The 1996 Freeze on Rolling Severance Into an RRSP: What It Costs You Is Room
Severance packages are being signed against the backdrop of a September in which Canada lost 68,000 jobs. The advice that arrives with a package is familiar: roll it into an RRSP tax-free. For anyone whose service with that employer began in 1996 or later, that transfer is now worth exactly $0, because the provision behind it stopped counting service that year. What survives is narrower, and it costs something the pitch leaves out: RRSP room you do not get back.
What a Retiring Allowance Actually Is
The tax treatment below applies only to a retiring allowance, which the CRA defines as “amounts paid to officers or employees on or after they retire from an office or employment, in recognition of long service or for the loss of an office or employment.” Sick-leave credits paid out on termination, wrongful-dismissal damages, and payments made after retirement recognising service all count. Salary, vacation pay, death benefits and wages in lieu of termination notice do not. Notice pay is the common case, and the distinction costs it two things specifically: the 60(j.1) transfer below, and the CRA direction to the employer not to withhold on a direct transfer. What notice pay keeps is the ordinary RRSP deduction against your own room, claimed on your return. The shelter still works. The withholding relief at source does not, so the money arrives taxed and you contribute it yourself.
Payroll treats it differently: no CPP or EI withholding; eligible amounts are reported under T4 code 66, non-eligible under code 67. Legal fees are not necessarily a dead loss: paragraph 60(o.1) lets a taxpayer deduct legal expenses “paid by the taxpayer in the year or in any of the 7 preceding taxation years to collect or establish a right to an amount of … a retiring allowance”, subject to limits that paragraph sets.
The 1996 Freeze That Guts the “Tax-Free RRSP Transfer” Advice
The provision behind the advice, paragraph 60(j.1) of the Income Tax Act, allows a transfer to an RRSP of “$2,000 multiplied by the number of years before 1996 during which the employee or former employee in respect of whom the payment was made … was employed by the employer or a person related to the employer”, plus a further $1,500 for each year before 1989 in which employer pension contributions had not vested. The contribution must be “paid by the taxpayer in the year or within 60 days after the end of the year” to qualify.
Run that arithmetic against three cases and the shape of the problem is obvious. Someone whose service with the employer began in January 2008 has an eligible transfer of $0. Someone whose service began in January 1990, with six years before 1996, gets $12,000. Someone whose service began in January 1986, with ten years before 1996 and three of those before 1989 unvested in an employer pension, gets $24,500. The clause is frozen at 1996: nothing accrues for service after that year, no matter how long the employee stayed or how large the eventual package.
The provision does not test a hire date, though: it counts years before 1996 during which the retiree “was employed by the employer or a person related to the employer,” a term that includes “(iv) any person whose business was acquired or continued by the employer, and (v) a previous employer of the retiree whose service therewith is recognized in determining the retiree’s pension benefits.” So someone hired in 2000 is not automatically at $0: not if their employer later absorbed a business they themselves worked for before 1996, and not if pre-1996 service with an earlier employer counts toward the pension they hold today. Both are worth putting to HR as questions rather than assuming the answer.
What Is Still Available: The Non-Eligible Portion, and the Room It Spends
The eligible portion is not the only way severance can reach an RRSP without withholding. The CRA is explicit on both. Where the eligible portion is “directly transferred to an RPP or RRSP, [the employer does] not withhold income tax on this portion.” And for the non-eligible portion, the employer “do[es] not withhold income tax on this portion” if it goes directly to the employee’s RRSP, provided it does not exceed their available deduction limit.
In the year of the transfer the two routes cost the same tax, which is why the two get discussed as one move. They are not. Subsection 146(5) lets a taxpayer deduct RRSP premiums, other than the portion “that was designated for any taxation year for the purposes of paragraph 60(j), 60(j.1) or 60(l).” A premium designated under 60(j.1) is carved out of that deduction, which is exactly why it never touches the ordinary limit: it is deductible on top of your room rather than out of it. The freeze did not end the ability to shelter severance, only to do it for free: the non-eligible route spends retirement room that does not come back, as our RRSP guide explains. Ask for more than the room can absorb and subsection 204.1(2.1) charges “a tax under this Part equal to 1% of that cumulative excess amount” for each month it sits there. Cumulative excess amount is the Act’s own term and it is not simply the amount above your limit, which is why the figure to confirm before the request reaches payroll is the room itself. We have set out what an RRSP over-contribution costs separately.
Withholding if You Take the Cash
Severance paid directly to you is withheld on a sliding scale the CRA sets for lump-sum payments: 10% (5% in Quebec) on $5,000 or less, 20% (10%) on $5,001 to $15,000, and 30% (15%) on $15,001 or more. It is calculated “from the portion you pay directly to your employee, not including any portion directly transferred to an RPP or RRSP,” so a split payment is withheld only on the cash portion. The rate is also set by “the recipient’s total amount of lump-sum payments paid or expected to be paid in the calendar year” rather than by each cheque on its own, so other lump sums in the same year can push the whole amount into the top band.
The Worked Example: A $40,000 Severance in Ontario
Take an Ontario employee earning $95,000, laid off at the end of October 2026 with $79,167 earned for the year, and offered a $40,000 retiring allowance with no eligible 60(j.1) room. Using CRA’s 2026 T4032ON Payroll Deductions Tables, tax on $119,167 of taxable income comes to $28,241.16 and tax on $79,167 alone comes to $15,250.27. Both figures carry the same $750 Ontario Health Premium and both leave out the CPP and EI credits, which are at their annual maximums on a $79,167 salary and are not withheld on a retiring allowance at all. Identical on each side, they drop out of the subtraction that follows. The severance costs $12,990.89, or 32.5%, and $785.41 of that is Ontario surtax. The two surtax tiers stack rather than slice: 20% applies to all basic Ontario tax above $5,818 ($489.82) and a further 36% to the part above $7,446 ($295.59), so a dollar of Ontario tax in that upper band arrives with 56 cents of surtax behind it. The employer withholds 30%, or $12,000, leaving $990.89 owed at filing. Withholding is not the tax bill.
