Three ways to stretch severance pay

1. Retiring allowance:Revenue Canada allows you to shelter money into what’s called a retiring allowance as part of the Income Tax Act. So long as your company qualifies — it must have a payroll of more than $2.5 million and one or more employees severed within the past six months — you can shelter $2,000 per year, for each year of service up to and including 1995 (even if you started work in November or December, for example, part years count as full years; therefore you can shelter the full amount for that year). For example, if you were hired in 1985 and severed in 1997, you would qualify for 11 years of sheltering.

2. Transfer to RRSPSuppose you determine you’ll have $10,000 remaining after your retiring allowance options are used. And to keep the exercise simple, also suppose you have $10,000 of RRSP contribution room available for the year. You can ask your employer to take that $10,000 and put it into your RRSP (the employer must get Revenue Canada’s approval to do so through a letter). At year end, the company will send you a slip that says they paid you $10,000 with no taxes withheld. Normally you would claim this as incomfor the year and pay taxes on it. But try to arrange to have the employer pay out this money the following year. That way it becomes income for 1998. And if you arrange for the RRSP transfer described above, you will have all this money tax deferred in 1998, meaning you can claim this contribution on your 1997 tax return, lowering your taxable income. In other words, you’ve made a healthy RRSP contribution at a time when your income is high and you have money growing tax deferred, a big help as you search for a new job or make other plans. Should you have to draw on these funds, you may be taxed at a lower amount, and when funds are especially tight, it’s nice to know you’ll be giving less to the government.

3. Reduce taxesAssume you have expenses of $2,500 a month and you have $5,000 in savings. If you think you could be out of work for some time and you don’t have the cash reserves to weather the storm, you may want to use your severance pay another way. Instead of taking this money in cash, you could put it all in an RRSP. If you don’t, be forewarned that Revenue Canada is going to tax it quite heavily; at a minimum 30 per cent. And, should you find a job sooner than expected, you’ll have just given Revenue Canada 30 per cent for nothing. Try rolling the payment into a short-term money market fund inside an RRSP. When your two months worth of savings have run out, you can begin to draw from the funds. Continue to pull out the same $2,500 as long as you need it, keeping in mind you’ll only pay tax on the amount you take out; anything under $5,000 is taxed at 10 per cent withholding tax. When you find your next job, roll the remaining money into something long-term.