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Normandin Beaudry

The retirement savings measures in the federal budget

LinkedIn

There, in black and white

NB Bulletin Vol. 8 N. 3, Febuary 2005

The February 23, 2005 federal budget contains some important changes affecting Canadian retirement savings plans, notably, higher contribution limits and the removal of the foreign property limit. This bulletin outlines these changes and their main impacts on your plans.

Higher contribution limits for retirement savings plans

This change increases the contribution limits for registered retirement savings plans (RRSPs), defined contribution plans (DCs) and deferred profit-sharing plans (DPSPs). As a result of the future increases in the contribution limits, the maximum pension payable under defined benefit plans (DBs) will also increase. The following table illustrates the differences between the old and new limits. 


 Old limitsNew limits
 

YearRRSP
contribution
DC
contribution(1)
Maximum
pension
(DB)
RRSP
contribution
DC
contribution(1)
Maximum
pension
(DB)

2005 $16,500 $18,000 $2,000 $16,500 $18,000 $2,000
2006 $18,000 Indexed(2) Indexed(2) $18,000 $19,000 $2,111
2007 Indexed(2) Indexed(2) Indexed(2) $19,000 $20,000 $2,222
2008 Indexed(2) Indexed(2) Indexed(2) $20,000 $21,000 $2,333
2009 Indexed(2) Indexed(2) Indexed(2) $21,000 $22,000 $2,444
2010 Indexed(2) Indexed(2) Indexed(2) $22,000 Indexed(2) Indexed(2)
2011 Indexed(2) Indexed(2) Indexed(2) Indexed(2) Indexed(2) Indexed(2)

(1) Annual DPSP limit is 50% of the DC limit.
(2) Indexation of the previous year’s limit by the increase in the Average Industrial Wage Index

Impact on capital accumulation plans 

  • For capital accumulation plans like group RRSPs, DPSPs and DCs, the higher contribution limits may potentially increase employee and employer contributions for higher paid members.
  • The higher contributions will also affect the pension expense recognized in the employer’s financial statements.
  • It may be necessary to amend the plan text if the maximum contributions are expressed as fixed dollar amounts and the plan sponsor’s intent is to offer the possibility for members to contribute up to the maximum allowed by the Income Tax Act (ITA). Following the previous increase in limits with respect to the 2003 budget, most plans are now written in such a way as to refer directly to the ITA limits.


Increase in liabilities and current service cost of DB plans
 

  • The increase in the maximum pension limits starting in 2006 will increase the funding liabilities for higher paid members as well as the current service cost of the plan. The impact will be more significant on final earnings plans due to salary projections.
  • The impact on the solvency liabilities will be less than on the funding liabilities and will become apparent gradually with the annual increase in the ITA limit.
  • The impact on plan costs will only be reflected in the next actuarial valuation, including valuations done prior to the budget.
  • DB liabilities and current service cost for accounting purposes will also increase, which means that the employer’s pension expense will rise. The effect of this increase could virtually be cancelled out by a reduction in the costs of a supplemental employee retirement plan (see below).
  • Like capital accumulation plans, most DBs now refer directly to the ITA limits and will not have to be amended. However, if the plan limits contributions to a fixed amount, the impact described above will not apply, unless the sponsor’s intent is to increase the maximum benefit allowed.

Supplemental employee retirement plan (SERP)
 

  • If a 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.
  • On the other hand, as the funded portion of the member’s total benefit increases, the member’s benefit will be better protected, especially on termination of employment.
  • For accounting purposes, the total expense for employers offering SERPs should not be significantly affected. For an unfunded SERP, the total assets on the balance sheet will increase in the future (or the liability will decrease) due to the increase in employer contributions. However, if the SERP is funded, the effect will be minimal.
  • 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 employer’s money. The employer may also receive an additional refundable tax to reflect the reduction in RCA obligations.

As you can see, the changes to the ITA limits improve pension benefits from retirement savings plans for higher paid employees. Therefore the impact of these changes is more significant for an employer with several higher paid employees who are eligible for contributions or benefits exceeding the ITA limits.

Elimination of the foreign property rule for retirement savings plans

The 2005 federal budget completely eliminates the 30% limit on foreign property investments in retirement savings plans, i.e., RRSPs, DPSPs, DCs and DBs, effective immediately.

The removal of this 30% limit will increase investment opportunities for members of capital accumulation plans and for DB pension funds since Canadian markets represent less than 3% of global market capitalization.

Administrators of capital accumulation plans and DBs should re-examine any synthetic foreign investments designed to get around the 30% limit. Where applicable, they should determine if there is a more efficient avenue to maintain or increase their foreign investment exposure, while hoping to reduce the tracking error.

DB plans

Administrators should reassess or reconfirm the investment policy of their DBs since removal of the foreign property limit will lead to better investment opportunities, not just for traditional asset classes but also for alternative classes like hedge funds, which are mainly composed of foreign property.

For plans considering an increase in the foreign content of their investments, greater attention must be paid to managing currency exposure. Although holding investments in foreign currencies has advantages in terms of diversification, greater foreign content increases currency-related risk, which must be taken into account since the underlying pension benefits are paid in Canadian dollars.

Capital accumulation plans

Capital accumulation plan administrators will most likely want to reexamine their investment platforms to determine if an increase in the number of foreign investment options is justified. Good education and proper communication with plan members about the appropriate asset distribution remain vital.

 

Please feel free to contact us for additional information.

514.285.1122
 
630, René-Lévesque Blvd. West, 30th floor
Montreal, Quebec, H3B 1S6