Wrongful Dismissal Settlement: Your Complete Ontario Investment Guide 2026
Key Takeaways
- 1Understanding wrongful dismissal settlement: your complete ontario investment guide 2026 is crucial for financial success
- 2Professional guidance can save thousands in taxes and fees
- 3Early planning leads to better outcomes
- 4GTA residents have unique considerations for sudden wealth
- 5Taking action now prevents costly mistakes later
Quick Summary
This article covers 5 key points about key takeaways, providing essential insights for informed decision-making.
Quick Answer
Wrongful dismissal settlements in Ontario are generally taxable as employment income, but retiring allowance portions may be eligible for tax-advantaged RRSP transfer. Before investing: (1) understand the tax treatment of each component, (2) maximize retiring allowance RRSP transfers, (3) set aside money for taxes, (4) build your emergency fund for job search period, then (5) invest the remainder strategically. Work with a Certified Financial Planner (CFP) to optimize your settlement.
After months of negotiations - or perhaps a legal battle - you've received your wrongful dismissal settlement. It might be the largest single payment you've ever received: months or even years of salary, potentially combined with pension funds, delivered all at once.
This windfall creates both opportunity and risk. Handled well, it can bridge you to your next career chapter and build long-term wealth. Handled poorly, it can disappear to taxes, lifestyle inflation, and poor investment choices before you find stable employment again.
This guide walks you through exactly how to optimize the tax treatment of your settlement and invest the proceeds for maximum long-term benefit.
Key Takeaways
- 1Most settlement amounts are taxable as employment income in the year received
- 2Retiring allowance portions may transfer to RRSP above normal limits (pre-1996 service)
- 3Large lump sums push you into higher tax brackets - plan for this
- 4Emergency fund is critical: job searches take 6-12 months on average
- 5Consider pension commuted value separately from settlement - it may be your largest asset
- 6Salary continuation can spread tax burden vs lump sum - negotiate strategically
Quick Summary
This article covers 6 key points about key takeaways, providing essential insights for informed decision-making.
Understanding Your Wrongful Dismissal Settlement
Wrongful dismissal settlements typically include several components, each with different tax treatment and investment implications.
Common Settlement Components
| Component | Tax Treatment | Notes |
|---|---|---|
| Pay in lieu of notice | Fully taxable | Subject to normal payroll deductions |
| Severance pay (ESA) | Fully taxable | May qualify as retiring allowance |
| Wrongful dismissal damages | Fully taxable | Includes amounts beyond ESA minimums |
| Retiring allowance (pre-1996) | RRSP eligible | Can transfer above normal limits |
| Bonus/commission owing | Fully taxable | Earned income through termination |
| Benefits continuation | Not taxable | Employer continues paying premiums |
| Legal fee reimbursement | Taxable | But legal fees are deductible |
| Pension commuted value | Partially RRSP/LIRA | Complex rules apply - see below |
The Retiring Allowance Opportunity
If you have pre-1996 service with your employer, you may be eligible for special RRSP contribution room:
Retiring Allowance RRSP Limits
- 1989-1995 service: $2,000 per year of service
- Pre-1989 service (no pension): $2,000 + $1,500 = $3,500 per year
This is ABOVE your normal RRSP deduction limit, allowing significant tax deferral.
Example: Retiring Allowance Calculation
Employee started in 1988, terminated in 2026:
- Years 1988: 1 year x $3,500 = $3,500 (pre-1989, no pension)
- Years 1989-1995: 7 years x $2,000 = $14,000
- Total eligible for RRSP: $17,500 (above normal limits)
This $17,500 can transfer directly to RRSP without counting against your normal room.
