Service pay/retirement allowance
Service pay/retirement allowance is income available to employees at the time of retirement. A retirement allowance (also called retiring allowance) is defined in the Income Tax Act as “an amount received on or after the retirement of an employee in recognition of long service or in respect of a loss of an office or employment. The amount, which may be paid by installments, may be received by the former employee, or after his or her death, by a dependant or a relation or by the former employee's legal representative.”
It is also defined as an amount received “in respect of a loss of office or employment of a taxpayer, whether or not received as, on account or in lieu of payment of, damages or pursuant to an order or judgment of a competent tribunal, by the taxpayer or, after the taxpayer's death, by a dependant or a relation of the taxpayer or by the legal representative of the taxpayer.”
In addition, early retirement incentive plans are generally designed to reduce the number of positions and the payments made in respect of these “retirements” are generally considered to be retiring allowances.
In Quebec, under the Act Respecting Labour Standards, wages in lieu of notice are also considered a retiring allowance.
Thus, it is generally considered termination pay that is provided either voluntarily or involuntarily (as a requirement of law or as a result of a court settlement, or severance payments, or retirement allowance policy).
A payment for unused sick leave credits on or after retirement qualifies as a retiring allowance.
In this specific circumstance, we are talking about employers offering service pay/retiring allowance (through workplace policy) to employees who have reached retirement age (generally 45 and over) and are giving up regular employment.
According to our latest HRinfodesk poll, which asked readers If your organization offers service pay or a retirement allowance at the time of retirement, how much do you pay? the majority of respondents (85.1%) indicated that they don't offer service pay or allowance to employees when they retire. Only 6.9% of respondents indicated that they offered less than one month's pay, and another 6.9% offered more than three months' pay. This is not surprising since most small-sized businesses are not financially able to fund such benefits. This trend may change soon; as the Canadian population ages, many individuals take early retirement, a number of employees are receiving retiring allowances. However, in the current employment context, characterized by a shortage of skilled workers and a rapidly aging workforce, many agreements now focus on ways and means of retaining older workers or facilitating their transition to retirement.
Below is a breakdown of the results of the poll and a commentary on the topic of service pay/retirement allowance.
Other legal requirements
A retiring allowance plan provides eligible employees with a retirement benefit based on their years of service with a specific organization. For the amount received to be considered a retiring allowance, the employee-employer relationship must no longer exist. There must be some evidence of the cessation of that relationship. Retirement refers to retirement from an employer, regardless of whether the employee is of normal retirement age.
According to the Canada Revenue Agency (CRA), the term “long service” is usually considered to have reference to the total number of years in an employee's career with a particular employer or with affiliated employers.
Usually, partial years of service count as full years.
Generally speaking, lump-sum payments in lieu of notice are considered to be retiring allowances, despite some indications by the CRA that payment in lieu of notice may be considered to be income. Where the payment can be characterized as severance, including statutory severance under the Employment Standards Act (in Ontario and the federal jurisdictions only), or as damages for wrongful dismissal, it will be viewed as a retiring allowance.
Salary continuance, vacation payments, bonuses, commissions, wages in lieu of notice (meaning termination/written notice as required by Employment Standards for all jurisdictions except Quebec), accumulated overtime pay, or any other employment earnings do not qualify as a retiring allowance. A retention bonus for reporting to work until the termination date would also not qualify as a retiring allowance.
A retiring allowance is usually a single payment, however, it may be paid in installments and still qualify. A retiring allowance plan may be paid over one or more years; but this plan cannot go on for longer than three years from the date of the termination. This benefits the employer because the organization does not have to come up with the cash all at once. It also helps the employee because he or she can often split income over a number of years and take advantage of graduated tax rates in each year. If an employee receives a retiring allowance in installments, the installments are taxable in the year received. Some or all of each installment may be transferred to an RRSP up to the maximum eligible amount.
A retiring allowance isn't subject to EI or CPP/QPP, or QPIP (in Quebec) withholdings and is not considered earned income for RRSP purposes. A retiring allowance is subject to lump-sum income tax withholding rates ranging from 10% to 30%, depending on the amount of the payment.
