Module 3

Stated Objectives for the Current Income Tax Regime

• The government's objectives for creating the Income Tax Act (ITA) include:
• Encouraging private retirement savings
• Eliminating inequities in tax assistance for different pension plans
• Enhancing flexibility in timing of retirement savings
• Introducing inflation-adjusted dollar limits on contributions and benefits

Taxation Rules for Registered Pension Plans

• Contributions:

• RPP contributions are deductible to certain limits

• Example: If an individual earns $50,000 annually and contributes $5,000 to their RPP, their taxable income for the year is $45,000

• DB-specific employer contribution rules:

  • Must be supported by actuarial valuation
  • Tax deductible within a tax year or 120 days past it

• DC-specific employer contribution rules:

  • Tax deductible if made according to RP rules

• Employee contributions are tax deductible in the year made

• Benefits:

• Pension benefits are fully taxable when paid directly to employees

• Individuals aged 65+ are eligible for a federal tax credit on pension income, up to $300

• Individuals under 65 are eligible for a similar tax credit on income from plans due to spouse or partner's death

• Investment Income and Capital Gains:

• Not taxable

Comprehensive Limit for Retirement Savings

• The comprehensive savings limit is based on the principle that the availability of tax assistance should be the same for all individuals with the same income
• Savings limit is equal to 18% of the member's compensation, up to a dollar maximum called the "money purchase limit"
• Disregarding the limit leads to deregistration of RPP/DPSP under ITA and a penalty tax for RRSP

Pension Adjustments (PAs)

• Used by the CRA to monitor tax limits for pension plans/DPSPs and calculate RRSP room for the next year
• Impact an individual's RRSP contribution room by reducing it based on the value of pension benefits earned through participation in employer-sponsored plans like RPPs or DPSPs
• Employer steps when reporting PAs to the CRA:
• Determine each employee's benefit accrual in the pension plan
• Calculate the dollar value of the benefit accrual
• Report pension credits as a Pension Adjustment on the T4 slip
• Total pension credits from all plans if the employee participates in multiple plans

Factor of Nine

• The factor of nine is used to estimate the approximate value of lifetime pension income in a DB plan
• Standardized factor chosen by the Department of Finance
• Used universally for determining the PA under all DB plans
• PA formula is based on benefit accrual, considering only current year earnings
• Calculation treats all plans similarly, potentially overestimating the value of tax assistance

Determining Pension Adjustments

• DC Plan: employer's contributions + employee contributions + reallocated forfeited amounts
• DPSP: similar to DC plan (except no employee contributions)
• DB Plan: 9 x benefit accrual for the year - $600

Past Service Pension Adjustment (PSPA)

• Used to adjust retirement savings limits when a DB plan increases benefits for past years of service
• Without PSPA, members may exceed the ITA limit
• PSPA is created if:
• Benefit formula in DB plan increases after 1989
• Past service benefits are added
• PSPA is not created if:
• Ancillary benefits improve pensions for service before 1990
• Pensions are upgraded for service before 1990

Pension Adjustment Reversals (PARs)

• Used when the Pension Adjustment previously reported exceeds the value of pension benefits actually received by the member upon termination/retirement
• Helps restore RRSP contribution room that was previously reduced due to an overstated PA
• Addresses the overstatement of PAs in two cases:
• DB Plan: "factor of nine" overstates pension credits
• Terminated members are not fully vested, but historical PAs assumed full vesting

RRSP Contribution Room

• Calculated by considering:
• Annual contribution limit (18% of earned income, subject to a maximum amount)
• Unused contribution room for previous years (can be carried forward)
• Pension adjustments (can reduce RRSP contribution room)

ITA Registration Rules and Contribution Limits

• Registration rules:
• CRA requires registration under ITA and under provincial/federal PSL
• Each province (except PEI) has its own laws for non-federal industries
• Retroactive registration allowed with the same calendar year effective date
• Consequences of noncompliance:
• Plan's registration status being revoked
• If registration is revoked, the arrangement is considered an RCA (Retirement Compensation Arrangement) from the date of revocation

Primary Purpose of an RPP

• The primary purpose of an RPP is to provide employees with payments post-retirement until death for their service
• Pensions must be lifelong, equal payments, unless adjusted for inflation or reduced after member/spouse death

Protection of Members' Benefits

• RPPs must forbid members from transferring or pledging rights
• Members cannot surrender or forfeit rights voluntarily
• Creditors cannot seize rights for a member's debt
• Exceptions for court orders, settlement agreements in relationship breakdown
• Government has the right to recover debts owed by attaching owed pension### Retirement Savings and Pension Plans
• An individual's taxable income can be reduced by contributing to a Registered Pension Plan (RPP), with a tax deductible contribution of $5,000 in a given year.
• Pension benefits are fully taxable when paid directly to employees, but individuals aged 65+ are eligible for a federal tax credit of up to $300.

