Your Release Year: Every Slip Thinks It's the Only One

Severance Is a Retiring Allowance

Severance pay on release is a retiring allowance under the Income Tax Act. That phrase does three things. It makes the payment income in the year it's paid, reported on line 13000 of your return rather than with your salary. It puts the payment in boxes 66 and 67 of your CAF T4 instead of box 14. And it changes how tax comes off it.

Box 66, the eligible part. A fixed amount of a retiring allowance can be moved into an RRSP on top of whatever room you have: $2,000 for each year or part-year of service before 1996, plus $1,500 for each year before 1989 in which no pension benefit vested. The years are the point. Someone releasing now with service that began after 1995 has no eligible part at all. Someone who enrolled in the early nineties has a few thousand dollars of it, and it's worth moving, because it's sheltered without using room.

Box 67, the rest. Everything that isn't eligible is ordinary income for the year. The only shelter is RRSP room you already have, and after a career in a pension plan there may not be much: the pension adjustment reported on every T4 has been reducing your room each year by the value of the pension you earned. Your most recent notice of assessment says what's left.

The withholding. Tax is taken off a retiring allowance at the flat lump-sum rates, which step up with the size of the payment, instead of through the payroll tables. For most members the flat rate is lower than the rate the money is actually taxed at once it sits on top of a part-year salary and a pension, so the slip arrives with less tax deducted than the return will want. The money isn't gone. It's just due in April.

If you were serving when severance stopped accumulating and chose to leave what you had in place rather than cash it out, this is the year it's paid, and the rules above apply to it.

The Pension: Three Doors

What the Pension Centre pays you depends on your age and service at release, and the tax follows the door you take. The service and age conditions are on the Pension Centre's release pages, linked at the end of this guide, and they differ in places by enrolment date. The tax treatment doesn't.

An annuity. An immediate pension, reduced or unreduced, is taxable income every month, reported on a T4A from the Pension Centre and withheld on like a salary. A deferred pension is nothing on this year's return; it becomes an annuity later and is taxed then.

A transfer value. If you release under 50 with a deferred pension entitlement, you can take the value of the pension as a lump sum instead. The election has to be made within a year of release, or the deferred pension stands. The lump sum arrives in two pieces. The part within the Income Tax Act's limit goes straight into a locked-in plan with no tax. The part above the limit is paid to you, and it's taxable income in the year it's paid unless you have RRSP room to put it in: certify the room to the Pension Centre and it pays that amount into your RRSP with nothing withheld.

The room you get back. Taking a transfer value ends your membership in the plan, and that triggers a pension adjustment reversal: if the pension adjustments reported on your T4s since 1990 add up to more than the value the plan paid out, the difference is restored to your RRSP room. It arrives on a T10 slip and goes into your deduction limit. For a younger member with a modest transfer value, the reversal can be exactly the room that shelters the excess, so look at both numbers together before deciding where the excess goes.

Timing. The excess is taxed in the year it's paid, and the year-long election window is a lever. Paid in December, it sits on top of a full year's salary, leave and severance. Paid in January, it lands in a year that may have little else in it yet. The Pension Centre's timelines are its own, so this is a conversation to have before the election, not after.

Fewer than two years. A return of contributions is your own contributions plus interest, paid in cash less tax or moved into an RRSP with nothing withheld. Moved is almost always better.

Pension Splitting Before 65

Most early retirement income can't be split with a spouse until 65. A CAF annuity can, from the first payment, at any age. Lifetime payments from a registered pension plan are eligible pension income regardless of age, which puts two things on the table from your release year on.

The pension income amount. A non-refundable credit on the first $2,000 of eligible pension income federally, with a provincial version alongside it, claimed on line 31400. It is routinely missed by a 45-year-old who doesn't think of themselves as a pensioner.

Pension income splitting. Up to half of the taxable annuity can be allocated to your spouse or common-law partner on a joint election filed with both returns each year. The tax withheld from the pension moves across in the same proportion. Where your spouse is in a lower bracket, the household bill drops, and the allocated part can earn your spouse a pension income amount of their own. The election is annual, so a year where it doesn't help is a year you don't make it.

The transfer value does not qualify, and neither does the excess paid in cash. The annuity does. If you're weighing the two, this is one of the things on the annuity's side of the ledger.

Final Pay, Leave, and the Second Payer

Pay to your release date and the leave cashed out with it are salary on your CAF T4. Nothing is special about them except volume: the leave arrives as a lump in your final month, on top of everything else, and tax comes off it through the payroll tables like any other pay.

The problem is the tables themselves. Every payer calculates withholding from a TD1 form, and a TD1 claims the basic personal amount by default. The CAF claimed it for you years ago. The Pension Centre asks for one when the annuity starts. A new employer hands you one on day one. Each of them then taxes the first slice of what it pays you at nothing and the next slice at the lowest rate, exactly as it should if that payment were your only income. Added together, a year that was really one income was taxed as three small ones. The difference arrives as a balance owing on April 30, and if it's large enough the CRA will ask for instalments the following year.

The fix is on the form. On the TD1 for every payer after the first, tick More than one employer or payer at the same time and enter 0 on line 13: that payer then withholds without the basic personal amount. The back of the form has a line to ask for additional tax to be deducted from each payment, which is the simplest way to have the pension withheld on at a rate closer to your real one. Or set the money aside and pay it in April. The one thing not to do is nothing, and then be surprised.

The Move Home

The CAF pays for a final move to an intended place of residence within a set time after release. Whether any of the costs you paid yourself are deductible turns on the condition the Act puts first: a moving expense is deductible only where you moved to work, or to run a business, at a new location. A move to retire, on its own, doesn't qualify, however far you went or what it cost.

Where the move is also to a civilian job or a business at the new location, and the new home is at least 40 kilometres closer to it, the rules are the same as for a posting: what the CAF paid can't be claimed, what you paid yourself can be, against income earned at the new location, on Form T1-M. Our posting-year guide has the full list of what the Act accepts and what it leaves out.

Whatever the reason for the move, the province you live in on December 31 is your province for the whole year's tax. Tax came off your CAF pay at the rates of the province you were working in, so a move between provinces leaves a gap one way or the other before anything else on this page.

A Medical Release

A medical release adds payments of its own, and the line between taxable and not matters more here than anywhere else on the return. Our veterans' benefits guide has the rule, and our benefit-by-benefit list has every VAC program with its slip and line. For the release year, three things are worth saying here.

Income replacement is taxable; compensation for injury is not. The Income Replacement Benefit replaces income and is taxed like income, with a slip. Pain and Suffering Compensation and the disability pension are compensation, generally not taxable, and generally arrive with no slip. Long-term disability payments under the CAF group plan are taxable and come with a slip, with tax withheld like a salary.

The Disability Tax Credit. The condition that led to release may meet the test for the disability amount, which is a separate decision from VAC's. The application is Form T2201, certified by a medical practitioner, and the CRA decides it. Once approved, the credit can be claimed for up to ten previous years in which the condition already met the test, which for someone whose condition predates release can reach back into service years.

The Education and Training Benefit. Taxable in the year it's paid, and VAC withholds nothing from it. A school year funded by it is a year to set money aside for April.

The Civilian Side

If the next step is a job, the TD1 section above is the whole of it. If the next step is self-employment or a business, the release year is also year one of a different set of rules: the T2125 for business income, instalments once nobody is withholding for you, and HST registration once sales cross $30,000. Our self-employed guide and our HST registration guide cover both, and if a corporation is on the table, incorporate or not is the place to start.

Released or serving makes no difference to us: the 15% service appreciation rate applies to this return and every one after it.