Severance planning: What your client should consider

As a result of Covid-19, some clients have lost jobs and received severance packages. Many people have no idea what to do with their severance or even what they should consider.

Imagine a client named Cole who’s 50 years old and has worked as a salesperson since 1990 at LCP Corp., an equipment manufacturing company. He was recently let go because the corporation’s revenue decreased substantially due to Covid-19. Cole was offered a severance of $300,000 or a salary continuance for 18 months. He’s wondering which option is best.

Lump-sum severance

If Cole chooses the lump sum, he wants to know what portion, if any, can be transferred to his RRSP on a tax-deferred basis. The rollover rules are as follows:

• $2,000 per year or partial year of service prior to 1996; plus
• $1,500 per year or partial year of service prior to 1989 if no contributions to a deferred profit sharing plan or registered pension plan were received or vested.

Since Cole has been with LCP Corp. since 1990, he can transfer $12,000 of his severance to his RRSP on a tax-deferred basis with no need for RRSP contribution room.

If Cole has RRSP contribution room, he could transfer a further portion of his severance, up to his RRSP contribution limit, to his RRSP or a spousal RRSP.

Unfortunately, he doesn’t have additional RRSP contribution room, so the balance of his severance will be taxable to him in the year he receives it.

Fortunately, he hasn’t received substantial income this early in the year, so he can receive some of the balance without being pushed into a higher tax bracket. He may want to ask the employer to split the severance over two years to keep him in a lower tax bracket.

If he decides to take the lump sum, you can help him invest the after-tax proceeds of the severance. Cole and his wife have never contributed to a TFSA: between the two of them, they have $151,000 in TFSA contribution room. Cole may want to consider contributing all or a portion of his after-tax severance not needed for income to his TFSA. And, since there is no tax payable on a TFSA, Cole can gift money to his spouse to invest in her TFSA without tax attribution rules applying.

Salary continuance

To make the salary continuation more attractive, Cole’s employer offered to provide health and dental benefits for the 18-month period of salary continuance. Initially, Cole found this option attractive for the stability it provided his family. But a clause stated if he found another job within the 18 months, the salary continuance and benefits would stop. This is a big concern for him because he intends to find another job.

Additional insurance needs

Cole had life, health and dental insurance as an employee. If he chooses the lump sum rather than the salary continuance, LCP Corp. has offered to extend his health and dental benefits for six months. Now is a great opportunity to discuss his insurance needs. Does his wife have benefits through her employer? Are these sufficient to meet the family’s needs or does Cole need additional insurance? If Cole is part of a professional association, assuming his wife has no insurance benefit options, he may also opt to subscribe to the insurance packages offered through his association.

Furthermore, you may want to discuss critical illness or disability insurance. Since Cole no longer has life insurance through LCP Corp., now is a great time to discuss his life insurance needs.

Conclusion

With Covid-19 continuing to wreak havoc on our society, it’s very likely you’ll have clients with questions about severance. Every situation is unique, and it’s important your clients know you can help them with severance in addition to your other services.

Jacqueline Power is an assistant vice-president with Mackenzie Investments. She can be reached at jpower@mackenzieinvestments.com.