It has been a long time since the Canadian Government made changes to Section 60 j.1 of the Income Tax Act and eliminated the years-of-service accrual room after 1995 for retiring allowances (also referred to as severance pay, golden handshake, sick-time accumulation; any amount received upon retirement in recognition of long-term service or in respect to loss of employment). When members are provided with severance packages today, we are looking for the ability to tax-shelter some or all of those funds and are finding that only by using their RRSP Room can they get any tax deferral. Where has that tax-sheltered capability gone to?
Up until the end of 1995, Canadians were able to transfer $2,000 per year of service into an RRSP without affecting their RRSP Room. If a company did not have a pension plan or a DPSP in the earlier years of someone’s employment, an additional $1,500 for each year of service prior to 1989 was included in the eligible calculation for those years. Starting with a company at age 18 and remaining there for your entire career was the norm into the 90’s. During the 80’s and early 90’s we were seeing large eligible retiring allowance transfers as these long-term employees with 30-plus years took advantage of generous early retirement packages. Many $45,000 to $80,000 transfers were seen each year.
After 1995, the $2,000 per year of service became based on only the service years prior to 1996. So in 2009 that means 14 years of service are NOT included in the eligible retiring allowance calculation and people will need to look at their RRSP Room Statement in order to obtain some tax-deferral ability for their severance pay.
One up-side to using RRSP Room is that the funds may be deposited to the member’s own RRSP, to a spousal plan where s/he is the contributor or divided between both plans in any fashion. This allows for some income splitting down the road once the 3-year spousal attribution rule is no longer a factor for withdrawals.
One big down-side is individuals may be maximizing their RRSP Room each year to defer their regular income and may have little or no RRSP Room available when a severance package is presented to them. Then unless the employer is willing to pay the severance over multiple tax years, there may be a large tax bill for receiving the lump-sum payment.
So although we may read that you should always maximize your RRSP contributions, someone who is working for a company that is known to provide severance packages and has a number of years within the company, may wish to consider retaining some RRSP Room each year in order to have an accumulation of Room available down the room “just in case”.