Lump-Sum Payments

If you leave a pension or deferred profit-sharing plan when you leave your job, you may receive a lump-sum payment. Depending on the details, you may have to report all of it as income, but you may be able to avoid that requirement in some cases by transferring the funds to a qualified retirement account.

You may receive lump-sum payments from registered retirement savings plans, registered pension plans and deferred profit-sharing plans. You may also receive a retiring allowance, which the Canada Revenue Agency considers to be a lump-sum payment.

All of these lump-sum payments are taxable, and your employer, plan administrator or whoever drafts the cheque should withhold income tax and remit it to the CRA.

However, if the total of your lump-sum payment and any employment income you received from your employee for the year are less than the amount claimed on your Form TD1, your employer does not have to withhold income tax from you lump-sum payment. There is one exception: If your lump-sum payment is a retiring allowance, your boss must deduct income tax, regardless how the figures compare to the claims on your Form TD1.

In some cases, you may receive a lump-sum payment from accounts held by your deceased spouse or common-law partner. The entity drafting the cheque does not have to withhold income tax on those amounts.

The CRA recommends a withholding rate to help employers determine how much income tax they should withhold from lump-sum payments:

• For payments up to and including $5,000, the withholding rate is 10 percent.
• For payments between $5,000 and $15,000, the rate is 20 percent.
• For amounts over $15,000, it is 30 percent.

However, the amount your employer withholds may not be your final tax rate. That will be determined when you file your income tax return and report all of your income and deductions.

If you anticipate owing more tax than will be withheld using the recommended rates, notify your employer and ask him to adjust how much tax he withholds accordingly.

If you receive a qualifying retroactive lump-sum payment, you may qualify for a special tax calculation that lowers the amount of tax you owe on the payment:

• To qualify, the income must be received after 1994, and it must not be related to years prior to 1978.
• Additionally, it must be at least $3,000
• It must be income from age-loss replacement benefits or from employment received under the terms of an order, judgement or agreement.

To take advantage of the special tax calculation, have your employer complete Form T1198, or have him draft a note about the lump-sum payment, the circumstances of the payment, and a breakdown of the principal and interest on the payment. Use this information while completing your income tax return.

If you receive a lump-sum payment, it appears on your Form T4A, Statement of Pension, Retirement, Annuity and Other Income, or your Form T3, Statement of Trust Income Allocations and Designations.

Transfer the amount of the lump-sum payment as indicated on either of these forms to line 130 of your income tax return.

If you have income from scholarships, fellowships, bursaries, study grants, death benefits or a few other types of income, you also need to report it on line 130. Add all of the relevant amounts together before noting them on this line.

To the left of line 130, note which type of income you are including on the line. Additionally, if some of your lump-sum payment is based on income you earned prior to 1972, you should also attach a note to your return indicating that fact.

For example, if you have income from both a lump-sum distribution from a retirement account and from a scholarship, you should note both of those sources on the side.

In some cases, the CRA applies a reduced income tax rate to those funds. However, you should not factor in the reduced rate while completing your return. Instead, you should wait to see if the CRA responds favorably to your request.

If your lump-sum payment appears in box 22 of your T3 slip, you can opt to transfer it to your RRSP. However, to qualify for the transfer, you must be 71 years or younger on the last day of the tax year when you completed the transfer. Additionally, you must complete the transfer within 60 days of receiving the lump-sum payment.

Transferring the funds to a qualifying retirement account helps you avoid income tax on them. Additionally, the amount you transfer does not count against your RRSP contribution limit for the year.