Money123 Article: Saving Tax on Severance or Retention Bonus

Want to save tax on your severance or a retention bonus? Here’s how!

As a financial planner for Global News’ Money123 online email newsletter, I answer reader questions about investing, managing your finances, and planning for your future.

In the latest email that went out to subscribers, I answered a question about someone who was laid off, but is now being retained with a bonus. The reader wants to know how to reduce the tax burden on it, since it’s a sizable sum

By the way, my answer is at the bottom of the email newsletter.

Here’s a link to the Global News Money 123 email newsletter with what I recommend: https://globalnews.ca/newsletter/10038601/

The Question:

“My company recently went through a set of downsizing and I have been laid off but retained during a transition period (until the end of the year). As part of this process, I will be receiving a sizeable retention bonus happening before the end of the year.

My question is: given that the retention bonus is significant and I am not sure how long it will take me to find a job in the new year, is there anything I can do to reduce the tax burden on this one-time bonus?

I am the sole income earner in my family and own my own house. I have already maxed out my RRSP contributions for the year but have some room left in my TFSA.”

— A Money123 reader 

Ed’s Answer:

“Receiving a significant retention bonus or severance pay can be a once-in-a-lifetime opportunity. It’s smart to invest most or all your extra money — not spend it all.

The most difficult part is that there are usually unknowns that make it hard to know for sure what is best for you. The biggest unknowns are how long it will take you to find a new job, whether your new job will be a higher or lower income, and whether your retention bonus will be extended.

Retention bonuses are usually a higher income than you would otherwise earn. Otherwise, you would leave as soon as you find a new job.

The three main ways to save tax are the three Ds: defer, deduct, divide.

In your case, you might be able to defer some tax by asking your employer to pay all or part of your retention bonus as a lump sum in January 2024. This would defer tax on that amount to next year, which helps you if you will be in a lower tax bracket next year. If your income for 2024 is lower than for 2023, this income deferred to next year could be taxed less. This could happen if you take a while to get a new job or your new job is a lower income than your retention bonus.

Also, 2023 might turn out to be your highest income year, so looking for other deductions can help you. You have done the most obvious deductions that could help you, since you have already maximized your RRSP contributions. You own a home, so you cannot contribute to an FHSA. You do not have to deduct all the RRSP contributions you made for 2023. If it turns out that you may be in a higher tax bracket in 2024, you can defer deducting your 2023 RRSP contributions until 2024 to get a larger tax refund next year.

If you have more money, the best place to invest it is your TFSA to avoid tax on the future growth.

After your TFSA is maximized, you can invest it in a non-registered account, which can be joint with your spouse, if you have one. In this case you can probably have investment income from these investments taxed to your spouse. Since your spouse is not working, you should pay little or no tax on the future investment income by having this income taxed to your lower income spouse.”

Ed