The Financial Advisor Guide to Corporate Retirement Plans Self Study Course # 4 CORPORATE RETIREMENT PLANS OVERVIEW In this module, we will look at the importance of retirement planning, and how different Corporate Retirement Plans can help offer your clients and prospects additional sources of retirement income when their working years are through. We will address the Rules & Regulations of these various types of plans, as well as advantages and disadvantages of each. It is our hope that by the end of this course, you will be in the position to market Corporate Retirement Plans to your prospects and clients. INTRODUCTION The retirement crunch Demographics suggest that there will soon be a shortage of skilled labour in Canada. An innovative pension plan is one incentive that could keep employees on the job. The Urban Futures Institute estimates that 70,000 Canadian nurses--more than a quarter of the current nursing workforce--will retire over the next five to 10 years. This comes at a time when the Canadian population is aging, and the demands for nursing care are rising. How will organizations that need nurses meet their staffing needs? How, for that matter, will employers who need engineers, auto workers, electricians and accountants ensure that they, too, will have the talent necessary to run their businesses? There are no easy answers to these questions, and the solutions vary widely depending on individual sectors and companies. However, there are some general conclusions that can be drawn to help employers prepare for the future. 2 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 The Pension Plan Solution What can plan sponsors do to address the future retirement boom? They can start by mapping out--to the greatest extent possible--their human capital needs 10 and 20 years down the road. Employers need to identify what type of employee they will require, where they'll find these individuals as well as whether the retention of older employees is a desirable goal. The organization can then position itself to be as flexible and creative as possible in its approach to retaining and attracting talent. The pension plan is an important tool within this integrated human capital strategy. As noted, company plans with generous early retirement options provide a disincentive to older workers to remain employed. Early retirement provisions subsidize the benefits of employees who use them. In general, the earlier an employee uses these retirement benefits, the bigger the subsidy from the plan. Should employers amend their plans to remove generous early retirement provisions? This is a dangerous road to travel with the potential for litigious potholes. Still, there have been plans where the early retirement provisions were made less generous while other plan benefits were improved. The net effect was that the changes were cost neutral to the plan and all plan members received improved benefits--not just those who would have been eligible for early retirement. It is important to remember that some form of grandfathering will be required for members who were eligible for the original early retirement provisions. Flexible pension plans are especially good at encouraging early retirement. These plans allow employees to contribute to an account which they use at retirement to buy ancillary benefits such as improved early retirement subsidies, bridging benefits or indexing. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 3 If employees cannot spend all of the contributions in their accounts upon retirement then they forfeit the leftover contributions. As the improved early retirement subsidy is by far the most valuable ancillary benefit, a member delaying his or her retirement will most likely end up having to forfeit contributions. Companies could consider reimbursing employees in this situation with money from outside the flexible pension plan. What can be done to encourage employees to keep working by compensating them for the value of the early retirement provisions that they forgo? Is there some way, for example, to replace bridge benefits that would be forgone by employees choosing not to retire early? Based on current legislation, such compensation would likely have to come from outside the pension plan. If legislation were to change, then actuarially increasing an employee's pension at retirement to recognize the value of the early retirement provisions not elected might become an option. Such an option could be cost neutral from the pension plan's point of view with respect to employees who intend to retire early. What can be done to encourage employees who make use of the plan's early retirement provisions to return to work? Current rules prohibit employees from receiving a defined benefit (DB) pension while accruing a pension under a DB provision of the same or related pension plan. Perhaps employers could look at offering a defined contribution provision or a group registered retirement savings plan to rehired employees. The employees would then be able to collect their pension, earn employment income and accrue additional pension benefits. Thought should also be given to what type of pension plan older employees prefer. 