Retiring Allowance in Canada: Transferring, Saving and Taxes

Retiring from your career is a major milestone that requires thoughtful financial planning. For many Canadians, a key component of retirement preparation involves properly managing any retiring allowance they may receive from their employer.

Our article will cover everything you need to know about retiring allowances in Canada.

What is a Retiring Allowance?

A retiring allowance, also known as termination pay, severance pay, or retirement gratuity, is a payment made to an employee upon retirement or termination of employment. It is paid in recognition of long service or as compensation for loss of employment.

According to the Canada Revenue Agency (CRA), a retiring allowance may include:

• Payment for unused sick leave credits upon termination
• Lump sum payment when employment is terminated for any reason

The key is that the payment must be tied directly to loss of employment, not just bonus income.

The following are NOT considered a retiring allowance:

• Salary, overtime pay, vacation pay
• Pension, superannuation or annuity payments
• Death benefit payments
• Payments for unused vacation time

Understanding the distinction between a retiring allowance and other forms of employment income is important. This will determine how payments are treated for tax purposes.

Source: Government of Canada, Retiring allowances

How is a Retiring Allowance Taxed in Canada?

According to the Income Tax Act, retiring allowances are fully taxable as income in the year received. However, special rules allow retirees to reduce taxes by transferring all or part of their allowance into their registered retirement savings plan (RRSP) or registered pension plan (RPP). The key is understanding the difference between eligible and non-eligible portions.

Eligible vs Non-Eligible Retiring Allowances

Retiring allowances can be divided into two components:

Eligible retiring allowance – The amount that can be transferred to an RRSP without impacting your RRSP contribution room.

Non-eligible retiring allowance – Any amount exceeding the eligible retiring allowance is considered non-eligible. This portion can still be contributed to an RRSP or spousal RRSP, but it will use up your RRSP contribution room to avoid a penalty.

With proper planning, both eligible and non-eligible amounts can help maximize your retirement savings.

Withholding Tax on Retiring Allowances

When an employer pays out a retiring allowance, they are required to withhold income tax. The withholding amount depends on the size of the payment:

However, there are options to reduce withholding taxes:

• Direct transfer to RRSP: No withholding tax if transferred directly by the employer
• Form T1213: File this form to request a reduced withholding tax rate
• 60-day transfer: Transfer after receipt and claim refund when filing taxes

With proper planning, you can minimize withholding taxes and retain more of your retirement allowance.

Source: Canada Revenue Agency, Employers’ Guide – Payroll Deductions and Remittances

How Can I Transfer My Retiring Allowance?

There are two ways to transfer a retiring allowance:

• Direct transfer: Your employer transfers the funds directly into your RRSP / RPP
• Indirect transfer: You receive the funds personally and then contribute to your plan independently

A direct transfer is simplest since it avoids withholding taxes. Talk to your employer about their process and limitations. For indirect transfers, be sure to contribute within 60 days to defer taxes. Keep records for your tax return.

Here are the key rules and considerations on how to transfer your retiring allowance:

Eligible Allowance Transfer Rules

The eligible portion is calculated based on your years of service with the employer paying the retiring allowance:

• $2,000 for each year or part year of employment before 1996
• Plus $1,500 for each year before 1989 in which you were not covered by a pension plan or DPSP

For example:

• Mark worked for ABC Company from 1985 to 2020 (35 years).
• His eligible allowance is:
  • $2,000 x 11 years (1985-1995) = $22,000
  • Plus $1,500 x 4 years (1985-1988) = $6,000
  • Total eligible portion = $28,000

This eligible portion can be directly transferred into an RRSP without impacting the contribution ro

For the eligible portion, special rules apply:

• Must be transferred into an RRSP in your name (where you are the annuitant)
• Your employer can transfer directly without withholding tax
• You can transfer within 60 days of receipt to defer taxes
• Does not reduce your RRSP contribution room

This provides significant flexibility to maximize your RRSP tax deferral.

Non-Eligible Allowance Transfer Rules

The non-eligible portion follows the standard RRSP contribution rules:

• Can be transferred to your RRSP or spousal RRSP
• Reduces your available RRSP contribution room for the year
• The transfer must be made within 60 days of receipt
• You need RRSP room to avoid overcontribution penalties

Proper planning is key to avoiding negative tax implications.

Transfer your retiring allowances to an RPP

Retiring allowances can also be directly transferred into an RPP without impacting your contribution room. This is beneficial if you have an RPP from your former employer or a new employer. Talk to your plan administrator for details.

Is it possible to transfer a retaining allowance to a spousal RRSP?

Unfortunately, the eligible portion cannot be transferred into a spousal RRSP under the special rules. However, the non-eligible portion can be contributed to a spousal plan if you have an RRSP room available. A spousal RRSP involves contributing to a plan in your spouse’s name to split retirement income for tax purposes.

Rollover Payments Over Multiple Years

If you receive your retiring allowance in installments over multiple years, the special transfer rules still apply:

• You can transfer each year’s payment to an RRSP or RPP
• The amount transferred cannot exceed that year’s eligible portion
• The total cumulative transfers cannot exceed the total eligible allowance

This maintains the tax deferral benefits.

Source: Government of Canada, Transfer of a retiring allowance

What is the Best Way to Maximize Retirement Savings?

Here are 12 key strategies and tips to leverage your retiring allowance in Canada

• Take advantage of the eligible transfer rules to move funds into your RRSP without impacting the contribution room
• Contribute any non-eligible amounts to your RRSP or spousal RRSP if you have available room
• Consider an RPP transfer if you have a pension plan with a contribution room
• If you have no RRSP room, use non-registered investments and pay taxes annually
• Withdraw over several years to maximize transfers under the eligible allowance rules
• If over 71, consider transferring to a spousal RRSP or using other tax-deferral avenues
• Obtain professional advice to ensure you develop the optimal savings plan
• Invest transferred funds wisely to optimize growth – consider balanced funds, GICs, etc.
• Review asset allocation and risk tolerance as you get closer to retirement
• Understand all payout options – lump sum, installments, annuity payments
• Consider which assets to draw from first in retirement for optimal tax efficiency
• Get guidance on withdrawing funds from RRSP/RRIF in a tax-efficient way

Following these best practices will allow you to take full advantage of your retiring allowance and retire with greater financial security.

You can also check out these articles on guidance and knowledge sharing to prepare for retirement in Canada:

• How Much Money Do You Need to Retire Comfortably in Canada?
• What is a LIRA in Canada?
• Life Income Fund in Canada
• What Happens to Your RRIF When You Die?

Frequently Asked Questions

The Bottom Line

Receiving a retiring allowance provides a valuable opportunity to boost your retirement savings. With proper planning, you can take advantage of the special tax rules to transfer funds into RRSPs or RPPs tax-efficiently. Be sure to get professional advice and develop an integrated retirement strategy. The key is understanding how to optimize your allowance, make appropriate transfers, and claim deductions correctly on your return. This will allow you to maximize savings from your allowance and take control of your retirement future.

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1. Guide to Retiring Allowance in Canada – protectyourwealth.ca