Tax assistance for pensions and RRSPs Hubert Frenken Tax assistance by barto


									Tax assistance for
                                                                                                   Tax assistance for pensions and RRSPs

pensions and RRSPs
Hubert Frenken

T   he tax treatment of retirement
    savings changed dramatically
in 1991. “[T]o provide fairer and
                                                      plans (DPSPs) and registered retire-
                                                      ment savings plans (RRSPs).
                                                                                                  one for those who did not. How-
                                                                                                  ever, it was thought to have
                                                                                                  “serious inequities ... [leaving]
                                                         The previous legislation, while
more flexible limits on tax assist-                                                               taxpayers at the same income level
                                                      stipulating limits on the savings
ance” (Department of Finance,                                                                     with quite different opportunities
                                                      that workers could accumulate in
1988), new legislation sought to                                                                  to save for retirement” (Department
                                                      RPPs, DPSPs and RRSPs, made lit-
provide uniform, comprehensive                                                                    of Finance, 1989a) because widely
                                                      tle attempt to harmonize the tax
limits on savings in all tax-assisted,                                                            varying benefit levels generated by
                                                      treatment of these plans. It did im-
non-government retirement pro-                                                                    RRSPs, DPSPs and different types
                                                      pose two ceilings for annual RRSP
grams (Figure): employer-spon-                                                                    of RPPs were largely ignored.
                                                      contributions: one for persons who
sored registered pension plans
                                                      participated in an RPP or DPSP and
(RPPs), deferred profit sharing

  Tax-assisted retirement savings programs in Canada

                                                       plans *

                RRSPs                  DPSPs                                             RPPs

       Individual       Group                          contri-                                                           Other **

                                                                                             Career and

                                                                                   Not         Step-rate      Offset
            Requires pension adjustment calculation                            integrated     integrated    integrated
                                                                              with C/QPP     with C/QPP    with C/QPP

  * See Data source and definitions.
  ** Combination of defined contribution and defined benefit plans, and other hybrid arrangements.

Hubert Frenken is with the Labour and Household Surveys Analysis Division. He can be reached at (613) 951-7569.

Statistics Canada - Catalogue 75-001E                                                                      Winter 1995 PERSPECTIVES / 9
Tax assistance for pensions and RRSPs

