A) The Canadian Pension System
The Canadian Pension System has a fine reputation. Some of the best performing Pension Funds are Canadian.
Like many other western countries, Canada has a three pillar pension system:
- Pillar 1: Governmental Pensions;
- Pillar 2: Workplace Pensions;
- Pillar 3: Private Pensions & Assets.
B) Canadian State Pension
Canada is home to some of the world’s most admired and successful public pension organizations. This was not always the case.
As recently as the mid 1980s, many Canadian public pensions were invested largely or entirely in domestic government bonds, were funded primarily on a pay-as-you go basis, lacked independent governance, and were administered in an outdated and error prone fashion.
Over the past three decades, a “Canadian model” of public pension has emerged that combines independent governance, professional in-house investment management, scale, and extensive geographic and asset-class diversification.
The Canada Pension Plan (CPP) retirement pension is a monthly, taxable benefit that replaces part of your income when you retire. If you qualify, you’ll receive the CPP retirement pension for the rest of your life.
To qualify you have to:
- Be at least 60 years old;
- Have made at least one valid contribution to the CPP.
Valid contributions can be either from work you did in Canada. Or as the result of receiving credits from a former spouse or former common law partner at the end of the relationship.
CPP payments are not automatic. You have to apply. You should apply in advance of when you would like your pension to start. It is their goal to pay your CPP retirement pension in the month of the start date you choose.
4. Contribution Rates and Maximums
The Canada Revenue Agency has published CPP contribution rates and maximums for 2020:
- The pensionable earnings maximum is increased to CAD 58,700, while the basic exemption amount remains CAD 3,500, resulting in maximum contributory earnings of CAD 55,200;
- The employee and employer contribution rates are increased from 5.10% to 5.25% (10.50% for self-employed);
- The maximum annual employee and employer contributions are increased to CAD 2,898.00 and the maximum annual self employed contribution is increased to CAD 5,796.00.
5. Pension Amounts
The amount you receive each month is based on:
- Your average earnings throughout your working life;
- Your contributions to the CPP;
- The age you decide to start your CPP retirement pension.
Your contributions to the CPP are based on your earnings. Everyone is entitled to CPP regardless of how many years they have worked. Thus there is no required minimum period.
The standard age to start the pension is 65. However, you can start receiving it as early as age 60 or as late as age 70.
If you start receiving your pension earlier/later, the monthly amount you’ll receive will be smaller/larger. There’s no benefit to wait after age 70 to start receiving the pension. The maximum monthly amount you can receive is reached when you turn age 70.
For 2020, the maximum monthly amount you could receive as a new recipient starting the pension at age 65 is CAD 1,154.58. The average monthly amount is CAD 679.16. Your situation will determine how much you’ll receive up to the maximum.
6. Additional Benefits
In addition to the CPP retirement pension, you may also quality for other CPP benefits listed below.
Like the CPP retirement pension, you need to apply for these benefits (except for the Post-retirement benefit if you already receive the CPP retirement pension):
- Post-retirement benefit;
- Disability pension;
- Post-retirement disability benefit;
- Survivor's pension;
- Children's benefit;
- Death benefit.
7. CPP Enhancement
Starting in 2019, the CPP will gradually increase due to the CPP enhancement.
The enhancement works as a top-up to the base, or original CPP, and will mean higher benefits in retirement in exchange for making higher CPP contributions.
The CPP enhancement will only affect you if you work and make contributions to the CPP as of January 1, 2019.
The CPP enhancement will increase the:
- CPP retirement pension;
- Post-retirement benefit;
- Disability pension;
- Survivor’s pension you could receive.
There’s no change to qualifying for CPP benefits.
C) Canadian Occupational Pension
In addition to the Canada Pension Plan, some Canadians have an employer-sponsored pension plan as part of the package as offered by the company.
These plans can be a great help in saving for retirement:
- They help you save money regularly from your pay;
- Your employer contributes all or some of the money into your plan;
- You won't have to pay taxes on the money your investments make in these plans until you retire and use the money.