Tax Planning for Your Settlement
The Lump Sum Tax Problem
Large lump sums create a tax concentration problem. If you normally earn $100,000 and receive a $200,000 settlement, you're taxed as if you earned $300,000 that year - pushing much of your settlement into the highest tax brackets.
| Ontario 2026 Income | Marginal Rate |
|---|---|
| $0 - $51,446 | 20.05% |
| $51,446 - $102,894 | 29.65% |
| $102,894 - $155,625 | 37.91% |
| $155,625 - $177,882 | 43.41% |
| $177,882 - $253,414 | 48.35% |
| Over $253,414 | 53.53% |
Tax Reduction Strategies
Strategy 1: Maximize RRSP Contributions
Use every dollar of RRSP room available:
- Normal RRSP room: Check your Notice of Assessment
- Retiring allowance room: Calculate based on pre-1996 service
- Unused room from prior years: Catch-up contributions
- Spousal RRSP: If spouse has lower income or more room
Strategy 2: Negotiate Salary Continuation
Instead of a lump sum, receive your settlement as salary continuation:
- Spreads income across multiple tax years
- Potentially stays in lower tax brackets
- Maintains benefit coverage
- Continues pension contributions (if applicable)
Example: Lump Sum vs Salary Continuation
24-month settlement, $100K/year salary:
| Approach | Tax Paid |
|---|---|
| $200K lump sum in Year 1 | ~$75,000 |
| $100K Year 1 + $100K Year 2 | ~$56,000 |
| Tax savings from spreading: | ~$19,000 |
Strategy 3: Charitable Donations
Large settlements create opportunities for tax-efficient giving:
- Donation credits offset up to 75% of net income
- Can carry forward unused credits for 5 years
- Donating appreciated securities eliminates capital gains
Strategy 4: Deduct Legal Fees
Legal fees paid to collect or establish a right to severance or wrongful dismissal damages are tax-deductible. Keep all invoices. If your employer reimburses legal fees, the reimbursement is taxable but your deduction offsets it.
Your Pension: The Other (Maybe Bigger) Settlement
Don't overlook your pension. For long-service employees, the pension commuted value can exceed the wrongful dismissal settlement itself.
Defined Benefit Pension Options
If you have a DB pension, you typically have these choices:
| Option | Pros | Cons |
|---|---|---|
| Leave in plan (deferred pension) | Guaranteed income, no management required | Inflation erosion, employer risk, inflexible |
| Transfer commuted value | Control, flexibility, estate value | Investment risk, must manage, taxable portion |
Commuted Value Tax Treatment
When you take the commuted value, part transfers tax-free to a LIRA (Locked-In Retirement Account) and part is taxable:
Example: Commuted Value Split
Commuted value of $400,000:
- Maximum transfer to LIRA: $280,000 (based on age and limits)
- Taxable cash portion: $120,000
- Tax on cash (45% bracket): ~$54,000
- Net after tax: ~$346,000
Important: If you have RRSP room, the taxable portion can often be contributed to your RRSP, deferring the tax. Check your available room before electing the commuted value.
Before You Invest: Critical Steps
Step 1: Get Full Settlement Documentation
Before investing a single dollar, ensure you have:
- Signed settlement agreement or court order
- Breakdown of all settlement components
- Tax treatment confirmation from your lawyer
- Net amount after legal fees clearly stated
- Payment timeline (lump sum vs installments)
Step 2: Calculate Your Tax Obligation
Work with a tax accountant to estimate taxes owing:
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Get Free Expert Advice- Consider all income sources for the year
- Factor in RRSP contributions you'll make
- Account for legal fee deductions
- Calculate any EI clawback (if over $79,000)
Critical: Set Aside Tax Money
If your settlement isn't subject to full withholding (common with negotiated settlements), you'll owe taxes at filing time. Set aside 30-50% of the taxable portion immediately. Do not invest this money - it's not yours.
Step 3: Build Your Emergency/Runway Fund
Job searches take time. Plan for:
| Your Situation | Recommended Runway |
|---|---|
| Entry/mid-level, strong market | 6 months expenses |
| Senior/specialized role | 9-12 months expenses |
| Executive level | 12-18 months expenses |
| Age 55+, niche industry | 18-24 months expenses |
Step 4: Address High-Interest Debt
Pay off credit cards and high-interest debt before investing. A credit card at 20% costs more than any realistic investment return.