 Data source and definitions
 The Revenue Canada RRSP room file           sequent year. It is calculated differently   income and paid out at the employ-
 provides data on all taxfilers with         for each type of RPP and for DPSPs. In       ee’s death, retirement or termination.5
 1991, 1992 and/or 1993 tax returns.         the companion article, “Who's saving
 The 1993 data are preliminary and           for retirement?” it is used as a proxy for   Registered pension plans (RPPs)
 exclude returns not yet submitted or        pension savings.1                            provide retirement pensions (and
 processed when the file was produced                                                     often disability and death benefits).
 (approximately 1% of all returns).          Past service pension adjustment              They specify an age of eligibility for
                                             (PSPA) measures pension credits              retirement pensions, including condi-
    A 2% sample file was used. Com-          accrued through the “buyback” of pen-        tions for early retirement. There are
 parisons of selected tabulations with       sionable service or by retroactive           two types: defined contribution and
 the entire file indicate similar results.   improvements in pension benefits for         defined benefit. The former specifies
                                             any period since January 1990. It also       an employer contribution rate and (if
    Annual data on each taxfiler             reduces RRSP room. 2                         required) employee contributions, but
 include total income, earned income,                                                     not the benefit formula. The latter
 pension adjustment, past service pen-       RRSP room is the deduction limit or          defines the amount of benefit the
 sion adjustment, RRSP room, and             maximum RRSP contribution amount             retiring member will receive, but usu-
 RRSP and employee RPP contri-               the taxfiler can claim in any year. It is    ally not the employer contributions.
 butions, as well as age, sex and            calculated by Revenue Canada based on        The employer contributes as needed
 province or territory of residence.         earned income, PA, PSPA and unused           to ensure that funds meet expected
                                             room carried forward.3                       pensions. 6 (A small number of RPPs
    These data, in conformity with the
 provisions of the Statistics Act, are       Registered retirement savings plans          have combination or hybrid formu-
 available only at the aggregate level       (RRSPs) are personal savings plans for       las.)
 in order to ensure confidentiality. This    which contributions are tax-deductible           Defined benefit formulas vary
 limitation notwithstanding, a wide          within certain limits and investment         considerably. They may be flat ben-
 variety of statistics is available on a     income is tax-exempt. Only benefits          efits, paying a fixed monthly pension
 cost-recovery basis through Karen           paid or withdrawals made from these          not related to earnings; career earn-
 Maser, Chief, Pensions Section,             plans are taxable. RRSPs can be indi-        ings, providing a percentage of aver-
 Labour Division, Statistics Canada at       vidual or group arrangements. Under          age earnings from all years of plan
 (613) 951-4033.                             group RRSPs, a single trust or contract      participation; or final earnings, grant-
                                             is established on behalf of employees        ing a percentage of the members’
 Earned income is the income quali-          or for members of a professional or
 fying for RRSP purposes: net income                                                      earnings during a specified period just
                                             trade association and contributions are      before retirement.
 from employment (both paid work             pooled. Individual RRSP contracts must
 and self-employment), rental prop-          be registered for each participant, how-        Most members of career and final
 erty, alimony and maintenance               ever, and separate accounts must be          earnings plans have a benefit formula
 arrangements and certain disability or      kept.4                                       that takes into consideration pensions
 loss-of-income plans, less some                                                          paid under the Canada and Quebec
 employment expenses such as union           Deferred profit sharing plans (DPSPs)        Pension Plan (C/QPP integration).
 dues and alimony and maintenance            permit employees to share in company
 payments.                                   profits. Employer contributions, either         For more information on the vari-
                                             a percentage of profits or a fixed dollar    ous plans, on C/QPP integration and
 Pension adjustment (PA) is a meas-          amount, are set aside in a fund. A sepa-     on the different rates of accrual of re-
 ure of pension credits earned during        rate account is maintained for each          tirement savings, consult Frenken
 the year under an RPP or a DPSP,            member, credited with investment             (1995a).
 which reduces RRSP room in the sub-

   This article shows how current            concepts common to all three, see            three-year period. Previously, par-
tax-assistance rules apply to mem-           Data source and definitions.                 ticipation in each program could
bers of different plans, how the lev-                                                     be studied only independently, and
els of tax-assisted savings can vary         New analytic tool                            for just one year at a time. RRSP
widely and how these savings are                                                          analysis was limited to defining the
integrated. It also notes the number         The RRSP room file contains 1991-            characteristics of taxfilers most
of persons falling into the various          to-1993 personal income tax infor-           likely to contribute in a given year.
tax-assistance categories. Along             mation that makes it possible, for           This file, however, permits the de-
with the next two articles in this           the first time, to analyze the extent        scription of those who maximize
issue it uses data from the new              to which individuals have been               their RRSP opportunities on a regu-
Revenue Canada RRSP room file.               saving for their retirement through          lar basis, those who contribute
For definitions of terms and                 each of the programs, and which              intermittently and those who never
                                             combinations were used over a                participate.

10 / Winter 1995 PERSPECTIVES                                                                 Statistics Canada - Catalogue 75-001E
                                                                                            Tax assistance for pensions and RRSPs