4 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 By offering a plan that is tailored to older workers, an employer may achieve a strategic advantage in recruiting. At the same time, the organization must be concerned about attracting and retaining younger workers. Multiple plans--one for older, one for younger and another for rehired workers--may make sense. Will there be Government Assistance? In 1995, there were five Canadians between the ages of 20 and 64 for each person aged 65 and over. By the year 2030, this ratio will have been cut in half. Government solutions to address the costs associated with the aging population might include reducing benefits to seniors, taxing working citizens at much higher rates or implementing measures that will stop the tax base from shrinking. The wholesale cutting of seniors' benefits doesn't seem particularly likely given Ottawa's historical aversion to angering this group. When the Canada Pension Plan (CPP) was last reformed, the additional cost was borne by all stakeholders with the exception of current retirees. Given that seniors are more likely to vote than working Canadians and have more time to lobby, Ottawa's attitude towards preserving seniors' entitlements is not surprising. A hike in personal income tax rates doesn't seem to be likely either in the short term given recent tax-cutting rhetoric. The most practical and viable alternative is clearly to stop the Canadian tax base from shrinking. One way to do this is to shift the focus of the tax system away from payroll and income taxes to consumption and property taxes. In all likelihood, the plan would also include increased immigration and government programs that encourage Canadians to work longer. Some changes to the operation of existing government programs would also help. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 5 A study by the C.D. Howe Institute, Flexible Retirement as an Alternative to 65 and out, discusses the tax disincentives to working beyond age 65. Most of these involve claw backs to Old Age Security and the Guaranteed Income Supplement (GIS) that result in punitive rates of taxation for income earners over age 65. The GIS, a safety-net program for low-income seniors, has a claw back rate of 50%. The study points out that for a low-income Ontario senior receiving both the GIS and the Ontario program of guaranteed annual income, the effective tax rate on any income is a staggering 100%. Another government program that could be altered is the CPP. In fact, several changes were introduced recently. It is now easier to collect benefits while continuing to work, and the attraction of collecting benefits earlier than age 65 has been significantly reduced, while the benefits associated with collecting benefits later have been enhanced. In the future, Canadians who start receiving CPP benefits before age 65 will receive up to 6% less pension income than what was available under the old rules. Canadians who delay receiving CPP benefits until after age 65 receive an increase to their benefits. Under the new rules this increase has been bumped up by as much as 12%! In short, under the new rules, CPP no longer encourages recipients to retire early. A Possible Solution Coming Out of Quebec One promising idea that was introduced by the Quebec government in 1997 is the concept of a phased-in retirement program. Each employer has the option of offering this program to their employees. 6 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Under Quebec legislation, a pension plan member who participates in a phasedin retirement program involving reduced working hours can receive an annual payment from his or her pension plan to make up for part of the resulting pay loss. Additional accruals within the pension plan may continue. The Quebec Pension Plan (QPP) even allows an employee whose working time is reduced because of phased-in retirement to earn QPP entitlements based on a deemed (higher) rate of remuneration if the employee contributes to the QPP based on the deemed rate of remuneration. The employee must have consent from his employer as the organization matches the higher contributions. In addition, deferred vested members or retired plan members who have not yet elected to start receiving pension payments may choose to receive an annual lump sum payment from the pension plan in each year before pension payments commence. The amount of their eventual lifetime pension is reduced accordingly. Phased-in retirement has not been as widely adopted by Quebec employers as originally hoped, and the programs that do exist usually have constraints regarding the number of employees that can participate. Possible explanations include the fact that many employers find it challenging to allow employees to work part time. As well, unions have not pushed to negotiate phased-in retirement during collective bargaining. Regardless of these obstacles, some variation on the Quebec legislation seems like a step in the right direction in providing employers and employees with more flexibility in determining how and when workers retire. What about mandatory retirement at age 65? The old adage about retiring at age 65 because you had to…is not too common today. Every province – with the exception of New Brunswick – has eliminated mandatory retirement at 65. Nova Scotia became the latest jurisdiction to enact a partial or complete ban on mandatory retirement in 2009. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 7 Bankers love the concept of mandatory retirement, or any other form of retirement. It means big money for the banks, which regularly fire up ads such as, "What are you doing after work?" And, "You're 20, you should be thinking of retirement." The big season for bankers is the February run-up to the deadline for RRSPs, when they try to scare the daylights out of people by warning them if they don't have $800,000 - or $500,000, or $1 million - socked away when they turn 65 they soon will be pushing their worldly goods ahead of them in a cart or living in a walk-up, eating cat food. Retirement is big business for banks. Bankers believe people hate their jobs as much as bankers hate theirs, so they set out to convince people that retirement Freedom 55 …Take This Job and Shove It - is the solution to worry and the road to happiness. And yet, many people enjoy their jobs and dread being forced out of them merely because they have turned 65, which is a lot younger than 65 used to be in the 1920s, when pensions began. Someone turning 65 today is expected to live another 20 years. The concept of retirement, especially mandatory retirement, is actually fairly new. It began in the early decades of the 20th century. The first old-age pension in Canada began in 1927, financed by the federal and provincial governments, but administered by the provinces. It was available to Canadian citizens 70 years or older. The pension amounted to $20 a month, a munificent $240 a year, but only if the Canadian citizen passed a strict and demeaning means test. This was the situation for nearly 25 years. Throughout the years, the age for receiving Old Age Security was lowered from 70 to 65. 8 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 There has been a sea change in attitudes to public pensions and the very concept of retirement, both mandatory retirement and early retirement. When the age of 70 was selected in the early 20th century as the age of eligibility for a government pension, life expectancy was between 60 and 65. Because people live so much longer, and retire so much earlier, Ottawa has demanded higher contributions to the Canada Pension Plan so it won't dry up. There will be increased demands to raise CPP contributions in coming years as the parade of boomers opt out of the work force. Compulsory retirement is especially hard on women, many of whom chose to stay home to be with their children in the early years, and then entered the work force in their late 20s or early 30s. Because they were, and often still are, paid significantly less than men, women aren't able to put away as much money as men. And it gets worse down the line, as women live, on average, five years longer than men. According to Canada's Urban Futures Institute, some 9.8 million Canadian baby boomers are approaching retirement. By 2020, the number of Canadians retiring each year will be 425,000. Today there are four workers in Canada for every retired person. By 2020, there will be three workers for every retired person. The ratio will sink further without a dramatic increase in immigration, preferably people with lots of money and excellent job prospects. This demographic shift is already making an impact in the United States, where the retirement age has been raised to 67 for those born after 1960 and is expected to be raised again, probably until it reaches 70 (which more accurately reflect the demographics and life expectancies of the near future). We are an aging society and our aging population is accelerating rapidly. In 1973, only seven per cent of Canadians were 65 or older. By 2011, close to 15 per cent were over 65. By 2023, approximately 20 per cent of Canadians will be over 65. And by 2041, 23 per cent will be seniors. Increasingly, the worry is a shrinking work force. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 9 Some companies are coping with this workforce shortage by instituting plans such as "retirees on call" and "phased retirement." These plans address the arguments of employers who favour compulsory retirement because it unloads workers who are at the peak of their earnings, allowing the companies in some cases to hire two young workers for the price of one older worker. Bankers are correct in assuming most people don't like their jobs and want to retire if they can afford to. Only eight per cent of workers continue to work fulltime after the age of 65. The average age of retirement in Canada is close to 62. But the eight per cent who want to keep working do so for a variety of reasons, including office camaraderie, job satisfaction, a sense of purpose and destination – and sometimes economic survival. The geography of a country like Canada also comes into play. If public pensions total, say, $18,000 – the amount can vary widely, depending on extra benefits – it makes considerable difference whether these pensioners live in Toronto or Portage la Prairie, Man. You could almost make it on $18,000 a year in Portage, but in Toronto $18,000 might keep you going three, four months. Many overestimate the joys of retirement. After a summer or two of playing golf or watching birds or afternoon soaps, they come to appreciate what Shakespeare meant when he wrote, "If all the year were playing holidays, to sport would be as tedious as to work. What Will the Future Hold for Canadians Gearing Up for Retirement? So, where do we go from here? The retirement of the baby boomers over the next three decades will bring changes to the Canadian labour market, which cannot, at this time, be predicted with certainty. The eventual outcome of this retirement crunch will depend on many factors, including the actions of our governments. Regardless of the uncertainty, each employer should adopt a proactive stance. 