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Normandin Beaudry

The budget features related to retirement savings

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There, in black and white

NB Bulletin Vol. 6 N. 1, Febuary 2003

The February 18¸ 2003 federal budget proposes modifications to the Canadian retirement system: a new option at retirement for defined contribution plans (DC) as well as increases in the RRSP contribution limit¸ the DC limit and the defined benefit (DB) maximum pension accrual. The following table illustrates the differences between the current and the proposed limits: 


 Current rulesProposed rules
 

YearRRSP LimitDC Limit(1)DB LimitRRSP LimitDC Limit(1)DB Limit

2003 $13,500 $14,500 $1,722.22 $14¸500 $15¸500 $1¸722.22
2004 $14¸500 $15¸500 $1¸722.22 $15¸500 $16¸500 $1¸833.33
2005 $15¸500 Indexed(2) Indexed(2) $16¸500 $18¸000 $2¸000.00
2006
 
Indexed(2) Indexed(2) Indexed(2) $18¸000 Indexed(2) Indexed(2)

(1) The annual limit under deferred profit sharing plans (DPSP) is 50% of the DC limit.
(2) Indexed according to the increase in the Average Industrial Wage Index.

Impact on Group RRSPs and DC Plan

For group RRSPs and DC plans¸ the increase of the contribution limit may potentially raise employer contributions for higher paid members. Increases in contributions will also mean higher pension expense. Amendments to the plan text may be required if maximum contributions are tied to the previous limits set by the Income Tax Act (ITA) and the employer wishes to offer the possibility for members to contribute up to the maximum allowed under the ITA.

New Option at Retirement for DC Plans 

The transfer of the accumulated balance out of a DC plan account at retirement will no longer be required. Starting in 2004¸ a DC plan member will be allowed¸ at retirement¸ to leave his/her accumulated balance in the plan and make partial withdrawals from his/her account. This option is added to the two existing options: the purchase of a lifetime pension with an authorized financial institution and the transfer of the accumulated balance to a life income fund (LIF). Under the new option¸ the withdrawal amounts will be determined based on the same rules as those applicable to a LIF. This will provide an opportunity for retirees to save on investment fees. Moreover¸ it will also be possible to allow a former member of a DC plan to transfer back in the plan the balance of his/her LIF. Consequently¸ the plan text will need to be modified to include these new provisions.

Amendments to DB Plan Texts 

A DB plan providing for future increases in the maximum pension by defining the maximum pension as the maximum allowed under the ITA¸ will not require amendments to its plan text. However¸ a plan which limits its benefits to $1¸722.22 (the previous limit)¸ will need to be amended only if the employer´s objective is to offer from the registered pension plan the maximum benefit allowed under the ITA. If the plan text is not amended¸ there will be no financial impact for the plan. However¸ if the plan text is amended¸ the changes will have an immediate impact on the funding of the plan. The impact of these changes is outlined in detail below.

Unless stated otherwise¸ the following only affects DB plans that will be amended to modify the definition of the maximum pension or those that already define the maximum pension as the maximum allowed under the ITA.

Increase in Liabilities and Current Service Cost 

The increase in benefits will increase going concern liabilities as well as the current service cost of the plan. The effect will be more significant on final average earnings plans due to salary projections. The impact on the solvency liabilities will be less than on the going concern liabilities and will be revealed gradually with the increase in the annual limit. The impact on the plan cost will only be reflected at the next actuarial valuation of the plan.

For a plan that requires an amendment to provide for the maximum pension under the ITA¸ there will be¸ as a minimum¸ a partial actuarial valuation required. Such partial valuation may reveal a solvency deficiency resulting from the drop in the financial markets during the last two years¸ leading to a contribution increase. Consequently¸ the impact is much more significant for a company that has benefited from a contribution holiday before the amendment¸ since it will possibly have to start contributing the current service cost and possibly the amortization payments of the deficits. 

Supplementary Employee Retirement Plan (SERP) 

If an unfunded SERP exists to provide benefits to all employees in excess of the ITA limit¸ the SERP liabilities will decrease proportionally with the increase in the registered plan liabilities. The total liabilities will remain fairly stable but the cash contributions will increase. On the other hand¸ as the funded portion of the total member´s benefits increases¸ the member will have a better protection of his benefits¸ especially on termination of employment. However¸ benefits will now be locked-in.

For a SERP funded through a Retirement Compensation Arrangement (RCA)¸ the liabilities and contributions under the RCA will decrease¸ resulting in a more tax efficient use of the company´s money. Moreover¸ the employer shall receive an additional refundable tax to reflect the reduction in RCA obligations.

Accounting 

The current service cost and the liabilities for accounting purposes will increase and result in an increase in the pension expense.

If there is a SERP in place to cover the benefits exceeding the ITA limit¸ the total pension expense for most employers will not be affected significantly. For an unfunded SERP¸ the total prepaid asset will increase in the future (or the accrued liability will decrease) due to the increase in employer contributions. However¸ if the SERP is funded¸ a limited effect is expected.

Plan Administration

The required contributions for higher paid members are usually determined based on the salary that provides the maximum pension. For such plans¸ an adjustment to the payroll system will be necessary to increase the contributions of the affected members. In some cases¸ a fix dollar limit is applied either to the salary or the required contributions. Such dollar limits may have to be reviewed according to the new ITA limits. Moreover¸ adjustments may be required to the Pension Adjustment (PA) calculations. Similar adjustments may apply for group RRSPs and DC plans.

Most administrative calculations will not be affected before 2004. Only plans which provide for future increases in the maximum pension upon termination of employment or death will need to be adjusted to reflect the new ITA limits.

Furthermore¸ declaration of Past Service Pension Adjustments (PSPAs) will not be required where the increase in the benefits relates only to increase in the ITA limit.

As you may have noticed¸ these changes to the ITA limits improve pension benefits from registered pension plans for higher paid members. The impact of these changes are more significant for an employer with several higher paid members eligible for contributions and benefits exceeding the ITA limits.

 

Please feel free to contact us for additional information.

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