Step 5: Calculate Investable Amount
Example Calculation
| Gross settlement: | $250,000 |
| Less: Legal fees (net to you): | -$40,000 |
| Net settlement: | $210,000 |
| Less: Tax set-aside: | -$65,000 |
| Less: Emergency fund (12 months): | -$60,000 |
| Less: Credit card payoff: | -$15,000 |
| Available for investment: | $70,000 |
Investment Strategy for Your Settlement
Account Prioritization
For wrongful dismissal settlements, account selection significantly impacts your after-tax wealth:
| Priority | Account | Why |
|---|---|---|
| 1 | RRSP (retiring allowance) | Extra room above limits, immediate tax savings |
| 2 | RRSP (regular room) | Reduces taxable settlement income |
| 3 | LIRA (pension transfer) | Tax-deferred pension growth |
| 4 | TFSA | Tax-free growth, flexible access |
| 5 | Non-registered | Remaining investable funds |
Investment Approach Based on Your Situation
If You'll Find Work Within 6-12 Months
Your settlement is a bridge to your next role, not early retirement money. Focus on:
- Keeping runway funds in high-interest savings (don't invest)
- Investing truly long-term money (RRSP, TFSA) in balanced portfolios
- Avoiding the temptation to "make the money back" through risky investments
If You're Considering Early Retirement
If your settlement plus pension creates a viable early retirement, prioritize:
- Sustainable withdrawal strategy (typically 3.5-4% annually)
- Income-generating investments to supplement before CPP/OAS
- Bridging strategy until government benefits start
- Healthcare costs before age 65 OHIP coverage
If You're Starting a Business
Be extremely cautious. Many terminated employees dream of entrepreneurship, but:
- Most new businesses fail in the first 5 years
- Your settlement may be your only safety net
- Consider starting part-time while seeking employment
- Never invest more than you can afford to lose completely
Sample Investment Portfolios
Bridge Portfolio (Expect Employment Within 12 Months)
Conservative approach for short-term holding
| Asset Class | Allocation | Purpose |
|---|---|---|
| High-Interest Savings | 40% | Runway funds, immediate access |
| GICs (1-2 year) | 25% | Guaranteed return, tax set-aside |
| Canadian Bonds | 15% | Stability, modest income |
| Balanced ETF | 20% | Long-term RRSP/TFSA portion |
Long-Term Growth Portfolio
For RRSP/TFSA funds you won't need for 10+ years
| Asset Class | Allocation | Example ETFs |
|---|---|---|
| Canadian Equities | 20% | VCN, XIC |
| US Equities | 30% | VUN, XUU |
| International Equities | 15% | XEF, VIU |
| Canadian Bonds | 25% | ZAG, VAB |
| Cash/GICs | 10% | High-interest ETF or GIC |
Common Mistakes to Avoid
Mistake 1: Not Maximizing RRSP Transfers
Every dollar of RRSP contribution reduces your current year taxes. Failing to use retiring allowance room or catch-up contributions can cost you thousands in unnecessary taxes.
Mistake 2: Lifestyle Inflation
A large settlement can feel like "found money." But it's compensation for lost income - income you would have earned over months or years. Don't upgrade your lifestyle until you have stable employment again.
Mistake 3: Lending to Family/Friends
Word spreads about settlements. Requests for loans will follow. Your settlement needs to support you through unemployment and beyond. Learn to say no, or create a small "gift fund" and be clear that's your limit.
Mistake 4: Revenge Spending
After a difficult termination, the urge to "treat yourself" is strong. A vacation makes sense. A new car or major renovation doesn't - not until you're employed again.
Mistake 5: Rushing to Invest
Markets will still exist in 90 days. Take time to understand your full picture - taxes, pension, EI, job prospects - before making irreversible investment decisions.
Mistake 6: Ignoring EI
Apply for EI immediately, even if you have a large settlement. Your waiting period is based on the severance allocation, but the clock doesn't start until you apply. Delaying costs you benefits.
Working with Professionals
Certified Financial Planner (CFP)
A CFP experienced with employment transitions can help you:
- Optimize the tax treatment of your settlement
- Model different scenarios (early retirement, career change, etc.)
- Create an investment strategy for both runway and long-term funds
- Coordinate settlement with pension decisions
- Build a sustainable income plan if retiring early
Tax Accountant (CPA)
A CPA can:
- Calculate your tax obligation precisely
- Identify all available deductions (legal fees, etc.)
