Unit 3

Employer Sponsored Pension Plans

• Defined Contribution RPPs
• Defined Benefit Pension Plans
• Individual Pension Plans
• Profit Sharing Plans
• Distribution Options
• Rules and Regulations
 Defined Contribution RPPs
• Describe the basic nature of a defined contribution pension plan
• Describe how a defined contribution pension plan compares with
other types of registered plans
• Explain how employee contributions are calculated
• Describe how pension benefits at retirement are projected
 Nature of Defined Contribution Pension Plans
• In a defined contribution pension plan, the contributions required
from the employer (and the employee in contributory plans) are
known up-front, but the ultimate pension benefits are not
• At retirement, contributions to the RPP and any accumulated
investment income are used to purchase a life annuity for the
employee
• The value of the pension depends on what can be purchased by the
total accumulation of contributions plus investment income (hence
the alternate name of money purchase plan)
 Defined Contribution plans –
Employer viewpoint Vs. Employee Viewpoint
• Employers prefer defined contribution plans because they know in
advance what their contributions will be.
• Employees may less desire defined contribution plans because no
guarantee of the amount of the pension he or she receives at
retirement.
Defined Contribution plans - Contribution Levels
• Contributions for the employer and the employee in a
contributory plan are typically expressed as a percentage of
salary
• The maximum combined contribution for the employer and
employee is the lesser of:
• 18% of earnings and
• The current money purchase contribution limit
• The Income Tax Act requires the employer to make a
minimum contribution of 1% in these plans
 Defined Contribution plans
• Past Service Contributions:
• Past service benefits can not be provided with defined contribution formula.
• Pensionable earnings and contribution rate:
• The contributions are based upon the pensionable earnings of the employee
and the contribution rate of both the employer and employee.
• Tax Treatment of Defined Contribution Plans
• Tax deductible to the employer and employee.
• Payments received by the recipient are taxed in the hands of recipient.
 Defined Contribution Pension Benefits
• On retirement, the employee can choose to purchase an annuity with
the accrued pension benefits
• The annual pension income is determined by multiplying the accrued
pension benefits by the current annuity rate
• In some cases, the annuity may be indexed for inflation
• Alternatively, the employee can choose to transfer the savings to a
locked-in retirement account
 Defined Benefit Pension Plans
• Describe the basic nature of a defined benefit pension plan
• Explain how employee contributions are calculated
• Describe the actuarial assumptions and methods used to estimate the
contributions required from the employer
• Describe the opportunities for past service contributions
• Describe the tax treatment for contributions made to defined benefit
pension plans
 Defined Benefit Pension Plans
• A defined benefit pension plan defines the pension benefit payable at
retirement based on a formula that relates the value of pension
benefits to earning levels and years of service
• The benefit is defined up-front
• Employee contributions (if required), are usually set as a fixed
percentage of employment earnings
• The employer must contribute sufficient money to ensure the
pensions of plan members are adequately funded
 Types of Defined Benefit Plans
1. Career-average
2. Final and best-earnings
3. Flat-benefit
 Career-average pension plans
• A career-average, defined benefit plan relates the pension benefit
payable at retirement to the average earnings during an employee’s
career and the number of years of credited service
• The employee earns a pension unit during each year of employment
(usually expressed as a percentage of his or her income for that year)
• The pension benefit payable at retirement is the sum of all of the
units accrued while the individual was a member of the pension plan
 Career-average pension plans Example
• Camille works for an employer who offers a career-average, defined-
benefit pension plan, with a 2% unit. Camille earns a constant
$20,000 over the 25 years that she was enrolled in the pension plan.
What is her annual pension entitlement at retirement?
• Solution:
• (unit percentage × pensionable earnings) × years of membership =
(2% × $20,000) × 25 = $10,000
 Career-average pension plans Example
• Frank joined a career-average pension plan with a 1.5% unit just 5
years before retirement. When he first joined the pension plan, he
earned $40,000 per year and his salary increased $5,000 each year
thereafter. What is his pension entitlement per year?
• Solution:
• (average earnings × unit percentage) × years of credited service =
(($40,000 + $45,000 + $50,000 + $55,000 + $60,000) ÷ 5) × 1.5%× 5 =
$3,750
 Final and Best-earnings Pension Plans
• Final and best-earnings plans are also unit-based plans—the ultimate
pension entitlement is based on a unit percentage for every year of
credited service
