What to take away
- Severance is taxable. The withholding on a lump sum is only an advance on the tax you owe for the year.
- Payments with different labels are taxed differently, so ask for the breakdown in writing before you sign.
- Part of a payment may be transferable to your RRSP without withholding, and the rules depend on your years of service.
Severance is taxable income, whatever it is called
Money your employer pays because your job ends is generally taxable. The CRA’s employer guidance defines a retiring allowance as an amount paid on or after retirement, in recognition of long service, or for the loss of an office or employment. Damages for wrongful dismissal are included. People often call all of this severance pay, and the CRA’s special payments chart uses the two terms together.
Not every payment in a termination package is a retiring allowance. Wages in lieu of termination notice, accrued vacation pay and salary continuance are treated differently, as the next section explains. The label in the agreement matters, so it is worth reading the wording before the payment arrives rather than after the first pay stub.
The pieces of a package are taxed differently
According to the CRA, a retiring allowance does not include salary, wages, bonuses, salary continuance, payment for vacation not taken before retirement, or wages in lieu of termination notice. Those amounts are employment income. The CRA’s special payments chart shows CPP contributions, EI premiums and income tax all being deducted from wages in lieu of notice and from vacation pay, while a retiring allowance has income tax withheld but no CPP or EI.
If one lump sum includes both wages in lieu of notice and damages, the CRA says the wages portion is employment income and the damages portion is generally a retiring allowance. If there is no breakdown at all, the full amount would generally be treated as a retiring allowance. That can work for or against you, because the two kinds of payment have different withholding and different effects on Employment Insurance. Ask your employer or the person who prepared the agreement how each amount will be classified.
What a lump sum has withheld
For a Canadian resident outside Quebec, the CRA lists three withholding rates for a lump-sum retiring allowance, set by the total of retiring allowances paid or expected to be paid to you in the calendar year: 10% on $5,000 or less, 20% from $5,001 to $15,000 and 30% above $15,000. The rate that matches that total is the one the employer uses.
Suppose, for illustration only, that you receive $40,000 as a single retiring allowance. The employer would withhold 30%, or $12,000, and pay you $28,000. That does not mean your tax on the $40,000 is $12,000. The payment is added to your other income for the year, and your actual tax depends on your total income, deductions and credits. Some people receive a refund and others owe more, so do not spend the withheld portion until you have estimated the year. The Sora tax calculators can help with a first estimate.
How the payment method changes the result
Employers pay severance in different ways: a lump sum, salary continuance, or deferred payments over several years. The Financial Consumer Agency of Canada notes that you may pay less tax with salary continuance than with a lump sum, and that spreading severance over more than one year may lower the tax owing each year. Salary continuance is employment income, so ordinary payroll deductions apply.
Tax is calculated one calendar year at a time. A payment made in December and one made in January fall into different years, and a lump sum on top of a full year’s salary can push more income into higher brackets. Whether you can influence the timing depends on the agreement and on what your employer is willing to do. Raise the question before you sign, and take legal advice on the agreement itself, since the tax result is only one part of the decision.
Moving part of the payment into your RRSP
If you had service before 1996, part of a retiring allowance may be an eligible amount. The CRA says it is generally $2,000 for each year or part-year of service before 1996 with that employer or a related employer, plus another $1,500 for each year or part-year before 1989 in which no employer pension or DPSP contributions had vested in you. The eligible part can be transferred directly to your own RRSP, with no tax withheld on it, and it does not reduce your regular RRSP deduction limit. It cannot go to a spousal RRSP, and amounts generally cannot be transferred to an RRSP if you were over 71 at the end of the year.
The rest is the non-eligible amount. It can also go to an RRSP without withholding, including a spousal RRSP, but only up to your available RRSP deduction limit, and the employer needs your written statement that the amount is within that limit. The employer reports the eligible amount in box 66 and the non-eligible amount in box 67 of your T4 slip. You report both on line 13000 of your return and claim the transfer as an RRSP deduction. Ask for the arrangement to be made before the payment is issued, because it is simpler than a later contribution. Confirm your RRSP limit on your notice of assessment first.
Employment Insurance and severance
Normally, separation earnings such as severance and vacation pay are allocated to the weeks after your job ends and can delay or reduce EI benefits. Service Canada’s current page describes a temporary measure: if your claim or the allocation starts between March 30, 2025 and October 9, 2027, earnings from separation are not deducted from your benefits, and the one-week waiting period is waived for new claims starting in that period.
This is a temporary rule with an end date, so check the Service Canada page on the day you apply. Apply for EI promptly after your last day of work, and keep the record of employment, the termination letter and the breakdown of what you were paid, since Service Canada may ask for them. Whether you qualify at all depends on your insurable hours and the reason for separation, which this article does not assess.
Records to keep and questions to ask
Keep the termination letter and signed agreement, the itemized breakdown of each payment, your final pay stubs, the record of employment and any RRSP transfer confirmation. When the T4 arrives, compare boxes 66 and 67 and the employment income box with what you were told. Errors are easier to fix with your former employer before filing than after assessment.
Questions worth putting to an accountant before you sign or deposit the money: how much of this is a retiring allowance, whether you have eligible service for an RRSP transfer, how much RRSP room you have, how the payment affects your tax for the year, and whether you will owe more at filing time. If you also had a bonus or other income, see our article on bonuses and tax withholding, and for the employer’s side see our article on final pay and the record of employment.
Sources & editorial notes
Sources checked October 24, 2026. The examples are illustrative and provide general information. Discuss how the guidance applies to your circumstances with your accountant.
- Payments of retiring allowances (payroll steps)Canada Revenue Agency
- Lump-sum payments, including qualifying retroactive lump-sum paymentsCanada Revenue Agency
- Special payments chartCanada Revenue Agency
- Transferring the eligible part of a retiring allowanceCanada Revenue Agency
- Understanding your severance payFinancial Consumer Agency of Canada
- Temporary Employment Insurance measures to respond to major changes in economic conditionsService Canada
Rules and guidance can change. Use the current official source and confirm the treatment for your facts. To flag an error, contact Sora.