If your employer offers a pension or retirement savings plan, look into joining. It can be a fine way to get started on saving for retirement.
1. Nature Of Plans
Pension plans are generally one of two types:
- Defined Contribution (DC) plan;
- Defined Benefit (DB) plan.
2. Defined Contribution Pensions
A Defined Contribution (DC) pension plan establishes a set amount that you and your company will contribute to your plan each year. The amount is based on how much you make.
Defined contribution plans don't guarantee what you will get when you retire; that depends on how well the plan is managed. You can work with a financial professional or a pension advisor to determine how much you will likely receive each year.
Defined contribution plans require that you collapse the plan by the end of the year you turn 71. At that point, you can withdraw the funds and pay tax on the income, transfer the assets to a registered retirement income fund (RRIF) or purchase an annuity.
3. Defined Benefit Pensions
A Defined Benefit (DB) pension plan promises to pay you a set income when you retire. A formula determines how much you will get. It is often based on your income when you were working and the number of years you have worked.
D) Canadian Popular Occupational Pension Plans
1. Single Employer Pension Plan (SEPP)
A Single Employer Pension Plan is one in which a single employer, or several related employers within a corporate group, participate and contribute to the same Pension Plan.
A SEPP can be provided to all employees or just to certain classes of employees. For example to all unionized employees.
It is usually governed and administered by the Plan Sponsor/Employer without input from Plan Members/Employees.
Contributions to SEPP’s are always made by the employer. However, some SEPP’s are Contributory Plans as plan members are also required to contribute to the plan.
Types of Benefits
A SEPP can be a guaranteed Defined Benefit (DB) Plan or an investment based Defined Contribution (DC) Plan or a combination of both types of plans.
If the SEPP provides Defined Benefits, your benefits are calculated using a fixed formula that is included in your plan's Employee Booklet. These benefits usually cannot be reduced once they are earned.
However, any kind of pension plan can be amended to change the pension benefits plan members earn in the future, or for a Defined Contribution Plan, the contributions members are required to make in the future.
The employer is required to make contributions to the plan, which provides your pension benefits and must cover any shortages if the plan does not have enough money to pay your benefits.
SEPP & PBGF
If the SEPP provides Defined Benefits and is covered by the Pension Benefits Guarantee Fund (PBGF), it is required to pay annual premiums to the PBGF.
The PBGF guarantees payment of Defined Benefits up to a maximum of $1,500 per month, if a plan is wound up, because the employer is insolvent and does not have enough money to pay the benefits it owes to plan members.
2. Multi-Employer Pension Plan (MEPP)
A Multi Employer Pension Plan (MEPP) is one in which two or more unrelated employers participate and contribute to the same pension plan.
It can be a guaranteed Defined Benefit (DB) or investment based Defined Contribution (DC) plan or a combination of both types of plans.
It can be a collectively bargained plan or a non-negotiated plan.
A Defined Benefit MEPP recognizes your years of membership in the MEPP when your pension benefits are calculated. Some MEPP’s may also recognize your years of employment with other employers that are part of the MEPP when your pension benefits are determined.
MEPP’s are usually established in unionized industries by a Union's Collective Agreement. However, some MEPP’s may be established by laws or other agreements.
If you work in such a unionized industry, your Collective Agreement will dictate the level of your employer's contributions to the MEPP. The level of pension benefits that are provided to plan members are established by the Board of Trustees that administers the MEPP.
If your MEPP provides Defined Benefits and your employer's contributions are not enough to cover the pension benefits, your benefits may be reduced. In these types of pension plans, benefits are only a target, as they are not fixed and may be reduced. As a result, these types of benefits are sometimes referred to as ‘target benefits’.
If MEPP’s are established by a collective or trust agreement, they are required to be administered by a Board of Trustees. (Unlike SEPP’s that are usually administered by the employer.)
At least half of the Board of Trustees must be representatives of the MEPP’s members/employees.
