Pension Plans, DPSPs, and LIRAs

Question 1

Integrated Plan

Answer 1

An integrated plan is a pension plan that recognizes that employees must also make contributions to the CPP on their earnings up to the YMPE.

CPP contributions are paid on an employee’s pensionable earnings from the year’s basic exemption to the year’s maximum pensionable earnings.

For an integrated plan, the RPP contribution rate on earnings below the YMPE is reduced to account for CPP contributions. Contributions to an integrated plan are required on earnings below the YBE and this reduced contribution rate is also applied to the earnings below the YBE.

If some integrated plans, members who retire before 65 receive higher benefits until they reach age 65, when their CPP and OAS benefits would normally commence.

The definition of pensionable earnings for a pension plan may or may not includes bonuses and other employment perquisites.

Question 2

Defined contribution pension plan.

Answer 2

All the risk lies with the employee.

In a Defined contribution pension plan, if the pension fund investments do not perform as expected, the employee will end up with a smaller amount with which he can purchase a pension at retirement. There is no requirement for the employer to make additional contributions to make up for poor investment performance. The employer’s obligation is limited to making fixed annual contributions, so it knows in advance what its contributions will be. Thus, all of the investment risk lies with the employee.

The pension fund manager is not responsible for the performance of the fund’s investments.

Question 3

Amount accumulated within a defined contribution plan is normally used to purchase a life annuity from an insurance company when the plan member retires.

How do you calculate the amount of annual pension?

Answer 3

(amount accumulated in pension fund / 1000) x X.

Where x is the annual annutization rate per $1000.

Question 4

Defined benefit pension plan

Answer 4

A defined benefit pension plan is a pension plan that as as definition of the amount of pension benefit that will be payable at retirement according to a formula that related the value of the pension benefits to the employee’s earning levels and year’s of service. For example, many DB plans provide a benefit of 2% or 1.5% per year of service. However, the definition of “earnings” for this purpose varies from plan to plan.

There are three main methods of relating defined benefits to earnings, as follows:

1. career average plan: defined benefit is related to the average earnings over the employee’s career
2. final-earnings plan: defined defined benefit is related to the employee’s earnings during the final three to five years of service;
3. best earnings plan: the defined benefit is related to the employees earnings during a period of three to five years that represent the highest earnings.

A forth type of defined benefit plan, called flat-benefit pension plan, provides a flat benefit for each year of service, regardless of earnings.

Question 5

Unreduced early retirement

Answer 5

Most pension plans provide for an unreduced early retirement as long as the plan member has reached a qualifying age.

The qualifying age is calculated as:
-((age of joining the plan + qualifying factor) / 2)

The qualifying factor is a number that is specified by each pension plan and tends to be 80, 85, or 90.

In addition, in most provinces, pension plan members may elect to receive a reduced retirement pension to members if they retire within 10 years of normal retirement age. The reduction may be done according to detailed actuarial evaluations, but more often it is done according to some formula, such as 3% for each year of retirement prior to normal retirement age.

Finally, most pension plans provide for the payment of a retirement pension to a member who becomes disabled prior to being eligible for a normal retirement pension. In this case, the retirement pension is based on the full pension credits earned to the date of disability without an actuarial adjustment. The addition cost of providing these unreduced pension benefits is absorbed by the pension plan.

Question 6

What is the normal form of pension payable at retirement?

Answer 6

In cases where a member of a contributory pension plan has a spouse, the Federal and provincial pension legislation specifies that the normal pension payable at retirement must take the form of a joint last survivor annuity.

This means that the pension will continue to be payable after the death of one of the spouses, although it may be paid at a reduced rate, depending on the plan. As a result, the pension payments will be less than a straight life annuity because there is a greater risk to the annuity provider that the payments will continue for a longer period of time.

Some provinces allow the non-member spouse to waive this requirement, resulting in the payment of a straight life annuity to the plan member. Otherwise, only single plan members will receive a straight life annuity.