• In final-earnings plans, the unit percentage is applied to the final 3 to
5 years of service
• In best-earnings plans, the unit percentage is applied to the average
of the best 3 or 5 years of pensionable service: either the final 3 years
of service or an earlier period of service when the employee’s best
earnings were achieved
 Final or Best-earnings Pension Plan - Example
• Trevor is planning to retire at the end of this year. He has been a member of his
employer’s pension plan for the past 30 years. His salary increased each year,
except for this year. His salary over the last 5 years was as follows:
• 4 years ago: $55,000
• 3 years ago: $60,000
• 2 years ago: $60,000
• Last year: $66,000
• This year: $58,000
• What is Trevor’s annual pension entitlement if the plan is based on the best-
earnings over three consecutive years, and a 2% unit. ?
• Solution:
• (average best-earnings × 2%) × 30 years = (($60,000 + $60,000 + $66,000) ÷ 3) × 2% × 30 =
$37,200
 Final or Best-earnings Pension Plan - Example
• What is Trevor’s annual pension entitlement if the plan is based on
the final-earnings over three years, and a 2% unit. ?
• Solution:
• (average final-earnings × unit percentage) × years of credited service =
((($60,000 + $66,000 + $58,000) ÷ 3) × 2%) × 30 =$36,800
 Flat-benefit Pension Plans
• Retiring members of a flat-benefit pension plan receive a flat-rate
benefit, regardless of their earnings
• The full benefit may only be available to those who have achieved a
minimum number of years of service (e.g. 25 years)
• A proportionally reduced pension is available to those with lesser
service
 Flat-benefit Pension Plans - Example
• Emilio's employer provides a flat-rate pension of $500 per month to
retiring employees with at least 25 years of service, and a prorated
pension for employees with less service. Emilio is retiring with 20
years of service. What is his monthly pension entitlement
• Solution:
• (years of service ÷ base years of service) × flat rate = (20 ÷ 25) × $500 = $400
 Flat-benefit Pension Plans - Example
• Nadia's employer provides a flat-rate pension of $12 per month at
retirement for every year of service, and she is retiring after 30 years
of service. What is her monthly pension entitlement?
• Solution:
• years of service × flat rate = 30 × $12 = $360 per month
 Defined Benefit Pension Plans –
Integrated Pension plans
• An integrated pension plan is designed to buildupon the CPP / QPP
• Most integrated plans call for stepped contributions: a lower
contribution rate applies to earnings up to the YMPE; a higher rate
applies to earnings above the YMPE
• Employee Contribution = (Contribution rate on amounts up to years’s
maximum pensionable earnings X YMPE) + (Contribution rate on
amounts above year’s maximum pensionable earnings X (Earnings –
YMPE))
• In some integrated plans, the contributions are stepped but the
ultimate pensions benefits are not. In other plans, both might be
stepped.
 Integrated Pension plans -Example
• Ruel is a member of a contributory best-earnings defined-benefit
plan. Assume Ruel's pensionable earnings are $60,000 and the YMPE
is $52,500. The first contribution rate on amounts up to the YMPE is
7%; the second contribution rate on amounts above the YMPE is
8.5%. How much is Ruel’s required contribution?
• Solution:
• ((the lesser of $60,000 and $52,500) × 7%) + ((the greater of $0 and ($60,000
– $52,500)) × 8.5%) = $4,312.50
 Past Service Contributions
• Some defined benefit plans allow members to make extra
contributions to purchase a pension for services that they provided in
the past.
• Some plans require potential members to achieve a minimum numbers of
years of employment (often 2 years) before they are permitted to join the
plan.
• An employer may establish a new pension plan with pension benefits
accruing from the time the plan is first established.
• An employer may upgrade the benefits provided by the pension plan (for
example, from a 1.5% plan to a 2% plan), with the upgrades applying only to
future benefits.
 Employer Contribution Levels
• By law, the employer must contribute sufficient money to the pension
fund to ensure there will be enough money accumulated to fund
future pension obligations.
• Actuarial evaluations substantiating the required level of
contributions must be carried out every three years.
• An actuary will make a number of actuarial assumptions regarding
possible future trends.
• Mortality
• Interest rates
• Expenses
• Other assumption
 Defined Benefit plan – Maximum Pension Benefit
• The maximum yearly pension payable under a defined benefit plan is
the lesser of:
• A dollar limit of the maximum yearly pension x
• The number of years of pensionable service and
• 2% of earnings per year of service
• The dollar limit of the maximum yearly pension is the greater of:
• $1,722.22 and
• 1/9 of the money purchase limit for the year
 Tax Treatment of Contributions
• Contributions made to the pension plans may be deducted in
calculating the taxable income of the contributor.
• There are limits to the total amount that can be deducted
 Maximum Pension Benefit Example
• Evan belongs to a defined-benefit pension plan based on 2% per year
of service. He currently has pensionable earnings of $145,000 per
