements for your jurisdiction. In Ontario this is dealt with through the Ontario Employment Standards Act. In general the amount of severance should be a fair representation for the position you held in your company, your age, your length of employment and in some cases, the financial contribution you made to the company’s success.
Severance payments invite some tax considerations so qualified professional advice regarding this issue should be received. If you are leaving employment close to the end of the year, it might be possible to negotiate a deferral of all or part of the payment until the beginning of the next year to minimize the tax consequence to you.
Ordinarily, income received from your Employer must be included as taxable income in the year received. However if all or part of the money received qualifies as a “Retiring Allowance”, then you may be able to transfer that particular value direct to your RRSP without a deduction for income tax. Retiring Allowances include severance pay and unused sick credits. For each year or part year of service prior to 1996, you can transfer $2,000 direct to a RRSP and for each year or part year of service prior to 1989 when you were not part of a pension plan, you can transfer an additional $1,500.
RRSP transfer and unused Contribution Room
The amount that qualifies as a Retiring Allowance does not affect your unused RRSP contribution room. So of the balance of the severance that is available, all or part of it can be used to make a RRSP contribution. This will reduce your taxable income in the year of the severance which in turn will reduce the amount of taxes owing for the calendar year benefit return. Whether or not this is the right choice will vary from individual to individual. The size of the severance, your income needs during your employment transition, your financial status and of course the length of time it takes to return to the workforce will all be important considerations.
Registered Pension Plans (RPPs)
Pensions are subject to different federal and provincial laws and rules under the Income Tax Act. However while there are some general guidelines that can be used when an employee leaves a Company, a good starting point will be to contact your Human Resources or Benefits Manager to obtain specific options that are available to you. It will be important to find out if your existing pension plan is a Defined Contribution, Group RRSP or Defined Benefit Plan. The first two will have a published cash value on our statements while the Defined Benefit Plan is expressed in terms of a future pension income based on years of service. Sometimes these values can be converted to a cash value (commuted value) for the purposes of transfer.
One option may be to transfer your pension pan value to the pension plan of your new employer. However there can be significant differences between these two plans that may prevent this. If a transfer is possible, you will need to obtain detailed information about both plans and compare the features to determine if this is the right choice for you. Call us for assistance.
Another option may be to transfer the commuted value of your pension plan to a Locked in Retirement Account (LIRA), an Annuity.
Finally, depending on your age and years of service, you may be able to start collecting the pension benefits as income now.
Commuted Value Proposal System
If one of your options is to leave your Defined Benefit Pension Plan with your former employer, an estimate of the value of your future pension income will be provided. This may contain both a Bridge Benefit and a Lifetime Benefit. In addition your future pension income may or may not have inflation protection. The future value of your pension income will also depend on whether it is reduced based on the commencement date you choose and on what type of survivor option, if any, is elected. All of this means it may be difficult to know whether your Pension Plan should be left with your former employer’s plan or if the commuted value should be transferred to your LIRA/RRSP.
It is for this reason that I developed our Commuted Value Proposal System. It compares the projected pension income from a Defined Benefit Pension Plan to the projected income that can be generated when the commuted value is invested in the market. Together with our retirement income planning service, “Your Retirement Map”™ we can help you make the right choice.
Deferred Profit Sharing Plans (DPSPs)
Several options also exist if you were a member of our company’s DPSP. Since contributions are made by the Employer, there usually is a vesting period during which time you are not entitled to benefits. However if the vesting period has expired (normally two years) you may have similar transfer options as those described above.
Contact a Hamilton Financial Planner today. We can show you how to make the best use of your severance package and help you make the right choices with respect to any Group RRSP or Pension Plan.