Question 7

Stepped contributions

Answer 7

Most registered pension plans that are integrated with CPP call for the employees to make stepped contributions, to provide some relief for those earning that are already subject to CPP contribution. However, employee contributions are required on all earnings, including those up to the yearly basic exemption (unlike CPP contributions).

Question 8

Purchasing pension credits for past service

Answer 8

Some DB plans allow members to make extra contributions to purchase pension credits for services that they have provided in the past. Members of DB plans may be given the opportunity to make a past service contribution to purchase pension credits:

• to cover their years of service prior to the establishment of a new pension plan.
• to cover their years of service prior to their membership in the plan
• to upgrade their existing benefit entitlements, in cases where the employer has upgraded the pension plan (the plan has been upgraded from 1.5% per year of service to 2% per year of service, from that point on.)

Question 9

Individual Pension Plan (IPP)

Answer 9

aka - executive pension plan

-is an employer sponsored RPP that is established specifically for the benefit of connected individuals of highly paid employees. A connected individual is an employee who is also a shareholder and who owns more than 10% of the shares of the corporation.

An IPP is advantageous for an owner/manager who:

• has steady income
• earns at least the earned income to make the maximum RRSP contribution
• is at least 45 years old

If an individual earns more than the earned income required to make the maximum RSP contribution, he might be able to make a larger tax-deductable contribution to an IPP than an RRSP.

However, funding to the IPP is based upon present value of the pension obligation. The Pension obligation is the requirement of the employer to pay the pension that the employer has undertaken to provide to the plan member.

Prior to about 45 years of age, the pension obligation is less than the contribution room to an RRSP. After about age 45 years of age, he might be able to make larger tax deductable contributions to an IPP than an RRSP.

IPP guarantees set level of income like DB plans

IPP benefits can be indexed

IPP is creditor proof, except for claims for support of a spouse and other dependants

Question 10

2015 RSP Dollar limit

Answer 10

$24,930

Question 11

Pension limit

Answer 11

The pension limit is a prescribed rate limiting the amount of a member’s pension benefit from a DB Plan

Pension limit is calculated as:
(money purchase limit/9)

For 2014, the pension limit was $2770

Question 12

Pension benefits Standards Act

Answer 12

Pension plans that are organized and administered for the benefit of employees who perform services in connection with any federal works, undertakings, or businesses that are within legislative authority of Parliament are governed by the federal Pension Benefits Standards Act (PBSA), regardless of the province in which the employee works.

The PBSA thus governs pension plans that are for the benefit of employees working in air transportation, railways, radio stations, banks or Crown agencies. The PBSA also covers employees working in the Yukon, Nunavut, and North West territories. However, the PBSA does not regulate employees of the Federal Government.

Question 13

Vesting

Answer 13

Vesting is having earned the right to benefit from the pension contributions made by the employer.

Pension legislation dictates the maximum vesting period for each pension plan. Pension plans that are offered by radio stations fall under the jurisdiction of the federal PBSA. According to PBSA, all pension credits earned after Jan 1 1987 must vest after two years of plan membership. Prior to the federal pension reforms in the late 1980s, the PBSA did not require the employer’s contributions to vest until the employee had reached 45 years of age and had 10 years of plan membership.

Question 14

Spousal pension benefit for pensions regulated under PBSA

Answer 14

In the case of post-retirement death, the PBSA requires a Spousal survivor’s pension of not less than 60%.

Question 15

Deferred Profit Sharing Plan (DPSP)

• employer contributions
• vesting

Answer 15

Since 1991, only the employer, not employee, can contribute to a DPSP. A DPSP can permit contributions to be made at the employer’s discretion, or to be contingent on a prerequisite, such as employee performance, without requiring the employer to make a minimum contribution. Contributions can be based on profits, employee earnings, or a fixed amount per employee.

It is common practice for an employer to make contributions to a DPSP after its fiscal year end when profits for the previous fiscal year have been determined. To facilitate this, and employer can deduct DPSP contributions that are made by the employer in the year of within 120 days after the year end.

