Ralph
Moss Limited
Today, the work force is more mobile than ever. A large number of workers change jobs several times during their working career. Until now, those who were members of registered pension plans (RPPs) or of deferred profit sharing plans (DPSPs) sponsored by their employers were penalized when they were leaving their job prior to retirement.
In order to improve the fairness of the system of tax assistance for retirement savings, the federal government has announced the reintroduction of the pension adjustment reversal (PAR).
On the other hand, the budget proposes to modify how the pension adjustment (PA) of any member of a defined benefit RPP must be calculated for 1997 and future years. As a result,the PA will be calculated as follows:
until 1996, the offset was equal to $1,000.
As a result, the PA reported each year will be increased by $400. Because the PA reduces theRRSP contribution room, this means that a member of an RPP will have his/her annual contribution limit reduced by $400.
However, high-income earners will not be affected by this new measure because, as announced in the 1996 budget, they already cannot contribute to RRSPs, and they will not be able to do so as long as the RRSP contribution limit is lower than $15,500. Please note that this limit is scheduled to be attained in2005.
Pension Adjustment Reversal (PAR)
The purpose of PAR is to restore lost RRSP contribution room for members of RPPs or of DPSPs who leave their job.
PAR had been first introduced in 1989 in the context of the tax reform relating to savings plans. However, PAR had been eliminated in 1990 by the House of Commons Standing Committee on Finance in order to reduce the complexity of the reform.
The PAR will have to be determined for any member of an RPP or of a DPSP who ceases, after 1996 and before retirement, to have any entitlement to benefits.
The first PARs must be reported to Revenue Canada at the end of 1998. PARs for terminations after 1997 will be added to a member's RRSP contribution room for the year of termination. PARs for terminations in 1997 will be added to the RRSP contribution room for1998.
The introduction of PAR has also the effect of eliminating the existing special
rules that allow the adjustment of the PA of a member of an RPPor of a DPSP
when he/she ceases his/her membership. With the introduction of PAR,these rules
will become redundant and will be eliminated in determining PAs for 1997 and
future years.
PAR is determined in accordance with the type of plan.
The following two examples reflect our understanding of how it is proposed that PAR be calculated. The department of Finance will shed some light on this matter in the next few weeks.
The PAR will effectively increase the RRSP room for defined benefit RPP members who leave their job, especially when they are young. We will recall that a factor of 9 is used when calculating the PA (9 x benefit accrual - $600). However, very often, a much smaller factor is used to establish the transfer value of a credited pension under an RPP.
The factor of 9 was to be an approximation of the factor used when determining the transfer value of an accrued pension under an RPP when transferred to another registered retirement vehicle such as a locked-in retirement account (LIRA) or a locked-in RRSP. The real factor varies according to the member's age, the current interest rates and the type of pension benefits provided under the plan.
Let us assume that a defined benefit RPP provides for a pension at retirement of 2% of the career average salary. The assumptions used are shown in the table below.
ASSUMPTIONS - DEFINED BENEFIT RPP Date of entry into the plan January 1, 1995 Date of termination of employment January 1, 1998 Accrued pension on termination date 2%x(30,000 + 31,000 + 32,000)=$1,860
1995 1996 1997 1998 Total $ $ $ $ $ Salary 30,000 31,000 32,000 N/A 93,000 PA 4,400(1) 4,580(1) 5,160(2) N/A 14,140 RRSP contribution room(3) 1,000 1,000 600 2,600
Member A Member B Member C Date of birth January 1, 1967 Janaury 1, 1957 January 1, 1947 Transfer value factor 1.20 2.15 3.85 Transfer value $ 2,230 $ 4,000 $7,160 PAR (4) $11,910 $10,140 $6,980
We suppose that the member is entitled to a deferred pension and that he/she chooses to transfer the present value of this pension to another registered retirement vehicle.
If the employer would not have sponsored an RPP, the member would have earned acumulative RRSP contribution room of 18% of the total salaries, $16,740.
As mentioned before, the PAR will restore that RRSP contribution room of $16,740 for the member who leaves his/her job. In the case of member A, for example, since he was participating in an RPP, the retirement savings allowed is $4,830:
The transfer value of $2,230 is determined by using a factor of 1.2 as opposed to 9.
The PAR creates the additional RRSP room to take into account the fact that a factor of less than 9 was used when the transfer value to be transferred outside the plan was calculated. Therefore, the PAR will be equal to $11,910 determined as follows:
This PAR, added to the $4,830, re-establishes the $16,740 RRSP room which the member would have been entitled to, if he had not participated in an RPP.
Since the PAR is reintroduced, the rules concerning PSPAs will be modified to ensure that the PAR created when a member ceased to be entitled to a benefit, will be void if the period of employment during which the right to a benefit was earned later becomes pensionable service under any other RPP. Furthermore, a special PSPA anti-avoidance rule will limit the reinstatement of RPP benefits covered by the PAR.
PAR will be equal to the total of all PAs reported since 1990 but for which pension credits are not vested in the member.
Let us assume that a defined contribution RPP requires the employer to contribute 5% of the salary and the member 3%. The assumptions used are described in the table below
Date Of Entry in the plan January 2, 1996 Date of termintation of employment January 1, 1998
1996 1997 1998 Total $ $ $ $
Salary 31,000 32,000 N/A 63,000 Employee Contributions 930 960 N/A 1,890 PA(1) 2,480 2,560 N/A 5,040 RSP Room(2) 3,100 3,200 6,300 PAR(3) 3,150
We suppose that the member is not entitled to the employer's portion. Therefore, he/she is only entitled to his/her contributions, amounting to $1,890 plus the investment income. The PAR, equal to $3,150, will be added to the unused RRSP contribution room for the year 1998.
If the employer had not sponsored an RPP, the member would have had a cumulative RRSP contribution room equal to 18% of the sum of his/her salaries, $11,340.
The PAR has the effect of restoring this contribution room for the member who leaves his/her employment. In our example, the member has already invested in terms of savings for the retirement $8,190:
The PAR creates the additional RRSP room to take into account the fact that the member has not earned the right to transfer the employer portion. Therefore, the PAR will be equal to $3,150:
This PAR, added to the $8,190, re-establishes the cumulative RRSP contribution room of $11,340 which the member would have been entitled to, if he had not participated in an RPP
Parents who wish to save in order to be able to finance the post-secondary education costs of their children have the option to pay contributions to a registered education savings plan (RESP).
In addition to the fact that the annual contribution limit to an RESP will be doubled to $4,000, it has been announcedthat parents will be entitled to transfer unused RESP investment income to their RRSP if their children do not pursue post secondary education and if parents have unused RRSP contribution room. The total amount of RESP investment income that can be transferred by an individual to an RRSP is limited to $40,000.
A parent will also be entitled to directly receive the RESP investment income if he/she does not have any unused RRSP contribution room or if he/she does not wish to make a transfer of the RESP investment income to his/her RRSP. This unused RESP investment income will be added to his/her income of the year and will be subject to supplementary tax of 20%.
The federal government has confirmed thatthe CPP will be subject to a package of reforms. However, some features of CPP will apparently remain unchanged (e.g., all retired pensioners or anyone over age 65 as at December 31, 1997 will not be affected; ages of retirement - early, normal or postponed - will remain unchanged).
The federal government has announced that it will table legislative measures at the House of Commons in order to put in concrete form, the project announced in the1996 federal budget in order for the Old Age Security and the Guaranteed Income Supplement to be consolidated into one benefit, which is the Seniors Benefit. This measure is expected to come into force in 2001.
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