The Golden Handshake — Make the Most of Your Severance Package
You’ve just accepted your severance package and, for the first time in many years, you’re unsure what you’ll be doing the following Monday morning. Will you take time to spend with your family, while you contemplate your next career move, will you immediately ramp up your job search to secure a new position as soon as possible, or will you test out the whole retirement thing everyone’s always raving about? Regardless of your approach, I’ve outlined a few ideas to help you make the most of your severance package.
The Challenge – Taxes!
When you receive your severance pay, it gets added on to your income for that tax year. As you can imagine, this means you will have more taxes to pay — something that few look forward to doing. How much more will you pay? It depends on the situation.
Let’s take a simple example: Mary receives a severance package in October 2018, paying her $160,000. She has already earned $80,000 to date in salary. In the eyes of Revenue Canada, she’s earned $240,000 in 2018. That brings her combined Ontario and Federal marginal tax rate of 53.53%, average tax rate of 38.06%, and a total taxes payable of over $90,000!
Ouch! Mary isn’t thrilled about parting with all that money. How can she reduce this tax burden?
The Solution – Max Out Your RRSP
Although you may need some of your severance pay to help you during your transition period, you’ll likely want to max out your RRSP anyways. Maxing your RRSP can significantly reduce your immediate tax bill, and defer the tax liability to future years at an assumed lower marginal tax rate.
Let’s go back to our previous example to illustrate how this works. Let’s assume Mary has $100,000 of unused RRSP contribution room. By contributing $100,000 to her RRSP, the taxable income falls to $140,000 vs $240,000. Her tax payable now come in closer to $40,000 which would save her roughly $50,000 of income tax!
PRO TIP #1 - Have you worked with your employer prior to 1996? If so, you may be eligible to contribute to your RRSP over and above your contribution room via a “retiring allowance”
PRO TIP #2 – If you instruct your employer early enough, they may be able to direct your RRSP contribution directly into your account and help you avoid the 30% withholding tax on those funds
Harper Wealth Management Group can not only help implement a strategic plan like Mary’s, but we can also help you build a comprehensive financial, retirement, and investment plan.
Be sure to share to share this article with anyone going through this transition, they'll be happy you did.
Marc