10 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Organizations will need to be as creative and flexible as possible in shaping their integrated human capital strategy. What do Employees Want the Most from their Employers? All your clients and prospects all looking to achieve goals, to feel that the thousands of hours that they spend working during their lifetimes are leading to a better future, and that at the end of it all, there might just be a pot of gold. They also want to believe that the Company that they were employed by for so many years will look after them. This is not always the case. Often, it is assumed that our retirement years will be good to us because there will be Government benefits available and maybe even income from an employer pension plan as well. The individual may have provided some retirement funding themselves throughout the years. The reality can be very different. The Reality of Retirement The total income they can expect from government and company pension sources is likely to be lower than their earnings during the working years. Many Canadians are not a member of an employment-related pension plan (less than half of all Canadians have the advantage of a company or union-sponsored pension plan). When people finally do get around to looking at their anticipated retirement income requirements on paper, they find the results surprising. In the majority of the cases, the figures show a far larger requirement for personal savings and investments than they even expected. Filling the financial gap between the retirement incomes they need and the retirement Income they expect to receive may just be available from Corporate Retirement Plans. Canadians can have a retirement based on today’s lifestyle or one that can be even more rewarding. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 11 If they are between 40 and 60 years of age, it is wise for them to aim for retirement income that is equal to roughly 75% or the income that they currently have. This percentage is considered the accepted guideline if they wish to maintain a comparable standard of living in their retirement years. Where will this additional retirement income come from? It is worth noting that tax incentives and increasingly flexible pension arrangements can tell a whole different story. Although this course will deal with the corporate side of retirement benefits, there is still a need for individuals to take the initiative in retirement planning. This is being encouraged because an increasing number of individuals will be drawing upon the pool of funds, which support government and private pension programs. Although we will look at these areas in a general way, we recommend that you do some research on your own so that you will be in a good position to be able to offer the best advice possible to your corporate clients and prospects. THE REALITY OF RETIREMENT If you're like most Canadians, you want to retire early and you're confident you'll have the means to do it. But chances are you won't be packing it in as early as you planned to – and you won't be living in the lap of luxury. Over the next five to 10 years, more Canadians than ever will be in a position to clean out their desks for the last time. In 1981, there were 4.6 million near-retirees (people between 45 and 64 years old) in Canada. They made up 27.8 per cent of the working-age population. By 2002, that number had grown to 7.6 million – or 35.7 per cent of the working-age population. In 2011, 9.8 million – or 41.1 per cent of the working-age population – will be close enough to the golden handshake to give it serious thought. 12 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 According to Statistics Canada, a third of them will conclude they haven't set aside enough to be able to afford to do it. A recent General Social Survey asked people who had been retired for a year, how they were faring financially now that they were collecting a pension. Just over a third – 34.1 per cent – said they were worse off. The rest said their situation was about the same – or they were better off. Some Additional Retirement Facts: The median retirement age fell from 65.1 years in 1976 to 60.6 in 1997. By 2009, it was up again – to 61.6 years. Canada/Quebec Pension Plans are designed to provide retirement income of no more than 25 per cent of the average Canadian wage ($50,100 for 2012). Throw in Old Age Security benefits, and you're up to 38 per cent. Most retirement planners say you should have accumulated enough assets to replace 70-80 per cent of your pre-retirement income by the time you stop working. Most Canadians retire on far less than that (and don't have 101 canned tuna recipes). About 40 per cent of Canadians are currently covered by an employer pension plan. Twenty years ago, more than half were. Low interest rates and prolonged market losses meant some pension plans that promised set retirement benefits were running huge deficits. And not just in the private sector. Many employers are turning to less-expensive pension options that put much more of the burden of saving on the employee. But what about the 60 per cent of Canadians who aren't part of any pension plan? Those who retire today can collect a maximum C/QPP of $986.67 and Old Age Security of $540.12 a month, if they're 65. That's a grand total of $18,321.48 a year - assuming those plans will be around when your time comes around. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 13 And if you've made it to 65, you've got better than even odds of making it past 80, according to the actuaries. You very well might find it tough to have a grand time for 15 years on just 15 grand per. On the bright side, if you are like most Canadians – and if your health holds up – your lifestyle in retirement will be pretty much what it was while you were working. If you didn't travel extensively while you were working, you probably won't be doing any travel after you retire. So if you prefer taking long walks or hanging out at the library instead of spending afternoons at the club or wintering in Tahiti, you might get by on government benefits. The 10 Retirement Misperceptions: Saving too little. Most people have not tried to estimate how much money they will need for retirement. Moreover, those who have calculated this amount often underestimate it. Not knowing when retirement will occur. Many workers will retire before they expect to, and before they're ready. Living longer than planned. As individuals learn to manage their own retirement funds, they may not understand that life expectancy is a very limited planning tool. In fact, some retirees will live long beyond their life expectancy, with a substantial risk of outliving their savings. Not facing facts about long-term care. Many people underestimate their chances of needing long-term care. Relatively few people either own long-term care insurance or can afford to pay for extended long-term care themselves. Failing to ensure guaranteed lifetime income. Although people find guaranteed lifetime income attractive, in practice they usually will choose to receive retirement plan benefits in lump-sum form. They pass up opportunities to get a lifetime pension or annuity, failing to recognize the difficulty of creating lifetime income streams on their own. 14 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Not understanding investments. Due to the growth of workplace retirement savings plans, workers are now responsible for managing investments for retirement. However, many workers misunderstand investment returns and how investment vehicles work. Relying on poor advice. A significant portion of retirees and pre-retirees do not seek the help of a "qualified professional." Yet they indicate a strong desire to work with a financial professional. Not knowing sources of retirement income. Workers misunderstand what their primary sources of income will be in retirement, and may be disappointed when trying to live on the income that's available. Failing to deal with inflation. Inflation is a fact of life that workers usually deal with through pay increases. But after retirement, few people can increase their income to keep pace with the cost of living. Not providing for a surviving spouse. Many married couples fail to plan for the eventual death of one spouse before the other. This can have serious consequences, especially when the survivor is the wife. (The 10 retirement misperceptions are the focus of a report from LIMRA International) What do the Professionals Say? In our research for this course, we came upon the following information that we felt would be of some benefit to the reader when speaking to their corporate clients about the need for employee retirement planning. According to a fall 2004 study by the Canadian Certified General Accountants, it was estimated that an additional $160 billion was needed to cover the deficit in private pension plans. If all plans were fully indexed to inflation, $240 billion would have been required. With the market collapse in 2008 these deficits soared further. They recovered significantly during 2009 - 2010, but by the end of 2011 were actually in worse shape than at the end of 2008. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 15 About 92 per cent of "defined benefit pension plans" in Canada were in deficit as of Dec. 31, 2008. Seventy per cent of these plans had insufficient funds to cover 80 per cent of their obligations, and 40% were unable to cover even 70 per cent of their obligations. As noted, low interest rates and poor market performance in 2011 have aggravated the deficit problems of these plans further. In some cases companies have been wound up so that pensioners only got a portion of what they expected, and former members of the pension board, including employee volunteers, have been sued for millions of dollars. Current legislation does not give pension plans any incentive to fund the plan any more than the minimum required by law. Only a small minority of companies have opted to fully fund their pensions to correct pension deficits. The CGA report noted that flat and career benefit pension plans are poorly funded compared to final average pension plans. A flat benefit plan gives a fixed dollar amount for each year of service at retirement. A career benefit plan provides a pension based on percentage of earnings over the entire period of employment. A final average plan provides the pension on a percentage of earnings in the last or best five years or service. (Flat and career plans are usually part of union collective agreements where improvements are negotiated in collective bargaining.) Planning for the Financial Risks of Retirement Is Definitely Part of the Process How do you plan to spend your retirement years? Do you envision enjoying life in a golf community? Traveling the globe? Volunteering for a favourite organization? Spending time with your grandchildren? Whatever your dream, you should take time now to understand some of the major financial risks you may face in retirement. 