If a Defined Benefit MEPP is established under a collective bargaining or trust agreement and does not have enough capital to cover the benefits that would otherwise need to be paid to plan members, it may:
- Reduce the benefits that you earned before the date of the amendment; and
- Be required to change the pension benefits that you have already earned or are currently being paid.
SEPP & PBGF
MEPP’s are not covered by the Pension Benefits Guarantee Fund.
3. Jointly Sponsored Pension Plan (JSPP)
A Jointly Sponsored Pension Plan is a special type of pension plan in which decision making and contributions are shared by both Plan Members & Employer(s).
A JSPP provides Defined Benefits to plan members and contributions are always made by both Plan Members and their Employers (A contributory plan).
If a JSPP becomes underfunded, both Plan Members and the Employer are jointly responsible for making any required additional contributions to deal with the shortage of funds. No reduction in earned pension benefits is permitted, unless the plan is wound up.
Decision making for a JSPP is jointly shared by both the Employer(s) and Plan Members. This includes all decisions about the terms and conditions of the plan, any amendments to the plan and the appointment of the plan administrator.
JSPP & PBGF
JSPP’s are not covered by the Pension Benefits Guarantee Fund.
E) Canadian Occupational Pension Plan Participation
Membership in an occupational pension plan can be mandatory (required as a condition of your employment) or voluntary.
If membership is mandatory, you have to join the plan when you become eligible.
If membership is voluntary and if you might decide not to join once you become eligible, you still have the right to join the plan at a later date.
An employer may establish a pension plan for all of its employees or only for one or more classes of employees. A class of employees is normally defined by the nature and terms of employment. For example, a class of employees could consist of:
- Salaried employees/hourly employees;
- (Non) unionized employees;
- Employees who work at a specific location or division.
Once a pension plan is established for a certain class of employees, every employee in that class is eligible to join that pension plan.
A class can also consist of only a few individuals. Thus a class might for example include only managers of a company.
If an employer wants to provide pension benefits to a particular person, it can also establish a separate single member plan called Individual Pension Plan (IPP).
Employers can establish separate pension plans for full-time and part-time employees. However, the pension plan that is established for part-time employees must provide benefits that are reasonably equivalent to those provided for full-time employees of the same class.
If there is no separate pension plan for part-time employees, they cannot be distinguished as a separate class of employees from full-time employees.
F) Canadian Occupational Executive Pension Plans
Canada allows Executive Only Pension Plans and thus does not forbid discrimination in favour of highly compensated employees like executives.
For example registered pension plans for executives are permitted as long as the class is carefully defined. In addition many employers sponsor plans (Supplemental Executive Retirement Plans/Retirement Compensation Arrangements) provide benefits in excess of the Canadian Income Tax Act maximum.
These plans are contractual in nature and are not regulated under minimum standards legislation if they are correctly drafted. Thus employers can define their own vesting and other rules.
Finally regarding the mentioned class definition: It is possible to establish a pension plan for specific classes of employees. If the plan is below the maximum tax deductible limit provided in the Income Tax Act, it must comply with the same requirements as any registered pension plan. The class of employees must be a bona fide class and defined in such a manner that the eligible members are determinable on the basis of objective criteria.
Executive pension plans such as SERP’s and RCA’s, which are limited to contributions and benefits beyond the maximum limits provided in the Income Tax Act, are not subject to the same benefit and funding regulations imposed on broad-based private pension plans.
G) Canadian Occupational Pension: End Of Participation
Many employees switch companies several times which means that they also often leave an occupational pension plan as active participant.
Whether your employer offers a guaranteed DB plan or an investment based DC plan, if you leave that organization before retirement age, you may have five options regarding the funds/claims that you have accumulated in your pension:
- Transfer the savings to your new employer’s plan;
- Leave your pension savings in your employer’s plan;
- Buy an annuity to get monthly income for life;
- Transfer the money to a special retirement income fund;
- Cash out some or all of your money.
