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.
How it works
The 10%/20%/30% withholding tiers apply as a single flat rate to the whole lump-sum payment based on its total size, not as stacked brackets the way regular income tax brackets work — a $20,000 severance payment is entirely subject to the 30% rate, not just the portion above $15,000. This is different from how tax is withheld from a regular paycheque, which uses payroll tables designed to approximate your actual annual tax rate.
Because the withholding rate is based only on the size of that one payment and ignores your other income for the year, it's frequently wrong in both directions: a large severance can push your total income into a higher bracket than the withholding rate assumed, leaving tax owing at filing time, while a smaller severance paid to someone with modest total income can be over-withheld, generating a refund.
You have some ability to manage the mismatch. Directing severance into an RRSP reduces your taxable income for the year, using available RRSP room or the special pre-1996 provision, and you can ask the CRA to authorize your employer to reduce withholding on the transferred portion so cash isn't tied up needlessly until you file your return.
Example: employer withholding vs. your actual tax bill
Say you receive a $20,000 severance payment. Because the total falls above $15,000, the entire amount is subject to 30% withholding — the employer withholds $20,000 x 30% = $6,000 and pays you $14,000.
But the $6,000 withheld is just an estimate, not your final tax bill. The severance is added to your other income for the year and taxed at your marginal rate. If your marginal rate on that income turns out to be lower than 30%, you'll get some of the $6,000 back as a refund when you file; if it's higher, because the severance pushed you into a higher bracket, you'll owe additional tax beyond what was withheld.
Frequently asked questions
Can I reduce the tax withheld from my severance payment?
Yes — directing part or all of it into your RRSP, using available contribution room or the special pre-1996 provision, reduces your taxable income, and you can ask the CRA to authorize your employer to withhold less tax on the transferred portion.
Is severance pay taxed at a different rate than regular salary?
Not in terms of your final tax bill — both are taxed as ordinary employment income at your marginal rate — but the withholding at the time of payment uses flat lump-sum rates instead of the payroll tables used for regular pay, so the two often don't match.
Does all of my severance qualify for the pre-1996 RRSP transfer provision?
No — only the portion tied to years of service before 1996 qualifies for the special transfer, up to $2,000 per pre-1996 year, without needing available RRSP room; anything tied to service in 1996 or later has to use your regular RRSP contribution room instead.
Related Terms
RRSP (Registered Retirement Savings Plan)
An RRSP is a government-registered account where contributions are tax-deductible and investments grow tax-free until withdrawal.
T4 (Statement of Remuneration Paid)
The T4 slip is issued by employers to employees by the last day of February each year.
Marginal Tax Rate
The marginal tax rate is the rate of tax applied to your last (or next) dollar of income.