year. If the dollar limit of the maximum yearly pension is $2,770,
Evan's maximum benefit entitlement for the current year of service=
the lesser of:
• The year's maximum dollar limit $2770 and
• (pensionable earnings × percentage limit = 145,000 X 2% = 2900
His benefit entitlement is = $2,770
 Maximum Pension Benefit Example
• Kevin belongs to a defined-benefit pension plan based on 1.5% per
year of service. He currently earns a base salary of $100,000 per year.
This year, the legislated dollar limit of the maximum yearly pension
per years of service is $2,770.
• Lessor of:
• 2770 and
• 100,000 X1.5% = $1,500
• His entitlement is = $1,500
 Defined contribution vs. Defined Benefit
Comparisons Defined Benefit Plan
% of registered plans 43.6%
% of RPP members 89.8%
Amount of Pension known in advance
Maximum amount of Pension annual maximum per year of
service
Investment Risk lies with employer
Inflation protection can be built in with higher
contribution levels
Annuity income Yes, an option
Transfer to LIRA Yes, an option
Locked-in Yes, with exceptions
Control member determines how pension
is paid
Defined Contribution Plan
47.0%
8.6%
depends on investment returns
no maximum, depends on
investment returns
lies with employee
no built in protection
Yes, an option
Yes, an option
Yes, with exceptions
member determines how pension
is paid
 Defined Benefit – Early Retirement Age
• Normal retirement for most members age 65
• Police officers and firefighters age 60
• Members may also eligible for an unreduced early retirement pension
provided that they are within 10 years of their NRA and either:
• Their age plus years of qualifying service, referred to as the Qualifying Factor,
is at least 90 for NRA 65, or 85 for NRA 60
or
• They have at least 30 years of qualifying service
• Earliest retirement age = (Age of joining the plan +QF)/2
• QF = Qualifying factor
Defined Benefit – Early Retirement Age Example
• According to her annual pension statement, Janet joined the Kingston
police service 4 years and 9 months (i.e. 4.75 years) ago, when she
was 29 years and 5 months old or 29.4 years of age. What is his
earliest retirement age?
• As a police officer he may retire with an unreduced retirement
pension at normal retirement age of 60. Qualifying factor is =85
• His earliest retirement age = (age of joining the plan + qualifying
factor)/2 = (29.4 + 85) ÷ 2 = 57.2 years
 Individual Pension Plans
• Describe the basic nature of IPPs
• Describe the suitability of IPPs
• Describe the advantages and disadvantages of IPPs
 Individual Pension Plans
• An employer-sponsored, defined benefit RPP established for those
defined under the Income
• Tax Regulations as Specified Individuals:
• significant connected individuals: shareholders owning at least
10% of the issued shares or
• Who do not deal at arm's length with the employer or
• Other highly paid employees: those earning more than 2.5 times
the YMPE
• often referred to as an executive pension plan
 Individual Pension Plans
• IPPs are most advantageous for:
• Owner/managers or executives of incorporated businesses
• Those with a high steady income: 18% of their income should
equal at least the maximum RRSP contribution limit for the year
• Those aged at least in their mid- to late -40s
 IPP – Guidelines with Respect to income and Age
• At minimum, 18% of the T4 employment earnings of a candidate
should amount to the RRSP contribution limit for the year.
• The target group for an IPP is comprised of those over 40 years of
age.
 IPP – Pension Benefits and contribution levels
• Pension benefits:
• It is designed to provide the highest level of pension benefits permissible.
• It is a defined benefit plan and must be based on career-average earnings and
can not be based upon best or final earnings.
• IPP contribution levels:
• Based on an individuals age, T4 employment earnings and actuarial
calculations approved by the CRA.
• 50% rule:
• Most IPPs are non-contributory (they are totally funded by the employer).
• According to 50% where the employee does make a contribution, it must
make up less than 50% of the accrued benefits.
 IPP – Past service Contributions
• Members may be able to make additional contributions to purchase past
service pension credits.
• Connected persons may only make past service contributions for service
prior to 1991 if the employer has provided, or is willing to provide, past
service benefits to non-connected employees that amount to at least 50%
of all of the accrued benefits in all of the RPPs operated by the employer
• Past service contributions can be funded over a maximum period of 15
years provided it is fully funded by retirement.
• In order to take advantage of an individual's past service, a qualifying
transfer must be made from the member's RRSP to the IPP. As a rollover,
there are no tax implications on the transfer.
• Non-connected IPP members may make past service contributions subject
to the conditions for all defined benefit pension plans.
 IPP – Advantages and disadvantages
Advantages Disadvantages
• tax advantages • costly administration
• forced savings • inaccessibility of funds
• protection from creditors • mandatory contributions

