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Severance Pay in Canada: The Essential Guide
Severance pay is an important concept for employees in Canada who are terminated without cause or laid off. This guide covers everything you need about severance pay, including eligibility requirements, how severance is calculated, factors that increase amounts, tax implications, exemptions, and tips for maximizing your settlement.
Gaining clarity on your severance pay rights and entitlements can significantly ease the financial transition during unemployment. Read on for a full overview of severance pay in Canada.
What is Severance Pay?
Severance pay, also known as termination pay, is compensation provided to employees who have been terminated without cause or laid off in Canada. It is essentially paid in lieu of the notice period they would otherwise have worked.
Severance pay helps protect employee rights and provides financial assistance during the transition between jobs when employment is lost unexpectedly. It is regulated by provincial, federal, and common law.
Now, let’s look at severance pay in Canada in more detail:
When Do You Qualify for Severance Pay?
There are several situations that may qualify you for severance pay in Canada:
Termination Without Cause
If you are terminated by your employer without cause, you are eligible for severance pay. Being let go for reasons unrelated to performance, such as downsizing or restructuring, entitles you to compensation.
Constructive Dismissal
If your employer makes significant changes to your employment conditions that effectively force you to resign, this is considered constructive dismissal. Some examples include demotions, pay cuts, and relocated workplaces. Resigning due to constructive dismissal entitles you to severance pay.
Layoffs
Being laid off from your job for 35 weeks or more in 52 weeks makes you eligible for severance pay, even if the layoff weeks were not consecutive.
Business Closure
If your employer shuts down part or all of its business permanently, resulting in loss of employment, you are eligible for severance pay.
Resignation During Statutory Notice Period
If you resign during the statutory notice period after being given formal notice of termination, you remain eligible for severance pay. To qualify, you must provide at least 2 weeks’ written notice of your resignation, and it must take place during the statutory notice timeframe.
How Severance Pay is Calculated in Canada
The amount of severance pay owed is based on the employee’s regular wages and years of service. Here is how it is calculated:
Step 1: Determine Regular Wages
For employees paid hourly or salary, this is the typical pay earned in a regular work week.
For those paid through commissions or other means, it is calculated by averaging earnings over the last 12 normal weeks worked.
Step 2: Multiply by Years of Service
The number of completed years of employment, plus the completed months divided by 12 for any partial years worked.
Step 3: Multiply Wages and Service
Take the regular weekly wages and multiply it by the years of service calculated above.
For example:
- Regular wages: $1,000 per week
- Years worked: 5 years, 3 months
- Calculation:
- Years of service: 5 + (3/12) = 5.25
- Regular wages x Years of service
- = $1,000 x 5.25 = $5,250
Result: $5,250 severance payment
The maximum severance pay required under employment standards legislation is 26 weeks. However, common law settlements often yield higher amounts.
Factors That Influence Severance Pay Amounts
While the calculations above determine basic statutory severance, there are many factors that can significantly increase the amount of severance pay an employee is entitled to under common law. These include:
Age
Older employees typically receive longer notice periods. Discrimination based on age is illegal, but greater experience often translates into higher severance.
Salary
Higher-earning employees receive more severance. Key factors like commissions and bonuses are also taken into account.
Length of Service
The longer an employee has been with the company, the higher their severance amount will be.
Type of Work
More specialized roles with higher responsibility justify greater compensation.
Availability of Similar Roles
If the job market lacks comparable job opportunities, increased compensation recognizes the additional difficulty of securing new employment.
Benefits
The discontinuation of benefits upon termination may warrant additional compensation.
Commissions and Bonuses
Recent earning trends like commissions and annual bonuses are included in severance calculations.
Invalid Termination Clauses
If the termination clause in your employment contract is invalid or unenforceable, you may be entitled to more than what is stated. An employment lawyer can determine if this is the case and secure full common-law entitlements.
How Severance is Paid Out in Canada
There are three primary ways severance pay is provided to employees:
Lump Sum Payment
A single payment for the full severance amount owed is issued to the employee. Income tax is deducted from the total sum.
Salary Continuance
Regular salary payments and benefits continue for the length of the severance notice period. Taxes are deducted as regular payroll.
Installment Payments
Severance paid out in installments over an agreed timeframe, up to 3 years. Taxes are only paid as income is received.
Employers may allow employees to choose how they receive severance pay. Consulting an accountant can help determine the tax implications of each method.
When Must Severance Be Paid Out?
