Termination options

Last month’s column outlined various decisions surrounding termination payments. So let’s look at related considerations for your clients, including replacing benefits and what to do with pension plans and remaining stock options.

The cessation of health insurance benefits with job loss could be particularly problematic if the terminated employee has a family and no access to alternate health benefits through a spouse’s employment. As part of the severance package, it’s advisable to try and negotiate an extension of group medical and dental plans for a defined period: These benefits would be tax-free. Alternatively, it may be possible to receive a taxfree lump sum payment in lieu of private health benefits.

Another tax-free benefit that might be useful to a departing employee is counselling to help him or her find a new job (outplacement services).

Regarding life insurance coverage, your client should see if there’s an option to convert the employer’s group coverage to a private policy. But he or she should also investigate whether it would be more economical to buy coverage elsewhere, perhaps through an industry or professional association.

If your client was a member of a company defined benefit pension plan, he or she will have to make some decisions regarding entitlement under the plan. Generally, there are three options:

1. Your client can leave funds in the plan and, depending on age, years of service, and terms and conditions, start receiving an early pension or opt for a deferred pension in future years. In addition to providing funding for the nonworking period, the benefit of an early pension (even if reduced as a result of early retirement) is the ability to split pension income with a spouse or partner and the eligibility of that income for the pension income credit.

2. If your client finds a new job quickly, and that position also offers a company pension plan, he or she might be able to transfer the previous pension to the new plan.

3. Your client has the option to transfer a lump sum amount representing earned pension benefits into a locked-in RRSP. This option will likely come with an accompanying pension adjustment reversal (PAR), which restores some RRSP contribution room. The PAR is generally the amount by which the pension adjustments in previous years of employment exceed the termination benefit. Purchasing RRSP investments in today’s economy, where security values have declined substantially, may provide an opportunity for significant growth in future years.

Those who leave employers with unexercised stock options generally have a specified period during which those outstanding options must be exercised. Your clients should take note of this period. Even where options are currently underwater, they may have future value if the underlying securities recover significantly in the exercise period.

Those who leave employers with unexercised stock options generally have a specified period during which those outstanding options must be exercised. Your clients should take note of this period. Even where options are currently underwater, they may have future value if the underlying securities recover significantly in the exercise period.

However, with depressed security values, departing or current employees might consider exercising options and holding the shares. The stock option benefit, generally taxable in the year of exercise, can be deferred by election until the year the shares are sold. Even so, the employee or former employee will have to finance the acquisition of the shares and this may not be practical if funds are limited. But if this option is affordable, there may be significant benefits available to former employees when the company shares appreciate in value.

Gena Katz, FCA, CFP, an executive director with Ernst & Young’s National Tax Practice in Toronto. Her column appears monthly in Advisor’s Edge.