• guaranteed level of retirement • no income splitting with spouse or

income common-law partner

• indexing of pension benefits

• reduced payroll taxes

• tailored to individual needs

• estate preservation
 Retirement Compensation Arrangements
• An employer, or possibly an employee, makes tax- deductible
contributions to a custodian
• The custodian is the trustee for the RCA and holds the funds in trust
until paid out to the employee (the beneficiary)
• Funds invested with the custodian are divided equally between:
• RCA Investment Account (controlled by the
• Employer/employee) and
• RCA Refundable Tax Account (held at the CRA)
 Retirement Compensation Arrangements
• 50% of all contributions to the RCA is paid to the CRA as a refundable
tax
• The other 50% in the investment account is invested and grows over
time
• 50% of investment income must be paid to CRA as a refundable tax
• When benefits are eventually paid to the employee, CRA refunds $1
for every $2 of benefits paid
• Essentially, the 50% that was initially taxed is fully refunded to the
plan
Structure of an RCA
 Profit Sharing Plans
• A profit-sharing pension plan is basically a defined contribution plan
• Employer contributions reflect company profits
• Treated just like defined contribution pension plans—generally all
legislative changes that apply to defined contribution plans, apply to
profit sharing pension plans
• Minimum employer contribution: 1% of the combined payroll of plan
members even in years with no profit
 Profit Sharing Plans
• Plan may be non-contributory or contributory
• Pension benefits are typically allocated to plan members based on
some form of point system
• Employer contributions are tax deductible to the employer; not a
taxable benefit to employee
• Employee contributions are tax deductible
• Investment earnings are tax-deferred
• As with other pension plans, pension benefits are taxable to the plan
member when they are received
 Profit Sharing Plans: Maximum contribution levels
• As with other defined contribution pension plans, the combined
contributions of the employer and employee must not exceed the
money purchase limit if they are to be tax deductible
• As with other defined contribution plans, contributions to the
pension plan reduce the amount that the employee can contribute to
his or her RRSP
 Allocation of Benefits - Example
• ABC Company offers a profit-sharing pension plan to its three
employees and contributed $10,000 of profits to the pension fund
last year. During the past year, Jack earned $40,000 and finished his
7th year of service. Rebecca earned $45,000 and finished her 6th year
of service. Stanley earned $27,000 and finished 3 years of service. The
benefit allocation is based on a point system — one point for each
year of service and one point for each $1,000 of earnings. Show how
the allocation of benefits is calculated and how much is the allocation
of last year’s profit contribution?
 Allocation of Benefits - Example
• Jack: 40 pts for earnings + 7 pts for service = 47 pts
• Rebecca: 45 pts for earnings + 6 pts for service = 51 pts
• Stanley: 27 pts for earnings + 3 pts for service = 30 pts
• Total plan points = 128 pts

• Allocation of last year’s profit contribution:

• Jack: (47 ÷ 128) × $10,000 = $3,672
• Rebecca: (51 ÷ 128) × $10,000 = $3,984
• Stanley: (30 ÷ 128) × $10,000 = $2,344
 Distribution Options
• Describe the various options for distribution upon normal retirement,
early retirement, termination of employment, death, or disability
• Identify and explain the most common pension arrangements
 Distribution Options
Distribution Upon Termination Prior to Retirement
• If an employee terminates employment after his or her contributions
have vested, his or her contributions, as well as the contributions
made by the employer are usually locked-in
• The funds must be used to provide a retirement income typically
through a deferred life annuity
• Other options now permitted in most jurisdictions include
transferring the funds directly into the pension fund of a new
employer or into a locked-in retirement account
 Distribution at Death – Before Retirement
• If member dies more than 10 years prior to the NRA, the surviving
spouse or common-law partner can receive a deferred annuity based
on 100% of the commuted value of the deceased’s post-1986 benefits
• Alternatively, the funds may also be transferred to the surviving
spouse or common-law partner’s:
• own RPP if permitted by that plan
• a locked-in retirement account (LIRA)
• a financial institution for the purpose of purchasing an
• immediate or deferred annuity
 Death Before Retirement, But After the Early
Retirement age
• If member dies more than 10 years prior to the NRA, the surviving
spouse or common-law partner can receive a deferred annuity based
on 100% of the commuted value of the deceased’s post-1986 benefits
• Alternatively, the funds may also be transferred to the surviving
spouse or common-law partner’s:
• Own RPP if permitted by that plan
• A locked-in retirement account (LIRA)
• A financial institution for the purpose of purchasing an
• Immediate or deferred annuity
 Death After Early Retirement Age
• If death occurs within ten years of the NRA, the deceased is deemed
to have been eligible for a reduced early retirement pension, payable
on a joint and last survivor basis
• The spouse or common-law partner would receive at least 60% of
the reduced early retirement pension earned by the deceased
member
• These benefits are in addition to a refund of the employee’s
contributions plus interest with respect to plan membership prior to
1987
 Death After Retirement
• The disposition of benefits when death occurs after retirement
depends on the nature of the pension distribution and is described in
Retirement Distribution Options.
 Retirement Distribution Options
• All pension plans must define the normal pension, which specifies what
form the pension payments take and what benefits, if any, a member’s
beneficiary or estate receives if the member dies after retirement.
• The most common pension arrangements are:
• Straight-life annuities
• Refund annuities
• Annuities with a guaranteed period
• Joint and last survivor annuities
• Variable annuities and cost of living supplements
• Cash options
 Normal Retirement
• NRA is the age specified in the pension plan at which time the
member has the right to retire and receive a full, unreduced pension
• Some plans specify a qualifying factor, which is the combination of
age and years of service required to entitle a pension plan member to
an unreduced pension upon early retirement
• Earliest retirement age = [(age at which member joined the plan +
the qualifying factor)÷ 2]
 Early Retirement
• Most pension plans will permit members to retire early—up to 10
years before the NRA—and still collect a pension
• The entitlement from a defined benefit plan will be reduced to
account for the reduced years of service
• Under federal taxation regulations, pension payments must
commence no later than the end of the year in which the member
turns 71 years of age
 Integration of RPPS with CPP and OAS
• There are three types of RPPs:
• Normal plans
• Notched pension plans
• Bridged pension benefits
 Normal plans
• Unless their pension plans provide otherwise, individuals retiring
prior to age 65 will realize a jump in income at 65, when Canada
Pension and Old Age Security benefits commence.
 Notched Pension Benefits
• Some pensions provide a notched option for those retiring before age
65.
• The provision allows for higher-than-normal monthly pension
payments in the retirement years prior to age 65.
• The payments are then reduced to below normal once the
government benefits commence, resulting in a level income,
 Bridged Pension Benefits
• With this option, a bridging supplement equivalent to the anticipated
government benefits is provided by the plan in the years prior to age
65, in addition to the normal level of benefits.
• The bridging supplement also serves to level the retirement income.
• It is an additional benefit, and it imposes an additional cost to the
employer.
 Retirement Due to Disability
• Pension plans may have special provisions related to disability prior to
retirement.
• Unlike early retirement, most disability provisions stipulate that full
credit must be given for pensions earned up to the date of
retirement, without any reduction.
• The additional cost is assumed by the pension plan
 Rules and Regulations
• Explain the rules and regulations pertaining to employer sponsored
pension plans
• Describe the different ways pension plans must be documented
• Identify the eligibility requirements to join a pension plan
 Rules and Regulations
• Documentation:
• Plan Text
• Trust agreement for a trusteed plan
• Insurance contract for an insured plan
• Non-technical explanatory materials
• Administration
• Age Eligibility
• Eligibility
• Gender Discrimination
• Vesting
• Locking-in
• Portability
 Rules and Regulations
• Minimum Interest on Employer Contributions
• Survivor’s Benefit
• Post-retirement deaths
• Pre-retirement deaths
• Remarriage
• Relationship Breakdown
• Early and Postponed Retirement
• Integration with Government Pensions
• Indexation for Inflation
• Pension Plan Amendments
• Termination of Plans