The alternative is to park the $40,000 under ordinary RRSP room and draw it out in a low-income year. What gets taxed then is the withdrawal, in the year you make it. As a year’s only income it is taxed at $5,110.78, or 12.8%. Alongside EI benefits, on an assumption of 30 weeks at the 2026 maximum of $729 a week ($21,870 of taxable benefits), it is taxed at $8,652.49, or 21.6%.
| Taking the $40,000 | Tax on it | Effective rate |
|---|---|---|
| In 2026, stacked on $79,167 of salary | $12,991 | 32.5% |
| Withdrawn in a later year, alongside $21,870 of EI benefits | $8,652 | 21.6% |
| Withdrawn in a later year with no other income | $5,111 | 12.8% |
Column 2 rounded from $12,990.89, $8,652.49 and $5,110.78; arithmetic ours, on the 2026 federal and Ontario rates in CRA’s T4032ON Payroll Deductions Tables.
The way out is withheld too. When you withdraw from an RRSP “your financial institution withholds the tax”, at “30% (15% in Quebec) on amounts over $15,000”, and in Quebec “there will also be provincial tax withheld”. So $12,000 is held back against an actual bill of $8,652.49 in the alongside-EI case and $3,347.51 comes back at filing. The gap, $4,338.40, is the difference between the two figures this article prints: $12,990.89 minus $8,652.49. The RRSP room spent getting the money in does not come back at all.
The EI Side the RRSP Move Does Not Fix
Timing the severance into a lower-tax year addresses the tax bill, not the EI clock. Subsection 36(9) of the EI Regulations states: “Subject to subsections (10) to (11), all earnings paid or payable to a claimant by reason of a lay-off or separation from an employment shall, regardless of the period in respect of which the earnings are purported to be paid or payable, be allocated to a number of weeks that begins with the week of the lay-off or separation in such a manner that the total earnings of the claimant from that employment are, in each consecutive week except the last, equal to the claimant’s normal weekly earnings from that employment.” A later top-up adds to what is already allocated under subsection 36(10), on which “a revised allocation shall be made.”
Normal weekly earnings on our arithmetic are $95,000 divided by 52, or $1,826.92. The $40,000 severance divided by that figure allocates across 21.89 weeks, which is 21 full weeks at normal weekly earnings plus a partial one, before EI benefits begin to pay. Service Canada’s 2026 figures set the ceiling once they start: the maximum weekly benefit is $729, and for most people the basic rate is 55% of average insurable weekly earnings.
Filing the claim need not wait for that allocation. Subsection 35(6) states that “the earnings referred to in subsection 36(9) and allowances that would not be deducted from benefits by virtue of subsection 16(1) are not earnings to be taken into account for the purposes of section 14,” the test for an interruption of earnings. So the severance is excluded from that test, and it is not the thing standing between a reader and an open claim, though the ordinary conditions for a benefit period still have to be met. Subsection 36(9) then allocates the money against benefits payable once the claim is open.
Sending the retiring allowance straight into an RRSP changes the tax year it is taxed in. It does not change the week EI starts paying, because the allocation runs on earnings paid or payable by reason of the separation, not on how or where that money is eventually deposited. Salary continuance does not get around this either: it spreads the income across tax years without spending any RRSP room, but subsection 36(9) allocates it exactly the same way it allocates a lump sum, against normal weekly earnings starting the week of the separation.
Disclaimer: The content on bestcanadianstocks.ca is for informational and entertainment purposes only and does not constitute financial advice. Past performance is not indicative of future results. Always consult a qualified financial advisor before making investment decisions. The definition of a retiring allowance, the list of what is and is not one, the eligible and non-eligible withholding treatment and the T4 codes 66 and 67 are from the CRA’s Payments of retiring allowances page, retrieved October 13, 2026. The $2,000 per year before 1996 and $1,500 per year before 1989 amounts and the 60-day rule are quoted from Income Tax Act paragraph 60(j.1) on Justice Laws, act current to September 21, 2026. The lump-sum withholding rates of 10, 20 and 30 percent and their Quebec equivalents, and the two conditions quoted, are from the CRA’s Lump-sum payments page, retrieved October 13, 2026. The earnings definition and the allocation of separation earnings are quoted from Employment Insurance Regulations subsections 35(2) and 36(9) on Justice Laws, regulations current to September 21, 2026. The $729 maximum weekly EI benefit for 2026 and the 55 percent basic rate are from Service Canada’s EI regular benefits benefit-amount page, retrieved October 13, 2026. The 2026 federal and Ontario brackets, the basic personal amounts of $16,452 and $12,989, the Ontario surtax thresholds of $5,818 and $7,446 and the Ontario health premium are from CRA T4032ON, Payroll Deductions Tables for Ontario effective January 1, 2026. Every tax figure in the worked example is our own arithmetic on those rates, income tax only, net income taken equal to taxable income, claiming only the basic personal amounts. The Ontario surtax is computed with the two tiers stacked, per T4032ON: 20 percent of basic Ontario tax over $5,818 plus 36 percent of basic Ontario tax over $7,446. The withholding on an RRSP withdrawal is from the CRA’s Tax rates on withdrawals page, a different payer from the employer payroll table, retrieved October 13, 2026. Paragraph 60(o.1) on legal expenses, subsection 146(5) on the exclusion of premiums designated under 60(j.1), and subsection 204.1(2.1) on the 1 percent monthly tax are from Justice Laws, act current to September 21, 2026.