                                                                                            are significant, because aggregate
 Table 1                                                                                    unused room has been growing at a
 Current schedule of dollar deduction limits for RPPs, DPSPs and                            dramatic rate (see “RRSPs – unused
 RRSPs                                                                                      opportunities” in this issue).
                            RPPs                   DPSPs                   RRSPs
                                                                                            Pension savings
                                                                                            The PA calculation, striving for
 1995                      15,500                    7,750                  14,500
 1996                      13,500                    6,750                  13,500          fairness and seeking to reflect con-
 1997                      14,500                    7,250                  13,500          tributions, varies from plan to plan.
 1998                      15,500                    7,750                  14,500          For members of a DPSP or defined
 1999                     indexed *                indexed *                15,500
 2000                     indexed *                indexed *               indexed *        contribution RPP, the PA consists
                                                                                            of total employer and employee
 Source: Finance Canada                                                                     contributions during the year. For
 * Limits are indexed to changes in average wages and salaries.
                                                                                            example, a worker earning $40,000
                                                                                            per year and participating in a typi-
   The file will be augmented annu-          schedule was changed in the 1992               cal defined contribution RPP, re-
ally, providing a longitudinal data-         and 1995 budgets and is currently              quiring contributions of 5% of
base. As more data are added, it will        projected to reach $15,500 by 1998             earnings by both employee and
be possible, for example, to evalu-          for RPPs and 1999 for RRSPs                    employer, would have a PA of
ate any effect the recession of the          (Table 1).10                                   $4,000. A DPSP member whose
early 1990s may have had on RRSP                                                            employer contributed $2,000 into a
participation and contribution               Greater flexibility                            profit sharing fund would have a
levels.                                      Taxfilers who do not use their an-             PA of $2,000.
                                             nual RRSP room no longer forfeit                  For defined benefit RPP mem-
New deduction limits                         the opportunity: since 1991, un-               bers, employer contributions can-
                                             used room may simply be carried                not be quantified as easily. They
The 1991 legislation set new ceil-           forward. This provision would per-             may fluctuate from year to year,
ings for annual savings in RPPs,             mit, for example, a taxfiler with              depending on the financial posi-
DPSPs and RRSPs.7 RPP/DPSP sav-              RRSP room of $10,000 but able to               tion of the plan. (In fact, in a spe-
ings are limited to specific dollar          contribute only $2,000, to have the            cific year the employer may have
amounts (DPSPs at one-half that of           remaining $8,000 added to the                  been excused from contributing al-
RPPs), while RRSP contribution               room available for the next year.              together, because of a surplus in
ceilings are either a dollar amount          The implications of this provision
or 18% of earned income, which-
ever is lower.8 The RRSP deduction
limit still depends on the taxfiler’s         Table 2
participation in an RPP or DPSP the           Membership* in RRSPs, DPSPs and different types of RPPs, 1993
previous year. For these partici-
pants the RRSP room is reduced by                                                                                      Members
the pension adjustment (PA), a cal-                                                                                         ’000
culated value of the annual pension
credits provided by the RPP or                RRSPs                                                                        5,110
DPSP.                                         DPSPs                                                                          350 **

                                              RPPs                                                                         5,245
Dollar amounts                                  Defined contribution                                                         460
The annual dollar limit was initially           Flat benefit                                                                 891
                                                Non-integrated career and final earnings                                     434
set at $11,500 (for RPPs in 1990                Step-rate integrated career and final earnings                             2,510
and for RRSPs in 1991 9) and sched-             Offset integrated career and final earnings                                  791
uled to increase each year by                   Other †                                                                      159
$1,000 until reaching $15,500, be-            Sources: RRSP room file, Revenue Canada, and Pension Plans in Canada database
fore being indexed to average                 * See Data source and definitions. Workers may belong to more than one plan during
wages and salaries. A pension from               the year.
contributions at this level over a            ** DPSP membership is estimated, based on data obtained from Revenue Canada,
                                                 Registered Plans Division.
full career was considered compa-             †
                                                 This includes RPPs with different formulas for different categories of members, a
rable to the maximum benefit from                combination of formulas, and other hybrid arrangements.
a defined benefit RPP. The original

Statistics Canada - Catalogue 75-001E                                                             Winter 1995 PERSPECTIVES / 11
Tax assistance for pensions and RRSPs