Under ITA, all amounts must vest within the beneficiaries once they have two years of participation in a DPSP.

Question 16

DPSP

-options at retirement or ceased to be employed

Answer 16

If an employee is a member of a DPSP, upon retirement she is entitled to receive all amounts that have vested in the plan within 90 days of the day that she ceased to be employed.

In addition, if the plan provides for it, at any time including before or at retirement, she can elect to have all or part of the vested benefits:

1. paid to her directly from the DPSP in equal installments at annual or more frequent periods over a duration of 10 years; or
2. transferred directly to an eligible issuer in order to purchase a registered annuity, naming herself as the annuitant, so long as the annuity does not have a guaranteed term of more than 15 years, and from which payments begin no later than 71st birthday.

You can choose to transfer lump sum directly to RRSP or RPP, or another DPSP, provided the new DPSP can reasonably expect to have at lest 5 beneficiaries throughout the year of the transfer. These transfers must be done between the DPSP and the other registered plans in order to continue the deferral of tax.

Question 17

Withdrawal of shares from DPSP

Answer 17

Normally, when a taxpayer withdraws from DPSP, the full amount of that withdrawal must be reported as income. However, if the taxpayer is closing out his DPSP, and he takes a single lump sum payment that includes company shares, he can report the FMV of those shares as income for the year, or he can file an election to report only the cost of the amount of those shares as his income for the year with respect to the shares.

If he chooses to file the election, this cost amount becomes his ACB for the shares, and when her later sells the shares, he will realize a capital gain to the extent that his proceeds of disposition exceed the cost amount. To qualify for this election, the shares must be received as a single payment that signifies the complete termination of the beneficiary’s interest in the DPSP.

Question 18

Retirement Compensation agreement (RCA)

Answer 18

An RCA is type of employer-sponsored, funded retirement savings arrangement under which an employer contributes to a custodian in connection with benefits that an employee is to receive on, after, or in contemplation of any substantial change in the services rendered by the employee including retirement or the loss of employment.

RCAs are little used because of the limited tax advantages. However, they can serve as an income averaging tool reducing tax on large severance payments. You do not need contribution room to contribute to a RCA.

You could be taxed at the top marginal rate on a large severance payment.

The amount of a severance payment transferred to an RCA would be taxed at 50% rate. However, this is a refundable tax that is refunded to the RCA when the funds are distributed as taxable income to the beneficiary.

The refundable tax is applied to funds transferred to an RCA, but the trustee can pay the funds of the RCA plus the refunded tax to the beneficiary.

In calculating the tax saved by the beneficiary, the 50% refundable tax is not a factor, except to the extent that is reduces the amount of investment income earned in the RCA by 50%.

By passing the severance payment through an RCA, Anthony would save $20,000 in tax calculated as:

–(Severance payment x ETR on severance payment) - (total amount of RCA withdrawals x ETR on RCA withdrawals)

Question 19

Pension Adjustment (PA)

Answer 19

The pension adjustment is the value of all contributions to the taxpayers DPSP or defined contribution plan, and an estimate of the value of the benefits that the taxpayer earned as a member of the defined benefit pension plan.

The pension adjustment reduces the taxpayer’s current contribution room for RRSP purposes, thereby accounting for the tax assisted savings the taxpayer has already taken advantage of through her RPP or DPSP. The PA attempts to equalize the potential tax assisted savings of all Canadians.

If a taxpayer terminates her membership in an employer sponsored pension plan, and her termination benefit from that plan is less than the pension adjustment that she incurred while she was a member of the plan, then she can report a pension adjustment reversal (PAR) equal to the difference between these two amounts. The PAR will increase her RSP contribution room.

Question 20

Calculating PA

Answer 20

The new RRSP contribution room arising in the current year is reduced by a PA incurred as a result of participation in an RPP in the previous year.

For defined contribution plans, the PA is calculated as:
(prior year’s pension earnings x contribution rate) x number of contributors.

