Pay & Salary

What Is Severance Pay in Canada?

June 11, 2021

Many companies offer severance packages to aid employees that are let go permanently or temporarily laid off through no fault of their own. Every company offers severance packages with different amounts, terms, and conditions. So, it's important to understand what your company offers before you sign your contract to ensure you are protected.

In this article, we look further at what severance pay is, how it works, when companies offer it, how they determine the amount to pay, and frequently asked questions you may have about severance pay to help you fully understand it.

What is severance pay?

Severance pay is a form of compensation that employers may offer to employees they are laying off or letting go of for reasons beyond their control, such as bankruptcy or downsizing. It is meant to help employees in the period between jobs to ease the transition and alleviate stress.

How does severance pay work?

There are different conditions regarding employees being eligible for severance pay. Eligibility regulations even change between provinces and territories. For example, you are eligible for severance after one week with a company in British Columbia, but in Ontario, you need to have worked for a company for over five years. Check your work contract, employee handbook, or offer letter for the exact requirements you need to meet to be eligible.

If you are eligible for severance pay, you may be able to choose how you receive it. Choose from a lump-sum payment, a salary continuance, or deferred payment. Before your employer gives you your severance package, you typically have to sign an agreement that stipulates the terms of your termination and how you will receive your severance pay.

When does severance occur?

Severance can occur in a number of situations, such as the following:

  • An employer is letting you go because they are filing for bankruptcy
  • The employer lays you off for 35 weeks or more in a year
  • The establishment is closing permanently
  • The employer is eliminating your role

It's important to note that employees that are fired for poor performance at work are usually not eligible for severance pay. Instead, it is for employees that the company had to terminate suddenly. Most companies decide to offer severance pay so the employee doesn't sue them for wrongful termination, unpaid wages, or discrimination. Of, companies offer severance as a sign of good faith and to uphold a positive image in their community.

How do companies determine severance pay?

There is no exact amount of severance pay that every employee receives. It varies depending on the industry, role, size of the company, and length of time you've been with them. Usually, the longer you've been with a company, the more severance you will receive.

Employers typically give you one week's pay for each year you've worked with them to a maximum of 26 weeks. If you haven't completed a full year, employers will still include the months in their calculation as well. Multiply your wage for a week by the number of completed months of employment. Then, divide it by 12 to determine how much you will get.

For example, if your weekly pay is $1,000 and you've worked with a company for five years and four months, you will get $5,000 for the five years. Then, multiply $1,000 by four months, which is $4,000. Divide that by 12 and you will get an additional $333. So, you are eligible for $5,333 in severance pay. This calculation is just a general rule of thumb. Some employers may give you less, and some may give you more.

FAQs about severance pay

If you're still unsure about severance pay, here are some helpful frequently asked questions about severance and their answers:

1. Do I have to pay income tax on my severance pay?

Yes, you do have to pay income tax on severance pay. The amount you pay depends on the amount you are receiving and how you are receiving it. For example, if you get a lump-sum payment rather than a salary continuance, you will end up paying more on taxes.

The good news is that your employer won't deduct Canada Pension Plan (CPP) contributions, Quebec Pension Plan (QPP) contributions, or Employment Insurance (EI) premiums from your lump-sum severance pay as they would on a normal paycheque. However, if you are receiving your severance pay as a salary continuance, the usual deductions will come out.

2. Can I contribute my severance pay to my RRSP?

Some employers give you the option to deposit your severance pay as a lump-sum directly into your Registered Retirement Savings Plan (RRSP) or Registered Pension Plan (RPP). This is beneficial as your employer won't deduct income tax from your severance pay. But you will have to pay the income tax when you deduct it.

It's important to check if you have enough contribution room in your RRSP to deposit your severance pay. If you don't, you will have to pay a tax of 1% for every month you were over.

3. Am I still eligible for employment insurance benefits if I'm getting severance pay?

You're not able to receive employment insurance while receiving severance pay. Once you finish receiving your severance package, you may be eligible for employment insurance until you find another job. You can apply for employment insurance directly on the Government of Canada website and they will let you know whether you're eligible and the amount you can receive.

4. How will I receive my severance pay?

You typically get to choose how you receive your severance pay. Here are your three options:

  • The first option most employers give is a lump-sum payment when you are let go. Employers can give you a cheque or deposit it into your account or your RRSP if you request it. With this option, the employer must pay you within seven days or on your next payday, whichever is later.
  • Alternatively, you may receive your severance pay as a salary continuance, meaning you continue to earn your regular pay and benefits for an agreed-upon time.
  • A less popular option some employers offer is severance in deferred payments over two or more years.

5. Is severance pay monetary?

Severance pay may not only be monetary. Some companies will also continue to pay for your benefits or give you assistance in finding another job. If you have unpaid vacation time, holiday pay, or sick pay, employers may also include it in your severance package.

6. Is termination pay and severance pay the same thing?

No, they're not the same thing. Termination pay, also known as pay in lieu of notice, is for employees that are fired on the spot. The amount of money you get will depend on how long you've been with the company as the longer you've worked there, the more notice they legally needed to give you.

On the other hand, not everyone is entitled to severance pay, even if you were let go without notice. Some companies give it to employees they need to let go of through no fault of the employee. This usually happens when companies are willingly or unwillingly downsizing.

7. When am I not eligible for severance pay?

There are a number of cases where you may be ineligible for severance pay. Here are a few common scenarios:

  • You refuse an alternate role from your employer when they eliminate yours
  • You are let go but retire on your full pension instead
  • The establishment is closing permanently because of a strike
  • You work in construction or maintenance of buildings, pipelines, structures, roads, etc.
  • You are guilty of misconduct, neglect, or disobedience

8. Am I eligible for severance pay as an independent contractor?

In many cases, independent contractors are not eligible for severance pay unless they have a contract that states they are. However, some companies hire independent contractors but treat them as employees. In this situation, a court may deem you eligible for severance pay.

The exact circumstances are different for every contractor, but if a company sets your schedule, gives you a uniform, supervises you closely, assigns your tasks, and provides you with the necessary equipment to complete your work, a judge may consider you an employee rather than a contractor. Talk to a lawyer or paralegal if you think you've been misclassified and terminated without severance pay.

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