- Model RRSP contribution strategies
- Handle complex returns in the year of settlement
- Plan for estimated tax installments if needed
Employment Lawyer (Already Involved)
Ensure your lawyer provides:
- Clear breakdown of settlement components
- Tax treatment guidance for each component
- Retiring allowance calculation if applicable
- Advice on pension election timing
Your First 90 Days: Action Plan
Days 1-30: Settlement Receipt
- ☐ Deposit settlement in high-interest savings account
- ☐ Get detailed breakdown of settlement components from lawyer
- ☐ Apply for EI (do this immediately)
- ☐ Calculate retiring allowance RRSP room (pre-1996 service)
- ☐ Set aside estimated tax obligation in separate account
- ☐ Begin documenting job search (EI requirement)
Days 31-60: Tax and Pension Planning
- ☐ Meet with tax accountant to optimize settlement treatment
- ☐ Make retiring allowance RRSP transfer (deadline: 60 days or by contribution deadline)
- ☐ Review pension options - don't rush this decision
- ☐ Meet with Certified Financial Planner (CFP)
- ☐ Calculate runway needs based on job market assessment
- ☐ Pay off high-interest debt
Days 61-90: Investment Implementation
- ☐ Make final pension election (if deadline approaching)
- ☐ Open investment accounts (TFSA if not maxed)
- ☐ Implement investment strategy for long-term funds
- ☐ Keep runway funds liquid (high-interest savings)
- ☐ Create monitoring plan for quarterly reviews
- ☐ Focus energy on job search - that's your best investment
Ready to Optimize Your Wrongful Dismissal Settlement?
A wrongful dismissal settlement represents significant - often life-changing - money. The tax and investment decisions you make in the first 90 days can impact your financial security for decades.
A Certified Financial Planner (CFP) experienced with employment transitions can help you:
- Minimize taxes through strategic RRSP contributions and timing
- Coordinate your settlement with pension decisions
- Build both a runway fund and long-term investment portfolio
- Model scenarios: new employment, early retirement, career change
- Avoid the common mistakes that erode settlement value
Book a free consultation to discuss your wrongful dismissal settlement and create a personalized plan. We work with professionals across Ontario navigating career transitions and sudden wealth events.
Disclaimer
This article provides general information about wrongful dismissal settlements in Ontario. It is not legal, tax, or investment advice. Settlement taxation and investment strategies vary significantly based on individual circumstances. Before making decisions about your settlement, consult with qualified professionals including your employment lawyer, tax accountant, and a Certified Financial Planner who can evaluate your specific situation.
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Frequently Asked Questions
Q:Is my wrongful dismissal settlement taxable in Ontario?
A:Yes, most wrongful dismissal settlements are fully taxable as employment income. This includes severance pay, pay in lieu of notice, and damages for wrongful dismissal. The exception is the 'retiring allowance' portion, which may be eligible for tax-advantaged RRSP transfer. Your lawyer should provide a breakdown of taxable components.
Q:What is a retiring allowance and how does it help with taxes?
A:A retiring allowance is a payment received upon termination in recognition of long service. Amounts attributable to service before 1996 may be eligible for direct RRSP transfer above your normal contribution limit ($2,000 per year of service before 1996, plus $1,500 per year before 1989 with no pension). This can significantly reduce the tax hit on your settlement.
Q:How is my wrongful dismissal settlement taxed differently from regular severance?
A:From a tax perspective, wrongful dismissal damages and regular severance are both taxed as employment income. The key difference is timing and amount - wrongful dismissal often results in larger payments (24+ months vs statutory minimums) received as a lump sum, creating a higher tax bill in a single year. Retiring allowance treatment may apply to portions recognizing long service.
Q:Should I negotiate for salary continuation instead of a lump sum?
A:Salary continuation spreads the tax hit across multiple years, potentially keeping you in lower tax brackets. It also maintains your benefits and pension contributions. However, lump sums give you immediate access to invest, and you avoid the risk of employer bankruptcy. For large settlements, consider a hybrid: some salary continuation plus a lump sum.
Q:What happens to my pension when I'm wrongfully dismissed?
