Winnipeg Free Press - PRINT EDITION

Money Makeover: Payout problems

Two federal employees receiving severance compensation seek advice

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Bill and Mabel will receive more than $35,000 in the coming days.

And they're stressing about what to do with the money.

Both federal government employees, they are receiving severance pay they've accumulated for years of service.

"You usually would get severance pay when you retire, and it would be a week's pay for every year that you worked," says Mabel, in her 30s. "It would be a large amount, but I guess with all these cutbacks, the federal government just said that 'we're going to pay out all these people and there will be no more severance pay when you retire.' "

Mabel will receive about $16,000 while Bill, also in his 30s, will get $19,500. But he has to decide how to receive his money before the end of the year. They've considered transferring some of the payout to their RRSPs, but they are concerned building up their registered savings too much will affect income and taxes in retirement because they will have a lot of guaranteed income from their defined benefit work pension plans.

Complicating matters further, Mabel is thinking of taking the next year off work after her maternity leave ends.

Still, the couple is in good shape financially.

They have no debt -- not even a mortgage -- and they've managed to save $40,000 combined in TFSAs and another $19,000 in savings. They also have about $69,000 in RRSPs, some of which Mabel is thinking about drawing upon while on leave.

"Where should I be taking money from? Should it come from an RRSP or a TFSA?"

Mabel and Bill have also been thinking about using the severance payout for a down payment on an income property. Mabel says housing prices keep increasing so they worry about delaying a year to buy.

A little bit of guidance would helpful, she says, on buying a home and their situation in general.

"We're just not sure what to do."

Chartered accountant Bob Walker says the couple should be able to minimize the amount they pay in taxes on their severance relatively easily.

Although Bill needs to decide how to receive his severance before the end of the year, when he receives the payment should make little difference on how much he'll be taxed.

"Based on Bill's annual income of $88,000, he will be taxed at 43.4 per cent on the severance pay," says Walker, director at PKBW Group Chartered Accountants and Business Advisors in Winnipeg.

Off the hop, he would have to pay a 30 per cent withholding tax on amounts over $15,000. Bill would then expect to pay the remaining 13.4 per cent in taxes on the payment at tax filing time.

But if he has RRSP contribution room, he can transfer the severance directly into the RRSP without taxes withheld. And as it turns out, Bill has about $34,000 in contribution room -- more than enough. This would allow Bill to defer taxes on the severance pay until he withdraws the money from his RRSP in retirement.

While they may be concerned about over-investing in RRSPs, Walker says this is not much of a worry.

"Bill will be paying tax on the severance pay at a relatively high tax rate, so transferring it to his RRSP would be beneficial for him tax-wise," Walker says. It's unlikely he would pay much more in taxes when he withdraws it from his RRSP once retired.

In contrast, Mabel has much less contribution room -- about $4,600 -- so a good portion of her severance will be taxable when she receives it. Her work income is also $80,000-plus so the money will taxed at a high rate too.

"If Mabel receives the severance in 2012 she will be taxed at around 42 per cent," he says.

But Mabel has another option that would see her pay substantially less tax. Because she doesn't intend to work next year, she should defer taking her severance until 2013.

"If Mabel receives the severance in 2013 and takes a leave of absence, she will be taxed at a lower rate -- as low as 26 per cent depending on how long she receives mat leave pay next year," Walker says.

In this case, it doesn't make much sense for Mabel to transfer any severance money to her RRSP because it's more likely the unused contribution room will be more beneficial when she returns to work, earning income that is taxed at a higher marginal rate.

"Alternatively, she could transfer the severance pay into her RRSP up to her contribution limit, but then she would not actually deduct the contribution on her tax return until she is in a higher tax bracket and, therefore, will receive more benefit from the deduction," he says.

But it's unlikely the couple will need the severance pay to make ends meet while she is on leave.

"Bill's income alone is sufficient to fund current living expenses of $3,000 per month," Bob says. "If additional funds are needed, they likely have enough in savings or their TFSAs to fill in the gaps."

Yet if they were to buy an additional home next year, they could struggle financially.

"They would likely have to use a lot of their savings for a down payment, so it may not be good timing to purchase a second home if Mabel will be on an unpaid leave of absence for a year."

giganticsmile@gmail.com

BILL AND MABEL'S FINANCES

Income:

Mabel: $84,000 ($4,600 a month maternity leave)

Bill: $88,000 ($4,400 monthly net)

Expenses: $3,000

Debts:

None

Assets:

Home: $298,000

Bill RRSP: $26,000

Mabel RRSP: $43,000

Bill TFSA: $20,000

Mabel TFSA: $20,000

Family RESP: $6,500

Savings: $19,000

NET WORTH: $432,500

Republished from the Winnipeg Free Press print edition December 22, 2012 B11

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