Severance Pay Tax

Severance pay and retiring allowances received when leaving an employer are taxable as employment income in the year received. The employer withholds tax at source, typically at a flat rate based on the lump sum amount: 10% on amounts up to $5,000, 20% on $5,001–$15,000, and 30% on amounts over $15,000 (higher rates in Quebec).

The withholding rate is not your actual tax rate — it's an estimate. Since the severance is added to your other income for the year, the actual tax owed depends on your total income and marginal bracket. A large severance can push you into a higher bracket, resulting in more tax owing at filing time, or the withholding may exceed your actual liability.

For severance from pre-1996 employment, you may be eligible to transfer a portion directly to an RRSP (up to $2,000 per year of pre-1996 service) without the transfer counting against your regular RRSP room. For post-1996 employment, you can still contribute severance to your RRSP using available room, which is often the most tax-efficient strategy.