How Severance Pay Is Taxed in Ontario

Losing a job is hard enough without the tax bill on your severance catching you off guard. Yes, severance is taxable — but the way it's withheld and reported can make the actual cash you receive feel much smaller than the number in your severance letter, which is one of the most common sources of confusion for Ontario employees going through a layoff or termination.

Is severance taxable? As a general rule, yes — a severance payment (often called a "retiring allowance" in tax terminology) is treated as income and taxed accordingly. What varies is how it's paid out, how much is withheld up front, and whether any part of it can be sheltered by contributing to an RRSP.

This article walks through the general mechanics so you know what to expect and what questions to ask.

Severance Is Taxable Income

A lump-sum payment made when your employment ends — whether it's called severance, a retiring allowance, or a termination payment — is generally treated as taxable income in the year you receive it. This is true whether the payment results from a negotiated settlement, a formal severance package, or a court or tribunal award connected to the end of your employment.

The label your employer uses matters less than the substance of the payment: a payment connected to the loss of your job is generally taxable, regardless of what it's called on the settlement paperwork.

How It's Withheld at Source

This is where most of the confusion happens. Severance is often paid as a single lump sum, and lump-sum payments are frequently withheld at a different — and often higher — rate than your regular paycheque, because the payer has to estimate tax on an unusually large one-time amount rather than spreading it evenly across the year like regular pay.

That higher up-front withholding doesn't necessarily mean you'll actually owe that much tax overall. When you file your return for the year, your total income (including the severance) is taxed based on your actual annual income, and any amount over-withheld during the year is refunded, while any shortfall is owed. The withholding on the payment itself is a prepayment, not the final word on what you owe.

The RRSP Rollover for Eligible Service

There's a special mechanism in the Income Tax Act that can allow part of a retiring allowance connected to certain earlier years of service to be transferred into an RRSP without using up your regular annual RRSP contribution room. This can meaningfully reduce the immediate tax hit on that portion of the payment.

Whether this applies to your severance depends on when you worked for the employer and the specific eligibility conditions tied to your years of service — this is a fact-specific rule, and the eligible-service calculation isn't something to estimate on your own. Ask an accountant or your employer's HR/payroll department whether any portion of your specific payment qualifies before you assume the answer either way.

Salary Continuance vs. Lump Sum

Employers sometimes offer a choice — or simply structure severance — as either a lump sum or "salary continuance," where you continue to receive regular paycheques for a period as though you were still employed.

Neither structure is universally better — the right choice depends on your other income for the year, whether spreading the payment across two tax years would reduce your overall tax, and your own cash-flow needs. This is worth modelling out with a professional before you agree to a structure, since it's often easier to negotiate the structure before signing a release than to change it afterward.

Structuring Ideas to Discuss With a Professional

1. Ask whether any portion of your severance qualifies for the RRSP rollover for eligible service, and get the calculation confirmed rather than estimated.
2. Consider whether splitting the payment across two calendar years (if your employer is willing) could reduce your overall tax by keeping you out of a higher bracket in either year.
3. Check your available RRSP contribution room before assuming you can shelter a large portion of the payment through ordinary contributions.
4. If your severance includes amounts for specific claims (such as unused vacation pay, notice, or a negotiated settlement amount), ask how each component is characterized for tax purposes, since they aren't always treated identically.

None of this changes whether severance is taxable — it is — but thoughtful timing and structuring can genuinely affect how much of it you keep.

Frequently asked questions