Regarding the choice you make, please always take tax and investment risk implications into account.
H) Canadian Occupational Pension Pay-Out
Once your pension benefits are vested, they are usually "locked-in." Which means that the pension money payable to you is to be used only for the purpose of providing you with a lifetime retirement income.
Thus once your pension benefits are locked-in, you normally cannot take any money out of the pension plan as a cash payment.
There are two advantages to having your pension benefits locked-in:
- You will have a regular income at retirement.
- Creditors cannot seize locked-in pension money.
If you leave the plan before you retire, you may be able to transfer the value of your pension benefit out of your plan. For example to a Locked-in Retirement Account (LIRA) or a Life Income Fund (LIF) or to another pension plan (if that plan allows it) or to buy a life annuity from an insurance company. But nevertheless the money remains locked-in.
There are some exceptions to the locking-in rule. For example, you may be able to access the money in your pension plan before retirement if:
- You have a medical condition that is expected to considerably shorten your life.
- Your employment ends and the annual benefit payable to you is small.
The locking-in rules do not normally apply to any Additional Voluntary Contributions (AVC) which you may have made into your occupational pension plan.
A participant to an occupational pension plan has two options:
1] Lifelong monthly old age pension which provides a steady income.
2] Lump Sum capital pay-out.
A Lump Sum payment might seem attractive but it can have negative aspects:
- High tax rates which increase tax exposure if you take the value of your pension as a single sum in one year and that amount exceeds what you can transfer to tax sheltered accounts. Then often 60% of the Lump Sum value is taxable income.
- After the payment the claim has ended and certain otherwise possibly existing claims like for example health insurance will also end directly.
- Once you have opted for the Lump Sum, you cannot change your decision.
- The Lump Sum is often not fully available as cash. Legislation can result in a significant percentage of it being locked in, allowing you to withdraw only a small percentage from the locked-in portion in a year. (Sometimes only 6%.)
A Lump Sum is (more) understandable if:
- There are justified doubts whether the pension plan will meet its future pay-out obligations.
- You are in bad health and expect not to live that long.
I) Canadian Occupational Pension Early Pay-Out
The standard retirement age in Canada is 65. However, the age upon which entitlement to full benefits arises varies by private pension plan.
Most jurisdictions in Canada require that a pension plan permit a participant to demand benefits at age 55, subject to an actuarial reduction. Which can quickly have a very substantial effect making such a move often not realistic.
For sake of completeness it be mentioned that plans are not permitted to allow distributions or loans of all or some of the plan benefits to members that are still employed.
J) Canadian Occupational Pension Working Abroad
Employees working outside of Canada are generally entitled to remain in their Canadian pension plan for up to five years. This entitlement is governed by the Income Tax Act.
In case this applies to you, please seek specialist advice.
K) Canadian Occupational Pension DB Funding Rules
While precise requirements vary slightly by jurisdiction, all guaranteed Defined Benefit (DB) pension plans have to file regular actuarial reports to the appropriate regulator. Pension plans are required to be 100% funded on both a solvency and going-concern basis.
If a DB Pension Plan is found to be underfunded, it must comply with heightened reporting obligations and meet various targets in resolving the funding deficiency.
While funding standards differ between jurisdictions, pension plans typically have between 5 to 10 years to resolve a solvency deficiency and 15 years to resolve a going-concern shortfall.
JSPP’s and MEPP’s are exempt from the solvency funding rules if they meet certain requirements.
L) Canadian Pension Benefit Guarantee Fund (PBGF)
If your employer might become insolvent/bankrupt, there might not be enough capital in the Pension Fund to pay-out your guaranteed Defined Benefit Pension Claim.
The Pension Benefits Guarantee Fund is created by the Government of (only) Ontario in order to provide pension benefits coverage in the event of a funding shortage for privately sponsored single-employer Defined Benefit Plans which are wound up. This subject to specific maximums and exclusions.
