When employment ends, whether due to restructuring, layoffs, or other circumstances, many employees inevitably turn their focus towards obtaining severance packages. For those receiving Long-Term Disability (LTD) benefits, however, the conversation about severance becomes more complex and difficult to navigate. Severance and LTD benefits can intersect in surprising ways, with significant financial and legal ramifications if not handled in the correct manner. 

This blog aims to outline how severance and Long-Term Disability benefits interact, what employees on LTD should be aware of when their employment ends, and how to protect your rights during a stressful time.

What Are Long-Term Disability Benefits?

LTD benefits provide income replacement if an individual is unable to work for an extended period due to illness, injury, or a chronic medical condition. LTD benefits support individuals who are no longer able to perform their job, or in some cases any job, because of a disabling condition or injury. 

 Most LTD plans have a two-stage definition of disability:

  1. Own Occupation Period (typically the first 24 months): You are considered “totally disabled” if you cannot perform the duties of your own job.
  2. Any Occupation Period (after 24 months): You are only considered “totally disabled” if you cannot perform any job for which you are reasonably suited by education, training, or experience.

 What Is a Severance Package?

A severance package, also known as severance pay, is financial compensation that an employer may offer when terminating an employee without cause, meaning the employment was not terminated for any alleged misconduct on the part of the employee. The goal of providing this compensation is to limit the financial strain caused by the loss of employment. It can include:

  • Pay instead of notice;
  • Continuation of benefits (health, dental, etc.);
  • Vacation pay or other accumulated compensation; or
  • Release of legal claims (in exchange for a signed waiver).

 Severance pay can be provided as lump-sum payments or as a salary continuance. Severance may be required under statutory severance which are considered minimum entitlements or common law severance which encompasses reasonable notice in severance agreements.

→ Statutory Severance

Statutory severance is the legislated, mandatory payment that an employer must give to an employee when their employment is terminated. Across Canada, each province and territory hasits own unique employment standards laws that set out the minimum requirements that employers must follow when terminating an employee’s employment. These laws generally require that employees receive advance notice, or, specify an amount of compensation that can be paid instead of notice, the amount of which often depends on the length of employment. 

→ Common Law Severance

Beyond the basic requirements set by employment standards legislation, employees in Canada may also have the right to receive reasonable notice under common law when their employment is terminated. This type of compensation is assessed by the courts and often exceeds the minimums outlined in provincial or territorial statutes. In deciding what is fair, courts take into account several key factors, including how long the person worked for the employer, their age, the nature of their job, and how easy it would be for them to find a similar role elsewhere. Depending on these circumstances, an employee could be awarded several months, or in some cases even years, of pay.

Can You Receive Both LTD and Severance?

Employees on LTD can still technically receive severance, but there are critical interactions between the two.

→ Impact of Severance on LTD Benefits

Many LTD policies include offset clauses, which allow the insurance provider to reduce your disability payments if you receive income from other sources, such as severance. This means that your LTD benefits could be lowered based on the severance you receive, especially if it’s structured as salary continuance rather than a lump sum amount.  

→ End of Employment Status

Accepting a severance payout typically means officially ending your employment relationship, which can affect your ongoing eligibility for LTD benefits—particularly for those who haven’t yet been approved for LTD or are in the application process. Some LTD policies only cover active employees, so severing the employment relationship too soon may unintentionally disqualify you from receiving LTD benefits.

→ Waiving of Rights

Severance agreements often contain general releases that waive an employees right to pursue a legal claim. If not carefully read and understood, by signing a release for a severance payout, you could accidentally sign away your right to continue or pursue LTD benefits.

 Strategic Considerations: What Should You Do First?

→ Review Your LTD Policy

Carefully examine the terms of your LTD policy or plan booklet. Some important things to look for include:

  • Definitions of disability – how does your employer define what it means to be considered “totally disabled”?;
  • Income offset provisions – what other potential income sources could reduce the amount in LTD benefits you receive?;
  • Subrogation rights – does your insurer have an entitlement to any settlement you may receive by pursuing legal action?; and
  • Termination of coverage clauses – are there any circumstances under which your coverage agreement could be terminated?.

→ Do Not Resign or Accept Severance Without Legal Advice

If you resign voluntarily, you may forfeit your right to LTD benefits. Similarly, accepting severance before LTD is approved can jeopardize your eligibility. 

Before signing anything, ensure to consult with a lawyer to make sure you receive the best possible outcome in the circumstances. This complex area of law demands professional guidance to ensure that you’re what you deserve. 

→ Coordinate with Your Employer

If you’re already on LTD, the employer may want to end the employment relationship with a severance offer. Work with your legal advisor to structure any severance settlement so it:

  • Does not jeopardize your entitlement to LTD benefits;
  • Does not trigger an overpayment of benefits; and
  • Reflects a fair valuation of your entitlements.

 What If You’re Denied LTD but Unable to Work?

This is both a common and frustrating situation.

If you were denied LTD but remain medically unable to work, you may still be entitled to severance, as you’re effectively being terminated while disabled. This could result in:

  • A larger common law notice period;
  • Additional compensation resulting from the employer’s duty to accommodate your disability; and/or
  • You may also appeal the LTD denial or pursue a legal claim against the insurer, especially if there is medical evidence that supports your disability claim.

 Tax Implications of LTD and Severance

It’s important to understand how LTD benefits and severance pay are taxed so you can plan ahead, minimize unexpected tax liabilities, and manage your payments effectively. 

→ Long-Term Disability Benefits

Whether LTD payments are taxable depends on who paid the premiums for the insurance plan:

  • If you paid the premiums with after-tax dollars, the benefits you receive are not taxable.
  • If your employer paid the premiums, or if the premiums were paid with pre-tax dollars, the LTD benefits are considered taxable income and must be reported on your tax return.

→ Severance Pay

Severance payments are generally taxable income in Canada, regardless of whether they’re paid as a lump sum or through salary continuance. This includes any pay in lieu of notice, statutory severance, or additional compensation negotiated through a settlement. 

There are a few tax planning options to consider:

  • Timing of payment: Negotiating to spread severance across two calendar years can help reduce your overall tax bill by keeping you in a lower tax bracket.
  • Retiring allowance rollover: Some severance amounts may qualify as a retiring allowance, which can be transferred into an RRSP without affecting your annual contribution limit, reducing your immediate tax burden.
  • General damages: If properly structured, amounts awarded for things like mental distress or human rights violations may be non-taxable, but this must be clearly justified and documented.

 Get Legal Support

Navigating the end of employment while dealing with a long-term disability is challenging, both emotionally and legally. Many employees unknowingly undermine their LTD claims or forgo compensation they’re entitled to. Employers and insurers are often more concerned with reducing liability than with ensuring fairness.

Before you make any decisions about severance or LTD, get legal advice to protect yourself and your rights. NOVA Injury Law and their team of lawyers are here to support you through every step of the process. There is a complimentary case evaluation with no obligations, no-fee payment structure where we only get paid if your claim is successful, and dedicated legal advocacy to pursue the compensation you deserve. 

To learn more or to schedule a free consultation regarding a Long Term Disability claim, contact NOVA Injury Law at info@novainjurylaw.com.