                                                                                        service, the PA would be $2,240. A
 Some remaining differences                                                             2% non-integrated career or final
 The 1991 legislation made the tax          Other ancillary benefits                    earnings formula would produce a
 treatment of retirement savings much                                                   PA of $6,200.11 For the most part,
 more equitable, although it did not        Many defined benefit RPPs provide           the more generous the promised
 manage to eliminate all situations that    such supplementary benefits as index-       pension, the higher the PA. Never-
 provide advantages for some individ-       ing and survivors’ pensions, not in-
                                            cluded in the calculation of the PAs.14
                                                                                        theless, some inequities still exist
 uals, largely because of the effect of                                                 (see Some remaining differences).
 the PA on RRSP room. Workers with          In 1993, nearly 2.2 million RPP mem-
 the same earned income, the same PA        bers had some form of automatic in-
 and the same remaining RRSP room           dexing of their future retirement           Varied membership
 may still accumulate different levels      pensions, and for almost 700,000 of
                                            these the pensions were to be adjusted      How many taxfilers participate in
 of retirement and supplementary ben-
 efits. Some examples of these situa-       annually to the full increase, if any, in   each type of retirement plan?
 tions follow.                              the consumer price index (CPI). Fur-        While 5.1 million persons contrib-
                                            thermore, 1.7 million workers partici-      uted to RRSPs in 1993, only about
                                            pated in plans that, in addition to their   350,000 participated in a DPSP 17
 Career versus final earnings               normal retirement pensions, provided        and 460,000 belonged to a defined
 Even though pensions based on earn-        survivors’ benefits for their spouses.      contribution RPP (Table 2).
 ings close to retirement are generally
 much higher than those using average       Early termination                              At the same time, over 4.6 mil-
 career earnings, the same pension ad-                                                  lion individuals belonged to de-
 justment calculation is used. (How-        In a highly mobile labour force, many       fined benefit RPPs: nearly 900,000
 ever, some employers with career           workers leave pension plans before          with a flat benefit formula and 3.7
 earnings plans periodically update         retirement, often losing significant        million with a formula based on
 their earnings base. The number of         benefits. With continuous participa-
                                            tion the value of RPP benefits earned
                                                                                        earnings (career or final earnings).
 members affected by these upgrades                                                     For most members with an earn-
 is not known. 12)                          during any membership period con-
                                            tinues to grow to retirement (particu-      ings-based formula, benefits were
                                            larly in a defined benefit RPP). 15         integrated with C/QPP pensions,
 Bridging benefits                          Therefore, these benefits are generally     most frequently using a step-rate
 Many defined benefit RPP beneficiar-       much greater than the compensation          benefit formula (Frenken, 1995a).
 ies are paid a supplementary benefit       provided on early termination,
 from the time of retirement until age      whether they are lump sum returns of        Summary
 65, formerly the earliest age for          contributions or a deferred pension
 C/QPP retirement pensions. 13 This         payable at retirement. The pension          The rules governing tax assistance
 supplement or “bridging benefit” is        adjustments charged against the mem-        for retirement savings changed dra-
 not considered when pension entitle-       ber’s RRSP room during the years of         matically in 1991. The new legisla-
 ments and PAs are determined. Nearly       participation reflected such projected      tion levelled the playing field for
 three-quarters of members of C/QPP         growth in RPP benefits. Yet no re-
                                            placement of RRSP room is provided
                                                                                        workers belonging to different
 integrated plans are able to retire with                                               types of retirement plans by intro-
 an unreduced pension plus a supple-        to compensate for the lower benefits.
                                            The Canadian Institute of Actuaries         ducing a pension adjustment (PA)
 ment before age 65; in most cases the
 member is paid a full benefit without      has estimated that benefits payable on      for members of employer-spon-
 the C/QPP integration until then           termination are often worth less than       sored registered pension plans and
 (Frenken, 1995a). The PA, however,         20% of the RRSP room the worker has         deferred profit sharing plans.
 is based on the benefit payable at age     forgone by participating in a pension
                                            plan (CIA, 1995).16                            PA amounts vary widely, partly
 65, resulting in a relatively lower PA
 and higher RRSP room.
                                                                                        because some types of retirement
                                                                                        plans tend to produce much higher
                                                                                        PAs than others. Although some
the pension fund.) Therefore, the              This calculation, which uses the         provisions that affect benefit
PA is calculated using the follow-          plan’s benefit formula, varies for          levels are not considered in PA
ing formula:                                each type of defined benefit RPP.           calculations (in particular, those
                                            (For information on the role of the         relating to bridging benefits, index-
nine times the pension entitlement,         formula in calculating annual ben-          ing and survivors’ benefits), gener-
less $1,000,                                efit costs see Revenue Canada,              ally the greater the accumulation
where the pension entitlement is a          1993). For a worker earning                 of pension credits, the higher the
calculated value of pension savings         $40,000 with a typical flat benefit         PA and, as a consequence, the
credited to the member during the           of $30 per month for each year of           lower the RRSP contribution oppor-