Severance pay must be provided to employees on the later of two dates:
- Seven calendar days after the last day of employment
- The employee’s next regular payday after termination
Employers have the option of paying severance in installments with employee consent or approval from the Ministry of Labour. However, failure to make payments as scheduled will immediately make the full remaining amount due.
Tax Implications of Severance Packages
Severance pay is considered employment income, meaning it is taxable in Canada. How and when taxes are paid depends on how the severance is structured.
Lump Sum Tax Deductions
If the full severance amount is paid out in one lump sum, income tax, CPP, and EI will be deducted by the employer. Tax rates depend on the province and total severance amount.
Direct RRSP Transfers
Employees can request that employers transfer the severance amount directly into a Registered Retirement Savings Plan (RRSP) account. This allows the severance payment to avoid immediate taxation.
Salary Continuance Taxes
Severance paid through salary continuance is taxed typically as employment earnings. This means CPP, EI and income taxes are deducted as regular payroll.
Installment Payment Taxes
Installment payments spread tax liabilities out over time. Income taxes are only paid on the portion of severance received each year it is paid out.
Withholdings vs. Actual Taxes Owed
The taxes withheld on lump-sum or installment payments may differ from the final amount owed. Ensure you set aside enough to pay any additional income taxes.
Severance Pay Exemptions in Canada
While most terminated employees are eligible for severance pay, there are some exemptions under employment standards and common law:
- Refusing an offer of reasonable alternative employment
- Retirement on full pension recognizing all years of service
- Termination due to strike, lockout or labour dispute
- Working in construction or building maintenance
- Dismissal for willful misconduct, disobedience or neglect
- Contract frustration from an unforeseeable event or circumstance
- Employed less than 3 months (statutory exemption only)
Additionally, employees who resign voluntarily without constructive dismissal are generally not eligible for severance.
It’s important to consult an employment lawyer, as many severance exemptions are complex or conditional.
Maximizing Your Severance Settlement
Here are some key tips to ensure you maximize the severance settlement you are entitled to:
- Ignore employer deadlines – There are no legal time limits to accepting a severance offer. Don’t let false deadlines pressure you.
- Calculate using an online severance calculator – Get a rough estimate of what you are legally owed before accepting any offer.
- Consult an employment lawyer – Over 90% of employers lowball initial offers. Have an expert review before signing anything.
- Don’t contact the Ministry of Labour first – The Ministry can only provide minimums. An employment lawyer can pursue your full common law entitlements.
- Question termination for cause – Many supposed performance issues are pretenses to avoid paying severance.
- Review your employment contract – Many contracts have invalid termination clauses that cannot supersede common law.
- Note the 2-year limitation period – If dismissed, you have 2 years to pursue legal action to claim the severance you deserve.
Key Takeaways on Severance Pay in Canada
These are the most important things to know about severance pay in Canada.
- Almost all employees terminated without cause are entitled to severance pay under common law or employment standards.
- Severance pay is based on regular wages and years of service, but factors like age, benefits, and commissions can significantly increase amounts.
- Severance can be paid as a lump sum, salary continuance, or installments. Each method has different tax implications.
- While exemptions exist, many are conditional, underscoring the value of legal guidance.
- Ignoring deadlines, calculating entitlements, and consulting experts are key to maximizing severance settlements.
The bottom line
Severance pay laws in Canada are complex, but vital to understand if you find yourself unfairly terminated or laid off. Taking the time to calculate what you are owed based on your specific situation and working with an employment lawyer to review any severance offers or employment contracts is crucial to receiving fair compensation.
With greater awareness of your severance pay rights, you can alleviate financial uncertainty and make the difficult transition between jobs a little easier.
FAQs on severance pay in Canada
What is considered regular wages for severance pay?
For salaried employees, regular wages are based on typical weekly earnings. For commission or variable pay, it is calculated using the average earnings over the last 12 normal weeks worked.
Where is severance pay regulated in Canada?
Severance pay is regulated through a combination of provincial and federal legislation, as well as common law precedents set by prior court decisions.
Why does severance pay increase under common law?
Common law takes into account many factors like age, salary, benefits lost, and ease of finding new work that increase severance amounts beyond basic statutory minimums.
Do all terminated employees get severance pay?
In most cases yes, but some exceptions exist, like termination for willful misconduct or refusing reasonable alternative work.
Can employers avoid paying severance with termination clauses?
Sometimes, but many contract termination clauses are unenforceable if they contradict common law entitlements.
Is severance pay considered taxable income?
Yes, severance pay is considered employment income and is subject to tax withholdings and deductions.