Module 3 Flashcards
Objectives for the income tax regime governing registered pension and non-pension retirement plans in Canada?
- To establish a tax framework to encourage increased private retirement savings
- To eliminate inequities in tax assistance
- To enhance flexibility in the timing of retirement savings
- To introduce a system under which dollar limits on contributions and benefits are adjusted for inflation and therefore do not decline in real value.
These objectives aim to create a fair and effective retirement savings environment.
Taxation rules for registered pension plan (RPP) contributions, benefits, investment income and capital gains.
-Contributions to an RPP are deductible up to certain limits.
-ER DB contributions must be supported by an actuarial valuation
-ER DB contributions made in the last 120 days of the year are deductible by the ER as long they were to funds benefit of current or former EE for the current tax year.
-ER DC contributions made in tax year are deductible by ER if made accordance with plan text and before end of tax year.
- Eligible employee contributions are deductible in the year made (except for past service defined benefit plan contributions made in respect of years of service prior to 1990).
-Benefits are fully taxable to employees when paid directly to them. Individuals age 65 or older may claim a federal tax credit in respect of the first $2,000 of pension income from most types of registered pension or savings plans, up to a maximum credit of $300. Individuals under age 65 may claim a similar tax credit in respect of income received from similar plans as the result of the death of their spouse or common-law partner.
Describe savings limit on tax-assisted retirement savings, the rationale and the consequences of failure to respect that limit
based on principle that the availability of tax assistance should be the same for all individuals with the same incomes, whether they save for retirement through participation in a registered pension plan, RRSP or DPSP or through a combination of those plans.
Savings limit is equal to 18% of the member’s compensation, subject to a dollar maximum called the money purchase limit
Failure to respect the limit will cause the deregistration of an RPP or DPSP under the ITA and will result in a penalty tax under an RRSP.
The federal tax credit for individuals age 65 or older applies to the first $2,000 of pension income.
Describe the purpose of pension adjustments (PAs)
mechanism that attempts to fairly identify the “value” of any one employee’s participation in their employer’s plan(s)
This limit ensures equitable tax assistance for individuals with similar incomes.
Steps taken by employers to determine PAs (A, B & C).
(a) Determine each plan member’s benefit accrual in the pension plan or DPSP for the year in question. If employees participate in more than one plan sponsored by the employer, this must be done for each plan
(b) Determine the dollar value of the pension plan or DPSP benefit accrual. In a DB plan, step (b) will be nine times the benefit accrual from step (a), minus $600. This amount is known as the member’s “pension credit.”
(c) The pension credit is the Pension Adjustment to be reported by the employer on each plan member’s T4 slip for the year in question. If employees participate in more than one pension plan or DPSP with the same employer, the employer must total the pension credits from each plan for each member, and that total will be the PA.
Deregistration leads to loss of tax advantages associated with registered plans.
How is benefit accrual usually set up when you have both DB and DPSP in order to leave room for PAs?
In a combination DB RPP and DPSP, the DB pension accrual is usually set lower than 2% to provide the ability to make some degree of DPSP contribution.
They ensure equitable treatment of employees participating in different plans.
Outline the rationale behind the “factor of nine” used to determine the PA for a DB pension plan
average factor to produce the approximate value of lifetime pension income under a generous DB pension plan.
ignores ancillary benefits such as early retirement reductions and indexation.
Identify situations when the factor of 9 is more or less an appropriate factor
Appropriate for estimating the value of pension benefits under generous DB pension plans for employees who participate over their full careers in those plans
PA treats career average plans with no ancillaries the same as final average plans with generous ancillaries. This results in a substantial over-calculation of the value of the plan’s tax assistance in many cases. If a PA is overstated, a plan member’s RRSP contribution room is less than it should be.
Explain how a PA is determined in a DC pension plan, DPSP and a DB pension plan
DC: EE contributions + ER contributions + reallocated forfeited amounts (from unvested terminated members)
DPSP: ER contributions + reallocated forfeited amounts (from unvested terminated members)
DB: (9 x benefit accrual) - 600 (whether vested or not)
3.5 Chen accrued $1,250 of pension in his employer’s DB pension plan in the past year. His co-worker Ester accrued $1,500 of pension in the same DB pension plan last year. Their co-worker Josh contributed $1,500 to a separate DC pension plan that their employer sponsors for recently hired employees, and the company also contributed $1,500 to that pension plan. Calculate the PAs that their employer will report on their T4
For the DB pension plan, the PA is nine times the approximate amount of annual pension accrued in the year, minus $600.
Chen’s PA will be (9 X $1,250) – $600 = $10,650.