Comprehensive Limit for Retirement Savings

• The comprehensive savings limit is based on the principle that tax assistance should be the same for all individuals with the same income.
• The savings limit is equal to 18% of the member's compensation, up to a maximum dollar limit (known as the "money purchase limit").
• Failure to respect the limit can lead to deregistration of the RPP or penalty tax for RRSPs.

Pension Adjustments (PAs)

• Pension Adjustments are used to monitor tax limits for pension plans and calculate RRSP room for the next year.
• PAs reduce an individual's RRSP contribution room based on the value of pension benefits earned through participation in employer-sponsored plans.
• Employers must report PAs to the CRA and ensure that the PA doesn't exceed the money purchase limit.

Factor of Nine

• The factor of nine is used to estimate the approximate value of lifetime pension income in a DB pension plan.
• The standardized factor is used universally for determining PAs under all DB plans, which can lead to overstated PAs and reduced RRSP contribution room.

Determining Pension Adjustments

• For DC plans, the PA is the sum of employer contributions, employee contributions, and reallocated forfeited amounts.
• For DB plans, the PA is 9 times the benefit accrual for the year, minus $600.
• For DPSPs, the PA is similar to DC plans, except there are no employee contributions.

Past Service Pension Adjustments (PSPAs)

• PSPAs are used to adjust retirement savings limits when a DB plan increases benefits for past years of service.
• PSPAs are created when the benefit formula in a DB plan increases after 1989, or when past service benefits are added.
• PSPAs are not created when ancillary benefits are improved for service before 1990 or pensions are upgraded.

Pension Adjustment Reversals (PARs)

• PARs are used to restore RRSP contribution room that was previously reduced due to overstated PAs.
• PARs are used when a member's pension benefit is less than the cumulative PAs and PSPAs reported.

RRSP Contribution Room

• The RRSP contribution room is calculated based on the annual contribution limit, unused contribution room from previous years, and pension adjustments.
• The annual contribution limit is 18% of earned income, subject to a maximum amount.

ITA Registration Rules and Contribution Limits

• The CRA requires registration of pension plans under the ITA, with each province having its own laws for non-federal industries.
• Retroactive registration is allowed with a same calendar year effective date.
• Noncompliance with registration rules can lead to revocation of the plan's registration status.

RPPs and ITA

• The primary purpose of an RPP is to provide employees with payments post-retirement until death for their service.
• RPPs must forbid members from transferring or pledging rights, and members cannot surrender or forfeit rights voluntarily.

Assets and Investments

• RPPs must follow minimum investment standards of applicable PSL jurisdictions.
• ITA rules prohibit RPP assets from being invested in members' shares or debt, with certain exceptions.
• RPPs can't borrow, except for short-term loans or borrowing for real estate investment.

Employer and Employee Contributions

• Employer contributions must follow the plan text, and failure to do so can lead to revocation of the plan's registration status.
• Employee contributions can be designed without employee contributions, but specifics must be included in the plan documents.

Working Outside of Canada

• Employment outside of Canada requires Minister of Finance approval.
• Pre-1993 plans credit all service, regardless of location.
• Foreign service is eligible under specific conditions, and DC contributions can be made with CRA consent.

DC Pension Plans

• Employer contributions must be specific to certain employees and allocated accordingly.
• Contributions can't be made if surplus is not assigned to employees.
• Forfeited employer contributions and their earnings from members who leave before vesting must be reallocated, used for plan expenses, or refunded to the employer.

DB Pension Plans

• The maximum benefit accrual rate is 2% of pensionable earnings.
• Bridge benefits are payable from a DB pension plan, with a maximum based on estimated CPP/QPP and OAS benefits.

Disabled Employees

• Disabled employees can receive their pension from a DB pension plan, with a maximum annual lifetime retirement benefit.
• The maximum benefit is based on the accrued pension at disability retirement, or the lesser of the projected pension if the member worked until age 65, or the YMPE at disability pension start.

Lump-Sum Settlements

• Plan members can commute pension from an RPP before or after commencing, as per ITA.
• PSL typically prohibits commuting pension already in pay.

Termination of Employment

• On termination, plan members can choose from a deferred pension, refund of employee contributions with interest, or a lump sum payment.
• The maximum amount of pension that can be provided in a DB pension plan is based on the defined benefit limit, or 2% of the highest average indexed compensation multiplied by years of pensionable service.

Individual Pension Plans (IPPs)

• IPPs are pension plans for one person with a DB provision.
• Business owners find IPPs attractive because contributions are tax-deductible, and can be more than RRSP contributions, including past service contributions.
• The ITA rules restrict benefits and contributions to IPPs, and are used to determine whether an IPP is a designated plan.