Severance Pay vs. Termination Pay: What Is the Difference?
Many people use the terms "severance pay" and "termination pay" interchangeably, but under Ontario law, they are two distinct entitlements. Understanding the difference is crucial because you may be entitled to both.
Termination Pay (Pay in Lieu of Notice)
Termination pay is the compensation your employer must provide when they end your employment without giving you working notice. Under the Employment Standards Act, 2000 (ESA), the minimum termination pay is based on your length of service:
- Less than 1 year of service: 1 week of pay
- 1 year but less than 3 years: 2 weeks
- 3 years but less than 4 years: 3 weeks
- 4 years but less than 5 years: 4 weeks
- 5 years but less than 6 years: 5 weeks
- 6 years but less than 7 years: 6 weeks
- 7 years but less than 8 years: 7 weeks
- 8 years or more: 8 weeks
Your employer can also choose to give you working notice instead of pay -- meaning they tell you in advance that your employment will end, and you continue to work during the notice period.
Severance Pay Under the ESA
Severance pay under the ESA is an additional entitlement that applies only when two conditions are met:
- You have been employed for 5 or more years (including all time, even if not consecutive); AND
- Your employer has a payroll of $2.5 million or more, OR the employer is severing the employment of 50 or more employees within a 6-month period because all or part of the business is closing.
ESA severance pay is calculated as one week of regular wages per year of employment, up to a maximum of 26 weeks. Partial years are prorated. For example, if you worked for 7 years and 6 months, you would be entitled to 7.5 weeks of severance pay.
Common Law Severance: Where the Real Money Is
The ESA provides only minimum entitlements. Most employees in Ontario are also entitled to common law reasonable notice, which can be significantly more generous. When people talk about "severance packages" in Ontario, they are usually referring to the total compensation owed, which often reflects common law standards rather than just the ESA.
Common law reasonable notice is determined by the courts on a case-by-case basis, considering four main factors (the Bardal factors):
- Length of service: Longer service generally means more notice.
- Age of the employee: Older employees typically receive more notice because they may have greater difficulty finding new employment.
- Character of employment: More senior or specialized positions generally attract longer notice periods.
- Availability of similar employment: If the job market is poor or the position is niche, the notice period may be longer.
Common law reasonable notice in Ontario can range from a few weeks to up to 24 months of total compensation (and in rare cases, even more). This includes not just your base salary, but also the value of benefits, bonuses, pension contributions, car allowances, and other forms of compensation you would have received during the notice period.
How to Calculate What You May Be Owed
Let us walk through a practical example to illustrate how severance entitlements work:
Example: Carlos's Situation
Carlos is 50 years old. He has worked as a warehouse supervisor for the same company for 12 years, earning $65,000 per year plus benefits worth approximately $5,000 per year. The company has a payroll over $2.5 million. Carlos is terminated without cause.
ESA Entitlements:
- Termination pay: 8 weeks (the maximum) = $10,000
- Severance pay: 12 weeks (one week per year) = $15,000
- Total ESA minimum: $25,000
Common Law Entitlement (estimated):
- Based on Carlos's age, length of service, position, and the job market, a court might award 14-18 months of reasonable notice.
- At $70,000 total compensation per year (salary + benefits): approximately $81,667 to $105,000
The difference between the ESA minimum ($25,000) and what Carlos could receive under common law ($81,667 to $105,000) is substantial. This is why you should always consult with a lawyer before accepting a severance offer.
Can Your Employment Contract Limit Your Severance?
Yes, in some cases. If your employment contract contains a termination clause, it may limit your entitlements to the ESA minimums or some amount between the ESA minimums and what you would receive under common law.
However, many termination clauses in Ontario are unenforceable. A termination clause can be struck down if it:
- Provides for less than the ESA minimum entitlements in any possible scenario.
- Fails to account for all ESA entitlements (for example, if it mentions termination pay but not severance pay).
- Uses ambiguous language that could be interpreted as allowing the employer to provide less than the ESA.
- Violates other provisions of the ESA, such as the prohibition on contracting out of the Act.
Ontario courts have been increasingly willing to strike down termination clauses, particularly following the landmark 2020 decision in Waksdale v. Swegon North America Inc., which held that if any part of a termination clause violates the ESA, the entire clause is void -- even parts that might be enforceable on their own. This has been a very employee-friendly development in the law.
What Should Be Included in a Severance Package?
A fair severance package should compensate you for everything you would have received during the reasonable notice period, including:
- Base salary for the notice period
- Benefits continuation (health, dental, life insurance) or compensation for the cost of replacing them
- Bonus and incentive pay you would have earned during the notice period
- Pension contributions the employer would have made
- Car allowance or other perquisites
- Accrued but unused vacation pay
- Stock options or RSUs that would have vested during the notice period
Negotiating Your Severance Package
If your employer presents you with a severance offer, remember these key points:
- You do not have to accept the first offer. Most initial offers are below what you are legally entitled to.
- Take your time. You have the right to review the offer and seek legal advice. Do not let your employer pressure you into signing quickly.
- Do not sign a release without legal advice. A release is a legal document that waives your right to make any further claims against your employer. Once you sign it, you generally cannot go back.
- Consider the full picture. Look beyond just the lump-sum payment. Consider benefits continuation, outplacement services, a positive reference letter, and the timing of payments (which can affect your taxes and EI eligibility).
The Duty to Mitigate
One important concept in severance law is the duty to mitigate. When you receive a severance package or pursue a wrongful dismissal claim, you are expected to make reasonable efforts to find new employment. If you find a new job during what would have been your notice period, your former employer may be entitled to reduce your severance accordingly.
This does not mean you have to accept the first job that comes along, but you must conduct a genuine job search appropriate to your skills and experience. Keep records of your job search efforts, as they may be relevant if your case goes to court or arbitration.
Tax Implications of Severance Pay
Severance payments in Canada are considered taxable income. Your employer will deduct income tax, CPP contributions, and EI premiums from your severance payment. However, if you receive a lump-sum payment, the withholding rate may not accurately reflect your actual tax rate, so you may receive a refund or owe additional taxes when you file your tax return.
One strategy to reduce the tax impact is to transfer some or all of your severance pay into a Registered Retirement Savings Plan (RRSP), if you have contribution room. There are also special rules for transferring retiring allowances to RRSPs. A financial advisor or accountant can help you understand your options.
What to Do Right Now
If you have been terminated or are facing termination, here are the steps you should take:
- Do not sign anything your employer gives you without first getting legal advice.
- Gather your documents: employment contract, offer letter, pay stubs, benefit information, performance reviews, and any correspondence about your termination.
- Apply for Employment Insurance (EI) through Service Canada right away.
- Consult an employment lawyer who can review your situation and calculate your full entitlements. Many offer free initial consultations.
At Imigrando, we help newcomers and immigrant workers understand and protect their severance rights. The law is on your side -- make sure you get what you are owed.