A:You'll typically have options: leave your pension in the employer's plan, transfer to a locked-in account (LIRA), or potentially receive a commuted value lump sum. For defined benefit pensions, the commuted value can be substantial - often $200,000 to $500,000+ for long-service employees. This pension component may be separate from your wrongful dismissal settlement.
Q:Can I claim EI while receiving a wrongful dismissal settlement?
A:It's complicated. Severance pay is typically allocated as earnings, delaying EI eligibility. However, damages for wrongful dismissal (beyond working notice) may not affect EI. The settlement allocation matters - your lawyer should structure it to minimize EI impacts where possible. Apply for EI immediately regardless; Service Canada will determine the waiting period.
Q:How long do I have to sue for wrongful dismissal in Ontario?
A:You have 2 years from the date of termination to file a wrongful dismissal claim in Ontario. However, if your employer has you sign a release waiving your right to sue (in exchange for severance), that deadline effectively becomes whenever you sign. Never sign a release without understanding your full entitlements.
Q:Should I accept my employer's first severance offer?
A:Almost never. Initial offers are often the legal minimum (ESA requirements) or slightly above. Common law entitlements - especially for long-service, older, or specialized employees - are typically much higher. Factors affecting your entitlement include age, tenure, position level, availability of similar employment, and how you were treated during termination.
Question: Is my wrongful dismissal settlement taxable in Ontario?
Answer: Yes, most wrongful dismissal settlements are fully taxable as employment income. This includes severance pay, pay in lieu of notice, and damages for wrongful dismissal. The exception is the 'retiring allowance' portion, which may be eligible for tax-advantaged RRSP transfer. Your lawyer should provide a breakdown of taxable components.
Question: What is a retiring allowance and how does it help with taxes?
Answer: A retiring allowance is a payment received upon termination in recognition of long service. Amounts attributable to service before 1996 may be eligible for direct RRSP transfer above your normal contribution limit ($2,000 per year of service before 1996, plus $1,500 per year before 1989 with no pension). This can significantly reduce the tax hit on your settlement.
Question: How is my wrongful dismissal settlement taxed differently from regular severance?
Answer: From a tax perspective, wrongful dismissal damages and regular severance are both taxed as employment income. The key difference is timing and amount - wrongful dismissal often results in larger payments (24+ months vs statutory minimums) received as a lump sum, creating a higher tax bill in a single year. Retiring allowance treatment may apply to portions recognizing long service.
Question: Should I negotiate for salary continuation instead of a lump sum?
Answer: Salary continuation spreads the tax hit across multiple years, potentially keeping you in lower tax brackets. It also maintains your benefits and pension contributions. However, lump sums give you immediate access to invest, and you avoid the risk of employer bankruptcy. For large settlements, consider a hybrid: some salary continuation plus a lump sum.
Question: What happens to my pension when I'm wrongfully dismissed?
Answer: You'll typically have options: leave your pension in the employer's plan, transfer to a locked-in account (LIRA), or potentially receive a commuted value lump sum. For defined benefit pensions, the commuted value can be substantial - often $200,000 to $500,000+ for long-service employees. This pension component may be separate from your wrongful dismissal settlement.
Question: Can I claim EI while receiving a wrongful dismissal settlement?
Answer: It's complicated. Severance pay is typically allocated as earnings, delaying EI eligibility. However, damages for wrongful dismissal (beyond working notice) may not affect EI. The settlement allocation matters - your lawyer should structure it to minimize EI impacts where possible. Apply for EI immediately regardless; Service Canada will determine the waiting period.
Question: How long do I have to sue for wrongful dismissal in Ontario?
Answer: You have 2 years from the date of termination to file a wrongful dismissal claim in Ontario. However, if your employer has you sign a release waiving your right to sue (in exchange for severance), that deadline effectively becomes whenever you sign. Never sign a release without understanding your full entitlements.
Question: Should I accept my employer's first severance offer?
Answer: Almost never. Initial offers are often the legal minimum (ESA requirements) or slightly above. Common law entitlements - especially for long-service, older, or specialized employees - are typically much higher. Factors affecting your entitlement include age, tenure, position level, availability of similar employment, and how you were treated during termination.
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