Severance Pay Tax in Canada: Retiring Allowance Rules
How a retiring allowance is taxed, the lump-sum withholding rates, the pre-1996 RRSP transfer, and what happens when the employee has moved to the United States
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
Severance pay in Canada is a "retiring allowance" for tax purposes: a payment on the loss of a job in recognition of long service or the loss of office. It is fully taxable when received, withheld at lump-sum rates (10, 20, or 30 percent outside Quebec), and a pre-1996 service portion may go to an RRSP. Non-residents: 25 percent withholding.
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What counts as a retiring allowance?
An amount paid on or after retirement or termination in recognition of long service, or in respect of the loss of an office or employment — including damages for wrongful dismissal (whether by settlement or court order) and payments under a termination agreement — a lump sum with no breakdown is generally treated as a retiring allowance, though wages in lieu of notice are employment income. It does not include: salary continuance (regular pay continued through the notice period — ordinary employment income, withheld at regular payroll rates, with CPP and EI deducted); accrued vacation pay (employment income); pension benefits; amounts for human rights damages or personal injury (non-taxable where properly characterized); and payments to a deceased employee's estate (a death benefit, with its own C$10,000 exemption). The characterization matters because a retiring allowance is not subject to CPP or EI, is withheld at the lump-sum rates, and carries the RRSP transfer.
How is it taxed and withheld?
| Element | Rule |
|---|---|
| Inclusion | Fully taxable as income in the year received (there is no averaging, though instalments across two calendar years split the income) |
| Withholding — Canadian resident, outside Quebec | 10 percent up to C$5,000; 20 percent from C$5,001 to C$15,000; 30 percent above C$15,000 (one rate, set by the total paid or expected in the year); in Quebec, 5, 10, or 15 percent federal plus provincial withholding |
| Withholding — non-resident | 25 percent Part XIII withholding, as the final Canadian tax, unless a treaty provides otherwise |
| CPP and EI | Not deducted from a retiring allowance |
| Reporting | T4 (boxes 66 and 67 for eligible and non-eligible portions) for residents; NR4 for non-residents |
| Legal fees to obtain it | Deductible against the retiring allowance income, up to the amount included |
The lump-sum withholding is a prepayment, not the final tax; a large severance withheld at 30 percent is usually under-withheld for a high earner and produces a balance due in April. Employees can ask the employer to withhold more.
The RRSP transfer for pre-1996 service
The eligible portion of a retiring allowance may be transferred directly to the employee's RRSP without affecting contribution room: C$2,000 for each year or part-year of service before 1996, plus C$1,500 for each year before 1989 in which the employee had no vested employer pension contributions. Service after 1995 generates no eligible amount. For a long-tenured employee who started before 1996 the eligible portion can be substantial — thirty years of service beginning in 1980 produces C$32,000 plus up to C$13,500 for the pre-1989 years — and the direct transfer avoids withholding on that portion entirely. The non-eligible remainder can also go to the RRSP, but only within the employee's existing contribution room, and it is withheld unless transferred directly by the employer.
The employee who has moved to the United States
Two cases. Severance paid after the employee became a non-resident of Canada — a laid-off employee who moved south before the payment: Canada withholds 25 percent as Part XIII tax on the retiring allowance (the treaty does not reduce this rate: a retiring allowance is not a pension under Article XVIII, and neither the employment article nor the other-income article caps Canada's tax), and the payment is also taxable in the United States as compensation, with the Canadian tax claimed as a foreign tax credit. The employee may elect under section 217 to file a Canadian return on the retiring allowance if graduated rates produce less than 25 percent — worth computing for a moderate amount. Severance paid while still a Canadian resident, before the move: taxed in Canada as above, with the withholding; the United States generally does not tax income earned before residency began (unless the employee was already a U.S. citizen or green card holder — the saving clause). Timing the payment relative to the departure date is therefore a real planning lever: a severance received the week before departure is Canadian income only; the same payment received the week after is Canadian-withheld and U.S.-taxable. The RRSP transfer remains available to a non-resident with an RRSP (the eligible portion is computed the same way), and the RRSP then follows the treaty deferral rules (the RRSP guide).
Worked example
A Toronto bank manager with service from 1988 is terminated in March with a C$180,000 severance package and moves to Charlotte in June for a new job. Option A — paid in April, while resident: eligible portion for RRSP transfer C$2,000 × 8 years (1988–1995) plus C$1,500 for 1988 with no vested pension = C$17,500, transferred directly with no withholding; the C$162,500 balance withheld at 30 percent (C$48,750), reported on her T4, and taxed on her Canadian return at graduated rates (a balance due, since 30 percent is below her marginal rate); the United States does not tax it — she was not yet a U.S. resident. Option B — paid in July, after departure: 25 percent Part XIII withholding on C$162,500 (C$40,625) as the final Canadian tax (or a section 217 return if graduated rates were lower — at this amount they are not); the C$17,500 still transferable; and the full C$180,000 taxable as compensation on her U.S. return with a foreign tax credit for the C$40,625 — leaving U.S. tax on the difference at her U.S. marginal rate. The two options come out within a few thousand dollars of each other once U.S. federal and state tax are counted — the payment date is a modeling question, not a rule of thumb, and her lawyer ran both before setting it.
Frequently asked questions
How is severance pay taxed in Canada?
As a retiring allowance — fully taxable in the year received, withheld at the lump-sum rates (10, 20, or 30 percent outside Quebec, set by the total paid in the year) rather than regular payroll rates, with no CPP or EI deducted.
Can I transfer severance to my RRSP?
The eligible portion — C$2,000 per year of service before 1996 plus C$1,500 per year before 1989 without vested employer pension contributions — can be transferred directly without using contribution room. The rest can go to your RRSP only within your existing room.
What is the difference between severance and salary continuance?
Salary continuance is regular pay continued through the notice period — ordinary employment income with CPP and EI, withheld at payroll rates. A retiring allowance is a lump sum for the loss of employment — no CPP or EI, lump-sum withholding, and the RRSP transfer.
How is severance taxed if I have moved to the United States?
If paid after you became a non-resident, Canada withholds 25 percent as the final tax and the United States taxes it as compensation with a foreign tax credit. If paid before you left, it is Canadian income only. The payment date is a planning decision.
Official sources
The CRA states: “Retiring allowances are amounts paid to officers or employees on or after they retire from an office or employment, in recognition of long service or for the loss of an office or employment.” — Canada Revenue Agency, Payments of retiring allowances, https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/payroll/calculating-deductions/determining-tax-treatment/retiring-allowances.html
Publication 597 states: “Pensions also include payments from individual retirement arrangements (IRAs) in the United States, registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs) in Canada.” — Internal Revenue Service, Publication 597, Information on the United States–Canada Income Tax Treaty, https://www.irs.gov/publications/p597
Next step
Fairlight Accounting is a cross-border accounting and tax practice with a U.S. Tax Desk and a Canadian Tax Desk. Our U.S. Tax Desk and Canadian Tax Desk handle retiring allowance planning — eligible RRSP transfer computations, payment timing around a departure date, section 217 elections for non-residents, and U.S. reporting with foreign tax credits. See pricing or book a call.
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