Ester’s PA will be (9 X $1,500) – $600 = $12,900.
For the DC pension plan, the PA is the total of employee and employer contributions.
Josh’s PA will be $1,500 + $1,500 = $3,000
Describe the purpose of a past service pension adjustment (PSPA)
attempt to maintain equity within the application of the ITA comprehensive retirement savings limit when DB pension plan sponsors grant retroactive pension improvements
recognize the difference between PAs reported in previous years and the PAs that would have been reported had plan benefits been higher through those years. A PSPA is calculated for each affected member of an RPP when an employer amends the plan to increase pensions already earned. A PSPA is applied against unused RRSP contribution room
Identify two types of RPP benefit improvements that do not create PSPAs.
If ancillary benefits are improved
If pensions for service before 1990 are upgraded or improved
3.7 Describe in general the requirements for pension plan administrators to report PSPAs to the CRA
Some PSPAs must be reported but are exempt from “certification.”
Generally, certification is not required if benefits are increased for at least 90% of the members and if certain requirements are met around the nature of the members who receive a benefit improvement.
Certification needs to be provided by CRA prior to implementation of the benefit improvement for “specified individuals” : owns 10% or more of company sponsoring the plan and/or very high earners.
Certification is normally provided as long as the PSPA does not exceed the member’s unused RRSP contribution room at the end of the previous year by more than $8,000. it is possible that the member’s PSPA will be certified after the member withdraws funds from their RRSP. Such withdrawals are called “qualifying withdrawals,” and they are taxable to the individual.
Explain the purpose of pension adjustment reversals (PARs).
PARs are another attempt to maintain equity within the application of the ITA comprehensive savings plan limits. Their purpose is to remedy the overstatement of PAs (and resulting reduction of RRSP contribution limits)
When do PARs occur:
(a) In DB pension plans, the use of the “factor of nine” often overstates the value of members’ pension credits
(b) At time of termination, not all pension and DPSP members are fully vested, yet historical PAs assumed full vesting.
How a PAR is calculated at termination
Termination benefit must be less than cumulative PAs and PSPAs reported for that employee. The excess will be the PAR and will restore RRSP room by that amount. No PARs if member simply collects pension.
Describe in general terms the approach for registering a pension plan under ITA
must apply for pension standards legislation registration first
A pension plan sponsor may apply for registration retroactively, but the effective date must be in the same calendar year in which the application for registration is submitted.
Discuss the consequences of noncompliance with the pension plan registration rules set under ITA.
causes the plan’s registered status to become revocable
If the plan’s registration is revoked, the arrangement is then classified as a Retirement Compensation Arrangement (RCA) from the date it ceases to comply with the rules and ceases to benefit from the preferential tax treatment afforded to RPPs
Explain the primary purpose of an RPP in the context of ITA
provide employees with periodic payments after retirement and until death in respect of their service as employees. The pensions must be payable for the plan member’s lifetime in equal periodic amounts, except where they are adjusted for inflation or reduced after the death of the plan member or their spouse.
Explain how the ITA requires that members’ benefits from pension plans be protected from most creditors
An RPP member can’t place pension for collateral for debt/obligation. RPP pension is also protected from creditors.
Explain the ITA restrictions placed on the types of assets acceptable for the investment of RPP monies under ITA
Investments must comply with PSL.
prohibit RPP assets from being invested in shares or debt instruments of any plan member, any employer that participates in the plan and generally any individual connected or related to a plan member or participating employer.
prohibition does not extend to shares or debt obligations of a participating employer where shares of the corporate employer are listed on a prescribed stock exchange inside or outside of Canada, certain government debt obligations, in interest to acquire such a listed security, and certain mortgages on real property.
An RPP may not borrow funds, with two specific exceptions:
Where the term of the loan does not exceed 90 days and none of the RPP’s assets are used as security for the loan (except where the borrowing is necessary for current payment of benefits or purchase of annuities)
Where the borrowed money is used to acquire real property to earn income from property, as long as no RPP asset other than the real property acquired is used as security for the loan and the loan does not exceed the cost of the property.
There is no foreign content limit on investments held under pension plans.
Identify general ITA requirements regarding how EE and ER contributions are needed
An RPP must require an employer to contribute with one exception. Pooled Registered Pension Plans (PRPPs) do not require employer contributions.
A plan can be designed that neither requires nor permits employee contributions.
If employees are required or permitted to contribute, plan documents must contain specific information on the amount and nature of their contributions.
Describe how ITA deals with periods when employees work outside of Canada
Where a member is employed outside Canada, that period of employment is not eligible unless the Minister of Finance considers it acceptable.
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