Garry Marr: Your severance could be a financial windfall, if you handle it right

Getting laid off is brutal. I’ve been there. In the heat of the moment, few people think of losing their job as anything less than catastrophic.

But when it comes with a severance package intended to cushion the financial blow, it can also be a windfall that requires planning to maximize the benefit and limit the tax consequences.

I’m not going to debate the merit of Canadian employment law, but the reality is that in most provinces being fired with cause is difficult and severance is the norm. Payouts can max out at more than two years of salary in some cases.

Jon Pinkus, an employment lawyer with Samfiru Tumarkin, said there are no set rules on severance compensation, but length of employment matters, as does age, job market prospects, where you even live and a variety of other factors that could impact your ability to find another job.

“I discourage people from thinking I will get a certain number of weeks per year of service if you end up in court,” he said.

You also can’t rule out negotiating with employers, including how the severance is paid out.

“Sometimes employers just want to pay you out in a lump sum,” said Pinkus, adding they may be motivated by tax reasons. “Other times, employers insist on salary continuance (while you remain unemployed) either for cash flow reasons or because there are some conditions on that salary continuance.”

Employees have the same tax considerations. Getting paid in lump sum on top of the money you already earned in a calendar year could mean taxation at the highest marginal rate.

“Sometimes employees will be more flexible (and take less) if the payment is made over multiple years if they don’t have adequate RRSP room ,” said the lawyer.

Pushing some of the money to the next year could lower that hit. But if you’re worried your company could become insolvent during a pay continuance, you may want the money all up front, given that severance would be at the bottom of creditors in any bankruptcy.

In most cases, if you get a lump sum payment, it is called a “retiring allowance,” with 30 per cent withheld for taxes. So, if you get $100,000, your employer will withhold $30,000. The problem is the employee may have additional taxes later on, if the severance difference sends them to a higher marginal rate.

“It doesn’t change your tax rate, but it’s taxed at 30 per cent at source,” said Pinkus, adding that having the money at the time protects people who lost their job from a cash flow perspective. “It’s just a deferral.”

A major consideration is how much RRSP room you have. That would lower your taxable income and potentially put you in a lower tax rate.

It’s becoming rarer, but there is an option that creates more RRSP room for long-term employees. For each year or part of a year you were employed before 1996, you can put $2,000 directly into an RRSP from a retiring allowance, reducing the immediate tax from a severance.

“People have definitely become aware of the live issue of tax consequences, and it’s the net dollars that matter to employees,” said Pinkus.

Jordan Damiani, an investment advisor at Meridian Private Health, cautions people about planning their life around a severance but said planning after you get that lump sum becomes important.

“When you receive a severance, you really have to ponder your plans,” said Damiani. “Some people receive it close to their retirement dates, and it’s actually what they want. It’s in essence a bonus they have been waiting for. Earlier in your career, it takes on a different meaning, and it could be part of your lifeline.”

If you find a job quickly, you could push up your taxable income to a higher bracket because you had two jobs in the same year and the severance on top. Damiani said it is worth filling out what is called a TD1 with your new employer, which is a form for additional tax withholding.

“Your new employer is probably not going to be aware you have all this other income,” said Damiani, adding that it helps avoid a tax bill at the end of the year.

From a tax perspective, if you get a really large sum, it makes sense to use up any RRSP room you have, provided you won’t need the money for day-to-day living.

“If you don’t have something lined up, I wouldn’t rush to put that money in an RRSP because you have until the first 60 days of the following year to offset any income,” said Damiani, adding that having to take it out later because you ran short it means you permanently lose the contribution room.

Putting your money in a tax-free savings account won’t lower your tax bill, but it might hamstring you a bit because if you put money in and they want to pull it later, you need to wait until the following January to get the space repatriated.

“You could find another job and say I don’t need all this money,” he said.

One thing changing in the workforce is people are not in jobs as long, said Cal Jungwirth, director of permanent placement services at talent recruitment company Robert Half Inc. While awards are rising for even shorter-tenured employees, long-tenured employees generally get larger settlements.

“It’s rare. I’ve been doing this 20 years, and I’m seeing those long-tenured people a little less than I used to,” said Jungwirth.

American adults are expected to have 12 jobs in their lifetime, according to the U.S. Department of Labour. But close to half of those jobs are held in youth years. The growing consensus is to get ready for multiple careers in your lifetime, with a few breaks.

“It’s healthy to have awareness of what is going on in the marketplace,” said Jungwirth. “If you get the sense you may be pushed, it can make sense to be proactive. But you don’t want too much movement. The biggest filter organizations have is too much movement.”

How much is too much? Hard to say, but every two years and a track record of it gets tougher to explain, Jungwirth.

Sometimes you have no choice, but his main advice is not to panic, and he said during a severance period you can use the opportunity to upgrade your skills, something he says you should always be doing.

“It’s like going to the gym. You need to continue to go all the time,” he said, cautioning that when you get laid off it’s probably good to clear your head and not just apply to “100 different jobs” but ask what you want to do strategically.

Ultimately, a severance package is really supposed to be a safety net, but it can refresh your career. It can also create more wealth. Jungwirth points out you could take contract opportunities until you find the right job and in many cases you could keep your severance on top of that.

Damiani said the larger lesson, though, is not to count on any severance. “It’s like an inheritance; it could happen, but I don’t bake it into a financial plan,” he said.

True, but like an inheritance, a severance can be a one-time financial windfall, and it makes sense to use it well. Not to mention avoiding immediate tax consequences.

• Email: gmarr@postmedia.com