Use these federal and provincial or territorial composite rates:
- 10% (5% for Quebec) on amounts up to $5,000
- 20% (10% for Quebec) on amounts over $5,000
- 30% (15% for Quebec) on amounts over $15,000
The amounts paid in any particular year may be transferred to an RRSP or an RPP but cannot exceed the employees' eligible portion of the retiring allowance minus the eligible portion transferred by the employee in a prior year. The amount that can be transferred is based on the following formula: $2,000 for each year of employment up to but not including 1996; plus, $1,500 for each year or part of a year before 1989 of that employment in which none of your contributions to the RPP or DPSP were vested in the employee's name when you paid the retiring allowance. Determine the equivalent number of years of vesting by referring to the terms of the particular plan. The number can be a fraction.
The amount of retiring allowance paid in each year to an RPP or RRSP should be reported in Box 26 of a T4A slip each year. The accumulated payments cannot exceed the total eligible amount. The balance (the portion of the retiring allowance that is non-eligible for tax-free rollover) should be reported in Box 27 on a T4A.
Like ordinary employment income, if a retiring allowance is received as cash it is subject to withholding tax at the lump-sum tax rates at time of payment.
Continued participation in the employee benefit package will not necessarily disqualify the amount as a retiring allowance, unless the employee is allowed to accrue pension credits after termination. Employers should examine the terms of their existing benefit plan (medical, dental, etc.) to see if continued participation in the plan is limited to employees only. If so, the company would need to have or would need to establish a benefit plan specifically for retirees or terminated employees. Otherwise, if benefit coverage is continued after termination, the payment(s) would be disqualified as a retiring allowance
The CRA stated in 2006 that if, following retirement, an employee is rehired by the same employer or by an affiliated, non-arm's-length company pursuant to an arrangement made prior to retirement, he or she would generally not qualify for a retiring allowance. If an employee leaves his or her job, collects a retiring allowance, and then goes back, even as a consultant or independent contractor, the Canada Revenue Agency doesn't rule out such situations but may invalidate their tax break if they return ‘shortly' after leaving. Arm's-length dealings are acceptable ‘at a later time' provided the employee was given no assurance of being rehired. This holds true for the former employer and related employers.
Smaller businesses are less likely to have a written retirement allowance policy or a retirement service recognition policy in place, but all organizations should have one. A retirement allowance policy or a retirement service recognition policy benefits both the organization and the retiring employee, providing certainty and averting the discomfort that can arise with individual negotiations. Of course, exceptions can always be custom-tailored to suit individual circumstances.
A retirement allowance policy defines the eligibility requirements and payment conditions governing the employees' retirement allowances. It should be specified in the policy that a retirement allowance may only be paid when an employee retires. How much written notice the employee must give the employer must also be indicated.
Even if mandatory retirement is now prohibited in most jurisdictions, eligibility must be defined by years of service starting at a specific age. The difference is that it is voluntary and employees are not forced to retire. They choose to retire and if they do, the allowance is available to them. For example, all employees who are at least 55 years of age and have at least 10 years of continuous service may be eligible for a retirement allowance.
Years of service are generally the full time years of credited service an employee accrues while an active employee of the organization.
The policy should indicate and outline that at retirement, the employee must decide how they want their retirement allowance paid and optional forms of benefit distribution and tax consequences.
For example, and in general, the retiring allowance policy statement would read as follows:
Employees may choose to retire from the organization at any age provided they are still capable of carrying out their duties.
Employees can retire as early as age 55 or any age thereafter and be eligible for the organization's retiring allowance.
Upon retirement from service, an employee who has completed 10 years of service with a certain organization, is entitled to an amount equal to their salary for one month, and, for each full year of service exceeding 10 years, is entitled to an additional amount equal to 1/5 of their monthly salary, to a maximum of three months salary (20 or more years of service).
Employees shall receive a retirement allowance at the rate of five working days for every year of completed full-time equivalent service.
For more information, obtain copies of the following publications. These are resources that no HR or payroll professional should be without when dealing with retiring allowances.
The Canada Revenue Agency's (CRA) Interpretation Bulletin (IT) - IT337R4 Retiring Allowances
Revenue Québec's Income Tax Interpretation Bulletin: IMP.311-1/R3, Retiring Allowance