12 / Winter 1995 PERSPECTIVES                                                              Statistics Canada - Catalogue 75-001E
                                                                                                      Tax assistance for pensions and RRSPs

tunity. Conversely, the sparser the               latory legislation prohibits RPP lump sum           supplementary benefits have not been lifted,
pension savings, the greater the                  payments.) To avoid tax deduction at source,        however.
                                                  members have the option of transferring the
amount of tax assistance available                amounts to an RRSP or other registered plan,        14 Many employers sponsoring RPPs with
through RRSPs.                                    or purchasing an annuity.                           no automatic indexing provide increases in
                                                                                                      retirement benefits on an ad hoc basis. There
   The extent to which taxfilers are              6 Employer contributions to RPPs are not            are no data on how many pensioners receive
taking advantage of these opportu-                available from these data. Three out of ten         such increases each year.
                                                  RPP members either had plans not requiring
nities is analyzed in the next two                personal contributions or elected not to con-       15 These benefits may profit from salary
articles in this issue. The first deals           tribute.                                            increases, plan improvements and benefit
with combined pension and RRSP                                                                        indexing.
savings and the second looks at the               7 The opportunity to contribute to a                16 This issue may be addressed soon, as
use of available RRSP room.                       spousal RRSP and yet claim these contribu-          stated in the 1995 budget: “The government
                                                  tions against the taxfiler’s own deduction          will investigate the possibility of modifying
                                                  limit was continued. The definition of spouse       the RRSP limits ... to restore lost RRSP room
                                                  was expanded in 1993 to include common-             to employees who leave pension plans before
  The authors of this and the follow-             law relationships.                                  retirement” (Department of Finance, 1995).
  ing two articles wish to thank Edwin
                                                  8 The 18% of earnings approximates the              17 There are no complete data on the number
  Williams, Programs Officer, Indi-
                                                  amount required to replace pre-retirement           of workers who participated in DPSPs. This
  vidual Returns and Payments                     earnings for most workers. It corresponds to
  Processing Directorate, Revenue                                                                     estimate is based on limited data obtained
                                                  the maximum benefit obtainable by a member          from Revenue Canada.
  Canada; and Ken Pawulski, Direc-                of a defined benefit RPP with a formula of 2%
  tor, Pension Advice Section, Office             of final earnings for each year of service. After
  of the Superintendent of Financial
  Institutions, for their valuable com-
                                                  the maximum period of contributory service
                                                  (35 years), a member would be entitled to
                                                                                                      n References
  ments and suggestions.                          70% of those earnings, “considered to be            Canadian Institute of Actuaries (CIA). Trou-
                                                  sufficient to avoid serious disruption of liv-      bled Tomorrows – The Report of the Cana-
                                                  ing standards” (Department of Finance,              dian Institute of Actuaries’ Task Force on
                                           o      1989a).                                             Retirement Savings. Ottawa: CIA, 1995.
                                                  9 Current RRSP room is always dependent             Department of Finance. Budget Plan: Includ-
                                                  on the previous year’s earned income, and the       ing Supplementary Information and Notices