The PBGF is funded by yearly contributions from employers who sponsor Defined Benefit Pension Plans and qualify for this coverage. In 2018, the maximum benefit the PBGF provided was $1,500/month.
The PBGF Assessment Certificate is an online Superintendent approved form which sets out the calculation of the PBGF assessment. It is filed electronically through the Pension Services Portal, by the PBGF assessment date, which is nine months after the fiscal year end of the pension plan. If a plan is winding up, a final PBGF Assessment Certificate must be filed within 6 months after the effective date of the wind up.
The PBGF Assessment Certificate should be completed by an authorized representative of the administrator of the pension plan (who is authorized on the Pension Services Portal). It does not need to be an employee of the administrator (for example, it could be the plan’s actuary). Note that the authorized representative is subject to the same fiduciary standards as the administrator.
The plan’s actuary must complete Part 5 of the PBGF Assessment Certificate (the actuary’s certification), after Part 2 is completed. The actuary must have authorized access through the Pension Services Portal.
For more information: https://www.fsco.gov.on.ca/en/pensions/pbgf/Pages/default.aspx
M) Canadian Personal Pensions
1. RRSP: For Extra Tax Benefits
A Registered Retirement Savings Plan (RRSP) allows savings for retirement to grow tax free in a special plan registered with the Canadian government.
RRSP’s are a key part of retirement planning due to the tax advantages they offer. But you need to know the rules to get the most mileage out of RRSP’s and avoid tax penalties.
The total amount you can contribute to your RRSP each year is made up of your contribution limit for the current year plus any "carry-forward" contribution room from previous years.
Your RRSP contribution limit for 2019 is 18% of earned income you reported on your tax return in the previous year, up to a maximum of CAD 26,500. For 2020, the dollar limit is CAD 27,230. If you have a company pension plan, your RRSP contribution limit is reduced.
If you don't make the maximum allowable RRSP contribution in any given year, Canada Revenue Agency (CRA) lets you carry forward the unused contribution room indefinitely and add this to the amount you can contribute for future years.
Both your annual contribution limit and any carry-forward contribution room are shown on your notice of assessment.
Do you have an employer-sponsored pension plan? If so, your RRSP contribution limit is reduced by the pension adjustment. The pension adjustment is calculated by your employer and reported to the CRA on your T4 each year.
If you're a member of a Defined Contribution registered pension plan (RPP) or defined profit sharing plan (DPSP), your pension adjustment is the total contributions to the plan made by you and your employer.
If your RPP is Defined Benefit, your pension adjustment is determined by a formula designed to reflect the pension benefit entitlement you earned in the year.
2. IPP: For Extra Tax Benefits
If you’ve reached your RRSP contribution limit and you fit all criteria, an Individual Pension Plan (IPP) is another way to save for retirement with tax benefits.
If you are a business owner or executive looking for an alternative to your RRSP to save for your retirement while saving on your tax bill, then an IPP may be interesting.
An IPP is a registered Defined Benefit (DB) pension plan for just one member. It can let you build your retirement income under a tax-sheltering umbrella and get the maximum pension that Canadian tax law allows.
If you’re a business owner or an executive, an IPP can create additional contribution room over and above an RRSP once you reach a certain age.
If you own your business, an IPP can save even more tax, because the IPP contributions your business makes, plus any administrative costs, are tax-deductible.
To start an IPP and become a plan sponsor, your company needs to be incorporated. To be an IPP plan member, you need to be an employee or a shareholder of the sponsoring company and earn “T4 income”. (Wages that’s reported on your annual T4 statement.)
An IPP can create a significant tax-planning opportunity for you and your business, both when you first start funding the plan and when you retire, through tax deductible lump-sum contributions known as “past-service funding” and “terminal funding,”.
In the first year of your plan, depending on your specific circumstances, your business may be able to contribute a large tax deductible lump sum to account for net “past services” that have accumulated with your business.
