Is severance pay taxed at 30% in Canada?

Not always. The 30% rate is generally a withholding rate for larger retiring allowances paid directly to Canadian residents outside Quebec. Your final tax depends on your total annual taxable income and applicable deductions.

Do I have to pay tax on severance if I do not find another job?

Yes. A taxable retiring allowance generally remains taxable even if you do not find another job during that year. However, having less employment income may affect your final tax liability.

Which T4 boxes show severance pay?

Eligible retiring allowances are generally reported in T4 box 66, while non-eligible retiring allowances are reported in box 67. They are included in income on line 13000 of your tax return.

Can I put my entire severance payment into an RRSP?

Not automatically. The eligible portion can qualify for a direct transfer under special service-year rules. The non-eligible portion generally requires sufficient available RRSP contribution room.

Is severance pay taxed differently from regular salary?

Yes. A qualifying retiring allowance generally has income tax withholding without CPP or EI deductions. Salary continuance and wages in lieu of notice are generally treated as employment income and follow regular payroll deductions.

Severance Pay Tax in Canada: How Much Will You Keep After Tax?

Key Takeaways

A retiring allowance generally attracts income tax withholding but no CPP or EI deductions, while salary continuance follows regular payroll rules.
The 30% withholding rate on a large lump-sum retiring allowance is not necessarily your final tax rate.
Eligible pre-1996 service amounts and qualifying RRSP transfers may help defer immediate taxation, subject to CRA conditions.

Is Severance Pay Taxable in Canada?

Yes. Severance pay is generally taxable in Canada because the Canada Revenue Agency (CRA) treats qualifying termination payments as income. However, the amount you ultimately lose to income tax depends on how your employer classifies the payment, your total annual income and your province or territory of residence.

The biggest mistake employees make is assuming that the tax deducted from their severance cheque represents the final amount they owe. It does not. Employer withholding is an advance payment toward your income tax, which is reconciled when you file your annual return.

How Is Severance Pay Classified for Tax Purposes?

A severance package can contain different types of payments, and each may receive different tax treatment. A retiring allowance is generally compensation received because of the loss of employment or in recognition of long service. It can include certain termination damages and unused sick-leave payments.

However, not every payment in a severance agreement is a retiring allowance.

Salary continuance means your regular salary and benefits continue for an agreed period.
Wages in lieu of termination notice are treated as employment income.
Vacation pay and unpaid wages are also generally employment income.
Qualifying retiring allowances are reported separately from regular employment income.

This classification matters because payroll deductions are different. Ask your employer for a written breakdown before accepting the payment arrangement.

What Are the Severance Pay Tax Withholding Rates in Canada?

For Canadian residents outside Quebec, CRA withholding rates on a retiring allowance paid directly to the employee are generally:

Total retiring allowance paid or expected in the calendar year	Income tax withholding rate
$5,000 or less	10%
$5,001 to $15,000	20%
$15,001 or more	30%

These are withholding rates, not final tax brackets. The rate is selected based on the total retiring allowance paid or expected during the calendar year, rather than treating each amount as a separate payment.

Quebec has different withholding arrangements. The CRA federal withholding rates for Quebec residents are 5%, 10% and 15% respectively, with provincial withholding handled separately.

How Much Tax Will You Lose on a $20,000 Severance Payment?

Consider an employee outside Quebec who receives a $20,000 retiring allowance as a single lump sum.

Under the applicable withholding rule:

Gross retiring allowance: $20,000
Income tax withheld at 30%: $6,000
Amount received before other adjustments: $14,000

Suppose the employee had little other income during the year. Their final tax liability could be lower than the amount withheld, potentially resulting in a refund. If they earned a substantial salary before losing their job, their final tax could be higher.

Does Severance Pay Have CPP and EI Deductions?

A qualifying retiring allowance generally has income tax withheld, but employers do not deduct Canada Pension Plan (CPP) contributions or Employment Insurance (EI) premiums from it.

Salary continuance is different. Because regular employment income continues, normal payroll deductions generally apply, including income tax, CPP or QPP contributions and EI premiums. This distinction can make two severance packages with similar gross values produce different take-home payments.

Can You Transfer Severance Pay Directly Into an RRSP?

Yes, but the rules depend on which portion of the retiring allowance you receive. The CRA recognizes an eligible portion for certain years of service before 1996. The calculation generally allows:

$2,000 for each year or part-year of service before 1996.
An additional $1,500 for each qualifying year before 1989 when the employer's pension or deferred profit-sharing contributions were not vested.

An eligible amount can be transferred directly to your own RRSP or qualifying registered pension arrangement without using your regular RRSP contribution room.

The non-eligible portion may also be transferred directly into an RRSP, but only within your available RRSP deduction limit. This can defer immediate tax, although withdrawals from the RRSP will generally be taxable later.

Check your CRA notice of assessment and ask your employer to identify eligible and non-eligible amounts before arranging a transfer.

Can Receiving Severance Over Two Years Reduce Your Taxes?

Potentially, yes. Some employers offer deferred payments or salary continuance instead of paying the entire amount immediately.

When taxable income is spread across two calendar years, it may reduce the amount taxed at higher marginal rates. However, this is not guaranteed. Your other income in both years, the payment classification and the agreement's terms all matter.

Salary continuance also means regular payroll deductions continue. Deferred retiring allowances have different withholding rules. Before choosing an arrangement, compare the after-tax outcome rather than focusing only on the gross payment.

TwikUp's Perspective

A severance payment can provide temporary financial support, but deciding how to use it requires careful planning. Families supporting a loved one with a disability may also want to explore how a Registered Disability Savings Plan (RDSP) can grow through government grants to build long-term financial security.

Before spending a lump-sum payment, consider your immediate expenses, future savings and available tax-planning options.

Disclaimer

This article is for general educational purposes only and does not constitute personalized tax or legal advice. Severance agreements and tax treatment depend on individual circumstances, payment classification and applicable federal and provincial rules. Consult a qualified tax professional or employment lawyer before making decisions.

Sources

Financial Consumer Agency of Canada