Question 21

Double Dipping

Answer 21

The double dipping strategy is a loop hole in the ITA that allows the taxpayer to double the amount that can be contributed to a tax deferred savings in one particular year.

The taxpayer’s new RSP contribution arising in the current year is reduced by any Pension Adjustments that resulted from the taxpayer’s participation in the previous year. So, PAs are a year behind in reducing RSP contribution room.

This means that, if he joins a pension plan in the current year, that taxpayer can contribute the maximum to his RSP based on 18% of his earnings, and also contribute the maximum to an RPP without affecting his RSP contribution room for the current year.
The effectively doubles the maximum tax-assisted savings for the single year in which the taxpayer joins the RPP, and this is known as double dipping.

Question 22

Pension limit or defined benefit limit

Answer 22

The max yearly pension that can be provided through a designated plan and for which the contributions can be deducted for tax purposes by the employer and employee is the lesser of:

• pension limit times the number of years of pensionable service
• the maximum benefit rate of 2% per years of service times the best three years of pensionable earnings.

The pension limit or defined benefit limit is calculated as:
-one ninth of the money purchase limit

The benefit entitlement is the value of the benefit earned by the plan member during the year, and for a defined benefit plan, it is calculated as:
-(pensionable earnings x unit percentage of the pension plan)

Pensionable earnings are usually restricted to base salary, and do not include overtime and bonuses.

The maximum annual pension benefit per year of service that can be earned by someone who is in a DB plan is calculated as:
-the lesser of (pension limit and 2% of pensionable earnings.) The 2015 pension limit is $2819.

The pension limit of DB limit is the maximum pension benefit payable by a DB pension plan.

Question 23

LIRA

Answer 23

LIRA is an RSP with a trust agreement attached to it in accordance with Federal or provincial pension legislation. This trust agreement restricts the funds so they can only be used to provide income at retirement.

A LIRA is established with vested pension benefits, and is often often referred to as a locked-in RSP. A taxpayer may be able to transfer some of all of his severance pay into a non-locked in RSP, subject to certain limits.

The ITA does not differentiate between RSP and LIRA, thus both must be converted to income funds by the end of the year in which the annuitant turns 71.

LIFs no longer are required to be purchased into annuity at age 80.

Question 24

RLIF - Restricted LIF

Answer 24

The annuitant of a federally regulated LIF who is 55 years of age or older is entitled to a one-time conversion of up to 50% of the holdings into a non-locked in registered plan, either a RSP or RIF.

A RLIF is a RIF that is regulated by the federal PBSA and from which the annuitant had the opportunity to unlock assets with a value of 50% of the FMV of the RIF by transferring them to a non-locked-in registered plan.
The 50% withdrawal must be made within 60 days of creation of the the RLIF. After this point, the RLIF will be subject to the same limits upon maximum and minimum annual withdrawals, and to the same limits on extraordinary withdrawals, as a LIF.

An RLIF can be transferred back to a locked RSP if the annuitant hasn’t reached 71 years of age to avoid income stream.

Question 25

Exceptions for withdrawing from restricted or locked in plans.

Answer 25

You can make withdrawal for financial hardship based on:

• expenditures on medical or disability related treatment; or
• low income for the year

If you expected to earn less than the low income limit, you could withdraw an amount based upon your expected income.

The low income limit is calculated as:
(75% of the YMPE)

The maximum permitted withdrawal amount is calculated as:
((50% of YMPE) - (2/3 of expected income) - financial hardship withdrawals).

Question 26

LIF - maximum withdrawal

Answer 26

The max withdrawal that can be taken from a LIF in any one year is designed to ensure that an adequate amount of money will remain in the LIF to provide life income.

Under the PBSA, the maximum amount that can be withdrawn from a LIF in any one year is the amount that the annuitant would receive if he used the LIF funds to purchase a term certain annuity to age 90 at an interest rate that is not greater that the rate offered by long-term Government of Canada bonds.

Question 27

LIF - Maximum withdrawal

Answer 27

FMV at beginning of year / (90 - age)