This means that an IPP can still be a powerful solution up to age 71 as the history of your T4 income with your sponsoring company affects the assessed value of your initial contributions. When you’re approaching retirement, depending on your situation, you may be able to top up your IPP through terminal funding.
These options let you use creative tax planning to enhance your retirement. Please take into account that RRSP planning is limited once an IPP is established. Contributions to an IPP will create a pension adjustment that will decrease (and likely eliminate) new RRSP contribution room. Also note that you need to make a non-taxable transfer from your RRSP account for a portion of the past-service funding.
Who is an IPP for?
To find out whether an IPP would be right for you and then to set one up, you’ll need to work with your financial advisor.
An IPP could be interesting if:
- You’re 45 or older;
- You don’t belong to another pension plan;
- You’ve been with your employer or owned your business for 10 or more years;
- The earnings on your T4 are CAD 75,000 or more.
What happens to your IPP once you retire?
When you retire or leave your employer, you have several options:
- Receive a monthly pension from the plan;
- Buy an annuity from a life insurance company;
- Transfer the value to a life income fund (LIF) or locked-in retirement income fund (LRIF).
The rules for IPP’s are similar to those for RRSPs. You have to start receiving income from your IPP by the end of the year you turn 71. When you die, any remaining value goes to your surviving spouse or to your estate. You could also wind up your plan early and take out the cash value but please seek tax advice upon deciding which route to take.
Finally deciding whether an IPP is right for you and ultimately setting one up requires advice.
N) Canadian Pensions & Tax
Like employment income, most retirement income is taxable. Which includes Canada Pension Plan (CPP), Old Age Security (OAS) and company pension payments.
It also includes income from annuities and registered retirement income funds (RRIFs). It doesn't include withdrawals from your tax-free savings account (TFSA).
2. Tax Free
When you take money from your pension capital, 25% is i.e. tax free. You pay Income Tax on the other 75%. Your tax-free amount doesn't use up any of your Personal Allowance. (The amount of income you don’t have to pay tax on.)
3. Retroactive Lump Sum Payments
If you receive lump sum payments from a superannuation or pension plan, the you can ask the Canada Revenue Agency (CRA) to tax the parts for previous years as if you received them in those years.
4. Tax Payment Procedure
When you retire, you will have to pay tax with any of the following:
- Tax withheld at source: If your main source of income is from a pension, you can have enough tax withheld at source to pay the tax you owe.
- Paying your income tax by instalments: If you receive certain pension payments, you may need to pay your income tax by instalments.
There are several aspects which influence the tax exposure on pension pay-out:
- A Lump Sum or lifelong annuity pay-out.
- As of which age you prefer to start the pay-out.
- To what extent you have the option for tax free pay-out.
- To reduce your tax on pension pay-out, you and your spouse or common-law partner can choose to split your eligible pension or superannuation income.
- In case you live outside of Canada and receive pension pay-out from Canada, how Double Tax Treaties prevent or mitigate double taxation in both residential and source country.
Due to this complexity, it seems advisable to seek professional tax consultancy advice.
O News September 2020
Pension Plan Funding Priority
Plan sponsors in Canada are finding it increasingly difficult to fund defined benefit (DB) pension plans, which rely on employer contributions to provide promised benefits to participants. As the population ages and investment performance slips, additional contributions are needed to adequately fund DB plans, but economic volatility makes finding the extra cash problematic.
As DB plans struggle, attention has shifted to capital accumulation plans. Both sponsors and participants contribute money to capital accumulation plans, which is often then left to the mercy of the markets. Some wonder whether capital accumulation plans will provide adequate retirement income—will participants have enough money to last the rest of their lives?
Federal, provincial and local governments are legislating temporary and permanent funding/solvency relief for DB plans. Governments and industry experts are also analyzing the possibilities of retirement income security for their aging populations.
Are lifetime income distribution options plausible? Should retirement saving be mandatory? Are participants receiving the information and education they need to plan for retirement and make wise investment decisions? These are just some of the issues to watch in the continuing debate.