A report by Generational Insight suggests that roughly 41.5% of the Canadian population consists of ‘Matures’ (those born between 1909 and 1946) and ‘Baby Boomers’ (those born between 1947 and 1966).
Given that the average retirement age in Canada is 62, almost half of our population is either retired or approaching retirement. In light of this fact, advisors can help clients plan for desired retirements by ensuring they retain as much of their retirement income as possible. One way to achieve this is by minimizing tax payable on retiring allowance payments.
When an employee reaches retirement, he or she may be entitled to a payment in recognition of long service known as a “retiring allowance”. A retiring allowance might also be paid when an individual is terminated from employment. Generally, whether or not an individual receives a retiring allowance depends on workplace policy and, in the case of terminated employees, employment legislation for the province in which the work is performed.
While retiring allowance payments are generally taxable, section 60 (j.1) of the Income Tax Act (ITA) provides for a tax-deferred transfer of all or part of the payment to an RRSP (where RRSP contribution room is not required) based on the following calculation:
-$2,000 per year of service prior to 1996.
-$1,500 per year of service prior to 1989 provided the employee is not entitled to employer contributions to a registered pension plan or deferred profit sharing plan in respect of that period.
For the purpose of the above calculation, “year(s) of service” includes any part or full year spent with the employer or a person related to the employer. Although the calculation seems pretty straightforward, many clients are unaware they may be entitled to larger transferrable amounts where they have worked with “related” employers.
Consider the following example:
After 36 years of work, Lance retired. Throughout his career, Lance worked with three different corporations. In 1975, he began his career as a technician at General Sports, a company specializing in the production of sports equipment. In 1990, Lance accepted a management opportunity with North American Marketing, a sister company to General Sports. As part of his new employment arrangement, Lance was able to participate in North American Marketing’s registered pension plan.
Thereafter, in 1995, General Sports was acquired by All Canadian Marketing who, looking for experienced talent, offered Lance a senior management position. As a condition of employment, Lance was given the opportunity to transfer his pension credits from North American Marketing’s pension plan to a pension plan with All Canadian Marketing, an opportunity he took advantage of. Lance worked for All Canadian Marketing from 1995 until his retirement in 2011. At retirement, in addition to pension benefits, All Canadian Marketing paid Lance a retiring allowance of $80,000 in recognition of his service.
Of the $80,000 retiring allowance received by Lance, how much can be transferred to his RRSP without requiring RRSP contribution room?
As earlier indicated, when a retiring allowance is paid, years of service with the paying employer, and also with persons related to the employer, are included in the calculation of the transferrable amount. The Income Tax Act (ITA) generally defines “related persons” as those that are controlled by the same person or group of persons. This definition is expanded for retiring allowance purposes to include:
i) Any company acquired or continued by the employer.
ii) A previous employer of the retiree whose service is recognized in determining the pension benefits of the retiree.
Although Lance worked for three different corporations and received a retiring allowance from only his final employer, his years of service with all three employers (up to 1995) is included in the calculation of the amount eligible for transfer to his RRSP. Because All Canadian Marketing acquired and continued the business of General Sports, the two corporations are related for retiring allowance purposes. Also, by transferring his pension credits from North American Marketing to his pension plan with All Canadian Marketing, these corporations are also related for Lance’s purposes.
With this in mind, the portion of Lance’s retiring allowance that can be transferred to his RRSP without requiring RRSP contribution room (ie. the eligible portion) is $63,000 calculated as $2,000 x 21 years of service prior to 1996 PLUS $1,500 x 14 years of service prior to 1989. The excess portion of Lance’s retiring allowance ($17,000) would be considered non-eligible, meaning RRSP contribution room would be required to shelter this portion of the retiring allowance from income tax.
As the ‘Mature’ and ‘Baby Boomer’ cohorts retire, many individuals will receive retiring allowance payments. If you encounter clients in this situation, knowing some of the finer details related to these payments can help to preserve net worth. This is a win-win situation – not only can this knowledge help secure the long-term financial security of impacted clients, but it would also provide further evidence of the value of your advice.