Severance Pay Tax
How severance and pay in lieu of notice are taxed, withholding rates, transferring to your RRSP, the pre-1996 eligible part and legal fees.
The short version
- Severance, pay in lieu of notice and wrongful-dismissal settlements are usually a "retiring allowance": fully taxable, but with no CPP or EI deducted.
- Your employer withholds tax as a lump sum: 10% on up to $5,000, 20% on $5,000.01 to $15,000, 30% over $15,000 (outside Quebec). Your real tax is settled on your return.
- You can have some or all of it transferred straight to your RRSP with no tax withheld, using your RRSP room. Service before 1996 can add extra room just for this.
- Legal fees you paid to get the severance are deductible, up to the severance received (less any amount transferred to your RRSP).
- Example, Ontario: $40,000 of severance on top of $60,000 of salary costs about $12,055 of tax, about what is withheld.
Severance Pay Tax in Canada
Losing a job is hard enough without the tax bill that follows the cheque. The good news is that severance is one of the few payments where a bit of planning saves real money: where it goes (your RRSP or your bank), when it arrives (December or January), and whether you paid a lawyer to get it. Here's how severance is taxed and how to keep more of it.
What Counts as a Retiring Allowance
| Payment | Tax treatment | CPP/EI |
|---|---|---|
| Severance pay | Retiring allowance | No |
| Pay in lieu of notice | Retiring allowance | No |
| Wrongful dismissal damages or settlement | Retiring allowance | No |
| Unused sick leave paid on leaving | Retiring allowance | No |
| Wages to your last day, vacation pay owed | Regular employment income | Yes |
| Salary continuance (stay on payroll) | Regular employment income | Yes |
Retiring allowances appear on your T4 in box 66 (the eligible part that can go to your RRSP without room) and box 67 (the rest). Slips explained on the T4 and the T4A.
Negotiating or just received severance?
Tell the assistant the amount, your income so far this year, your RRSP room, your years of service and province. It compares cash, an RRSP transfer and payment in January, after tax.
Three Ways to Take It
| $40,000 severance, Ontario, $60,000 earned so far | Withheld | Real extra tax | At filing |
|---|---|---|---|
| All in cash this year | $12,000 | about $12,055 | Owe about $55 |
| $15,000 to RRSP, $25,000 cash | $7,500 | about $7,563 | Owe about $63 |
| All in cash, but laid off early (only $20,000 earned) | $12,000 | about $8,837 | Refund of about $3,160 |
From our 2026 rules engine, rounded. The RRSP route doesn't make the tax disappear; it defers it to when you withdraw, ideally at a lower rate. If you're unlikely to work again this year, asking for the payment in January can push it into a lower-income year. Check what the deferral is worth in the RRSP tax savings calculator.
The RRSP Transfer
- Using your room: any amount up to your available RRSP room can be transferred directly by the employer, with no tax withheld. Room is on your notice of assessment.
- Extra room for long service: $2,000 for each year of service before 1996, plus $1,500 for each year before 1989 in which you had no vested employer pension or DPSP contributions. This "eligible retiring allowance" can go to your own RRSP without using any room (not a spousal RRSP, and not after the year you turn 71).
- Ask before the cheque is cut. Money already paid to you can still be contributed, but the tax has already been withheld and comes back only at filing. See RRSP.
Other Things to Know
- Legal fees to establish your right to the severance are deductible (line 23200), limited to the retiring allowance received minus amounts transferred to your RRSP. Unused fees can be carried forward up to seven years.
- EI may start later: separation pay can be allocated to the weeks after you leave, delaying benefits. Apply right away anyway; Service Canada sorts out the timing.
- OAS and benefits: a big severance raises net income, which can affect the OAS clawback and next year's child benefit.
- Owe in April? If too little was withheld, see why do I owe tax?
Severance Pay Questions
How is severance pay taxed in Canada?
Severance is usually a retiring allowance. It is fully taxable at your marginal rate, but no CPP or EI is deducted. Your employer withholds 10%, 20% or 30% depending on the amount, and the actual tax is settled on your return.
Can I transfer my severance to my RRSP?
Yes. Your employer can transfer it directly to your RRSP with no tax withheld, up to your available RRSP room. Years of service before 1996 can add extra transfer room that does not use your regular room.
Is pay in lieu of notice taxed as severance?
Yes. Pay in lieu of notice is generally a retiring allowance, taxed the same way as severance with no CPP or EI deducted.
Are legal fees to get severance deductible?
Yes. Legal fees paid to collect or establish a right to a retiring allowance are deductible, limited to the amount received minus any amount transferred to an RRSP, with unused fees carried forward up to seven years.
Does severance pay affect EI?
It can delay when EI benefits start, because separation money may be allocated to the weeks after your job ends. Apply for EI as soon as you stop working.
Is a retiring allowance taxable?
Yes. A retiring allowance, including severance and payments for loss of employment, is taxable. Part of it can be transferred to your RRSP without using room if you worked for the employer before 1996, based on your years of service.
Sources: CRA, Transferring the eligible part of a retiring allowance; Guide T4040. Checked October 2026. The eligible part can't go to a spousal RRSP or to anyone over 71 at year-end. EI allocation rules are set by Service Canada and have had temporary exceptions; check current rules when you apply. Examples use basic credits only.
Last reviewed October 5, 2026 against CRA and Government of Canada sources. How we check our facts.