                                                  pension adjustment used to reduce each year’s       of Ways and Means Motions. Ottawa, 1995.
n Notes                                           RRSP room is based on the previous year’s
                                                  RPP/DPSP participation.                             ---. Pension Reform: Improvements in Tax
1 The PA is calculated annually by
                                                                                                      Assistance for Retirement Saving. Ottawa,
employers and reported by taxfilers on their
tax returns. Taxfilers with more than one PA      10 Average wages and salaries have                  1989a.
(participation in more than one RPP/DPSP          increased more slowly than expected. The
                                                  earnings limit to which the 18% rate is             ---. Saving for Retirement: A Guide to the Tax
during the year) must report the combined                                                             Legislation and Regulations. Ottawa, 1989b.
amounts.                                          applicable is targeted at 2.5 times average
                                                  wages and salaries, or currently about              ---. Saving for Retirement: A Guide to the Tax
2 PSPAs must be reported by employers to          $75,000. Eighteen percent of $75,000 is             Legislation. Ottawa, 1988.
Revenue Canada as they occur, resulting in        $13,500, the RPP ceiling for 1996 and the
adjustments to the taxfilers’ RRSP room.          RRSP contribution limit for 1996 and 1997.          Frenken, H. “Pension plan potpourri.” Per-
                                                                                                      spectives on Labour and Income (Statistics
3 Taxfilers may also transfer certain types       11 C/QPP benefit integration reduces the            Canada, Catalogue 75-001E) 7, no. 2 (Sum-
of eligible income into RRSPs without incur-      PA. With a step-rated formula of 1.3% of            mer 1995a): 20-27.
ring a tax liability. From 1989 to 1994, as a     earnings up to the year’s maximum pension-
transitional measure, taxfilers could roll over   able earnings, and 2% on the balance of             ---. “RRSPs – unused opportunities.” Per-
up to $6,000 of periodic payments from RPPs       earnings, the PA would be just over $4,000.         spectives on Labour and Income (Statistics
and DPSPs into spousal RRSPs. They may            For an offset formula of 2% of earnings less        Canada, Catalogue 75-001E) 7, no. 4 (Winter
still roll over retiring allowances into their    the full C/QPP pension, the PA would be just        1995b): 20-25.
own RRSPs, up to certain limits.                  under $4,000. The actual reduction would be
                                                  one thirty-fifth of the C/QPP pension times         Frenken, H. and K. Maser. “Employer-spon-
4 Unlike RPPs, group RRSPs do not                 the number of years of service. For further         sored pension plans – who is covered?” Per-
require employer contributions, although          information on C/QPP integration see Frenken        spectives on Labour and Income (Statistics
employers may contribute. These contribu-         (1995a).                                            Canada, Catalogue 75-001E) 4, no. 4 (Winter
tions are treated as employees’ earned income                                                         1992): 27-34.
for income tax purposes, however.                 12 This is one of the reasons for treating
                                                  career earnings and final earnings plans alike.     Maser, K. “Who’s saving for retirement?”
     The number of group RRSPs and their          It also avoids the need for burdensome PSPA         Perspectives on Labour and Income (Statis-
participants, although not known, has been        calculations (see note 2) with each adjust-         tics Canada, Catalogue 75-001E) 7, no. 4
growing rapidly in recent years. Some             ment that might discourage some employers           (Winter 1995): 14-19.
employers have established group RRSPs in         from making changes and improving mem-              Revenue Canada. Employers’ Pension
lieu of RPPs (Frenken and Maser, 1992).           bers’ pensions.                                     Adjustment Calculation Guide. Form
5 Unlike members of RPPs, DPSP partici-           13 Since the mid-1980s C/QPP retirement             T4084(E). Ottawa, 1993.
pants may receive lump sum distributions          pensions have been made available as early
from their plans on retirement. (Pension regu-    as age 60, albeit at a reduced level. The RPP

Statistics Canada - Catalogue 75-001E                                                                        Winter 1995 PERSPECTIVES / 13

To top