16 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 And although no one can predict the future, learning about some of the possible risks may help you and your financial representative formulate a financial strategy to cope should you have to deal with one or more of them. Living Longer Costs More! The Longevity Risk Life expectancy, in general, has increased fairly dramatically since 1900. Living longer is a good thing, right? Of course! But to live "happily ever after" in our retirement, we need to anticipate and plan for a longer life expectancy. Why? Because living longer costs more. Without planning for a longer life, living longer can put your clients in serious financial jeopardy in their later years. For each year the employee lives beyond their investment plan, they will put themselves at increased risk of running out of savings. Over time, you will also continue to contend with the corrosive power of inflation. The Effects of Inflation: Today's Dollar, Tomorrow's Quarter! Did you know that a dollar in 1943 would only be worth about seven cents today? Put another way, a good or service that cost $1.00 in 1943 would cost about $14.30 in today's world. And if future inflation rates mimic the rates from the last 60 years', then a dollar today will be worth 67 cents in 10 years, 45 cents in 20 years, and only 31 cents in 30 years. So what exactly is inflation? Inflation is the rise in prices over time. Inflation affects everyone who purchases goods and services. Even an annual rate of three percent will reduce your purchasing power by 45 percent in 20 years. Without careful financial planning, you put yourself at risk of having your hard-earned dollars eroded by inflation. Retirees may find themselves at particular risk if they haven't invested in income products that are adjusted for inflation. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 17 Planning for Retirement – The Employee Should Know Their Challenges A successful retirement plan takes into account the factors that may negatively impact post-retirement financial health. They include (but this list is not exhaustive) the effects of inflation, outliving one’s savings, healthcare and investment risk. Inflation As noted, inflation is the rise in prices of services and goods over time. If the employee doesn’t make investment choices now to help them deal with the corrosive effects of inflation, their post-retirement income may not be enough for them to maintain a reasonable standard of living. So if they would rather spend their retirement years fly fishing than frying fish at a local fast food restaurant, then they should develop strategies for dealing with inflation. Longevity With medical and nutritional advances, retirees are living longer than ever before. Living longer is a good thing, right? Of course! But living longer can be financially difficult for people who haven't adequately planned for those extra years. The problem is…It's not free to live! And if the employee doesn’t plan for living a longer life, then they may use their savings too quickly by trying to maintain their standard of living. Coupled with inflation and health-care expenses, living longer than planned can take a serious toll on the money they have. Planning for retirement is a process. It takes some financial know how, a budget, and finding ways to deal with future challenges. And of course one of these ways to build a retirement nest egg is through the use of their employers’ retirement plans, if there are any in place! 18 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 HOW MUCH IS ENOUGH? Ask any financial adviser, “How much money do you need to support yourself in retirement in the manner you grew accustomed to during your working years?” and they'll probably tell you that you had better have put away enough to cover 70-80 per cent of your pre-retirement income. Say you earned a pretty healthy salary of $80,000 a year. Unfortunately, the company you worked for (which may have been your own) had no pension plan. That guy who relentlessly tried to sell you insurance and Registered Retirement Savings Plans kept telling you that you'd need $60,000 a year to get by when the time came to call it a career. And then it happens, you wake up one day and suddenly you're 65. You qualify for maximum Canada/Quebec Pension Plan benefits of $11,840 a year – and Old Age Security benefits of $6,481 a year. That takes you to $18,321 – not quite a third of the way there. If you're an average Canadian, you've set aside some money in a Registered Retirement Savings Plan – around $50,000. You stroke your chin and ponder the possibilities: stick that money in some safe investment and you might be able to earn a return of four per cent. There's another $2,000 or so per year. But other than that, the cupboards are pretty bare: putting the kids through university was a strain, and your spouse – well, the two of you haven't so much as talked since you went your separate ways. So you've got just over $20,000 a year to live on. Or about 25% per cent of your pre-retirement income. That’s about the same amount of income as Canada’s “working poor” – the 20% of workers who earn minimum wage. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 19 Is relying on government benefits a mistake? That guy who tried to get you on the investment bandwagon may have told you tales of how there'd be no CPP/QPP when your turn to collect came up. Turns out he was wrong. The thing about the Canada and Quebec Pension Plans is – and this is something a lot of people don't realize – they don't cost the governments a penny. The plans are fully financed by contributions from employees and employers. In 2012, the maximum CPP premium was $2,306.70. If you worked for yourself, you paid double ($4,613.40). At that level, the pension plan administrators say there will be enough to pay pensions to you, your kids and probably their kids as well. CPP is fully funded to cover all liabilities until 2085. Before 1997, CPP was a "pay-as-you-go" plan. You paid relatively little and were promised a higher benefit than your contributions would cover. The theory was future generations of workers would be able to kick in enough to support retirees. But baby boomer demographics wreaked havoc with that model. The boomers weren't having enough kids (future workers). Actuaries predicted the plan would be out of money within 20 years. Changes were ordered: contribution rates would be gradually boosted to 4.95 per cent of annual insurable earnings to the self-employed contribution of 9.9 per cent. The health of the plan would be reviewed every three years. Now the actuaries are smiling. As of June 2011, the CPP had a reserve fund of $153.2 billion. Are OAS/GIS benefits safe? Probably – but they are government-financed programs and could be altered. But seniors have a loud voice – and it's about to get louder than ever as millions of boomers approach that stage of life. 20 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Still not looking very good? So, your $80,000 income is being replaced by a little over $20,000 in retirement benefits from the government. Just 25 per cent of your pre-retirement income, as previously mentioned. Things don't look great, do they? But they may not be as bad as you think. Hopefully, you live in a home that's been paid off. You may have blown a lot of money in your day, but – like the majority of Canadians 65 and older – you don't owe anybody anything. Your expenses are pared to the bone as you won't pay much income tax on your $20,321. Your health-care premiums will likely be covered by the government – as will most of the cost of your prescription drugs. You won't be making mortgage payments. You will be paying property taxes. Or you might sell that house and move into something smaller, using the proceeds of the sale of your home to pay your housing costs (which could be subsidized because you're a lower-income senior). You won't be paying for the commute to work – or buying all those lunches and coffees. You may not be in a position to help the kids buy their own homes. But you also won't be that far behind a lot of retired Canadians. Those financial advisers who recommended you need 70-80 per cent of your pre-retirement income probably didn't tell you that most Canadians retire on far less than that – and manage to get by. A Statistics Canada study found that people whose pre-retirement income was $70,000 or greater tended to retire on about 45 per cent of that – or around $31,500. Those who earned around the average national wage – between $40,000 and $50,000 – retired on 59 per cent of their pre-retirement income. Only one in six people with a pre-retirement income of $40,000 or more had a replacement ratio of 75 per cent or more. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 21 So What Do You Do If – Your Pension Plan Can't Deliver? It is extremely rare for a pension plan to go bust. The money in them does not belong to the company offering the plan to its employees. But sometimes companies fail – and if a company fails when its pension plan is in less than ideal shape, employees may not get as much as they were expecting. There's not much you can do if your company goes under owing money to its pension plan. The pension plan – which is administered by an outside company for the employees and the employer – becomes just another creditor. The pension plan gets in line with everyone else owed money, hoping there's something left when the company's wound up. There's a system in place that's supposed to head off trouble before it happens. The rules can vary depending on whether your plan is federally or provincially regulated. Ontario is the only province that maintains a fund that will pick up part of the cost of paying out pensions when retirees are left with a plan that can't deliver what it promised. The fund will pay out a maximum of about $1,000 a month, usually far less than what the company pension would have paid out. Pension plan administrators have to submit reports on the health of their plans every three years. The Office of the Superintendent of Financial Institutions (federal) or the provincial regulator can ask for those reports at any time, if they have reason to believe the health of a plan may be at risk. If the report shows the plan is under-funded, the regulator will order the plan's administrator to restore the plan's health within five years. The administrator will have to file updated reports every year to show progress is being made. 22 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 WHAT CAN THE EMPLOYER DO IF THERE IS NO CORPORATE RETIREMENT PLANS IN PLACE? You would have to agree that the choices would be limited. Would they: Provide a bonus or cash at retirement? Continue to pay the employee? Present a parting gift (perhaps a gold watch)? Perhaps it would be a lot easier for the company not to enforce retirement. Advantages of implementing a Corporate Retirement Plan Establishes a formal Corporate Policy on employee retirement. Provides the employees with financial security, thereby enhancing goodwill and loyalty during their working years. Provides tax relief to employer and employees on contributions. Helps attract and retain good employees, and keeps channels of promotion open. As a management tool, it offers flexibility of design to achieve the corporate objectives. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 23 TYPES OF CORPORATE SPONSORED RETIREMENT BENEFIT PLANS Types of Retirement Plans Defined Benefit Final Average Defined Contribution Career Average Money Purchase Group RRSP Group DPSP Structured RRSP Voluntary RRSP 1. Registered Pension Plans (RPP’s) 2. Corporate Group RRSP Plans 3. Profit Sharing Plans 4. Employee Stock Option Plans 5. Individual Pension Plans (IPPs) Deferred Compensation Plans 1. Retirement Compensation Plans (RCA’s) 2. Leveraged Retirement Plans (Corporate Cash Surrender Value) 1. REGISTERED PENSION PLANS (RPP’s) Registered pension plans and group Registered Retirement Savings Plans are workplace benefits considered by many to be attributes of a "god job". These Employer sponsored pension plans (ESPP’s) are a basic element in employee compensation and security. 24 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 As well, these plans are a major component of aggregate retirement income, supplementing the basic coverage provided through federal and provincial retirement income programs. Less than half of paid workers are entitled to a pension plan or group RRSP through their employer. Some employees, however, fall through the cracks (part-time hours, non-permanent employment status, non-union status, low seniority and wages). The most financially insecure workers today (the non-permanent, part-time, nonunionized, short-tenured, low-wage earners working in small firms) are much less likely to have employer-sponsored plan coverage than those who have been working in a permanent, full-time, unionized, high-wage position in a large firm for many years. Upon death, periodic RPP payments may be made to the surviving spouse or a lump-sum distribution may be made. Only lump-sum payments may be transferred on a tax-free basis by the spouse to an RRSP, RRIF, or other RPP. Amounts to which beneficiaries other than a spouse are entitled are not eligible for a direct tax-free transfer to an RRSP. However, where a lump-sum payment out of an RPP is received by a child because of the death of a parent or grandparent, taxation of the lump sum may be spread through acquisition of a fixed term annuity for a period not exceeding the number of years the child is under 18 years of age. The annuity must be acquired in the same year the lump sum is included in income or within 60 days after the end of the year. RPP’s come in two main types: 1. Defined Contribution Plans (Money Purchase Plan). 2. Defined Benefit Pension (Unit Benefit Plan). Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 25 1. Defined Contribution Plan (Money Purchase Plan) The Defined Contribution Plan is a registered plan whereby the employer and each employee contribute based on a certain percentage of the employee’s income. A very standard example might be a matching contribution of 5% of salary on both sides. Defined contribution type of plans is like going into the gas station and telling the attendant to fill it up, and you pay for it by credit card. You do not know how much gas you are going to get until he fills up the tank. These types of plans provide a lump sum accumulation benefit, and when you retire, you buy your income at that time. The maximum allowable contribution for a money-purchase registered pension plan (RPP) has been increased to $23,820 in 2012 (from $22,970 in 2011). It is indexed annually to account for the average wage growth. Annual moneypurchase plan RPP contribution limits are 18 percent of pensionable earnings (the same as with RRSPs), up to the limits stated above. Deductions for RPP contributions, in respect of both current and past services rendered after 1989, are allowed during the year the contribution was made provided the contribution was made in accordance with the plan’s registered terms. This applies whether contributions are mandatory or optional. The deduction amount for past service contributions rendered before 1990 depends on whether or not taxpayers contributed to any RPP in the year to which the past service applies. If they were not a contributor during that period, they may account for $3,500 times the number of years of eligible service; however, the maximum amount deductible in any one calendar year is only $3,500. 26 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 For years of service during which the employee was a contributor, the maximum available deduction is also $3,500, reduced by any current year or past deductions (including those claimed for prior years while not a contributor to any RPP). Any remaining balance may be carried forward for deduction in subsequent years provided the taxpayer has the available contribution room. Individuals who make past service contributions to their RPP in instalments will probably pay accrued interest charges. The interest paid for years after 1989 is considered a past service contribution. The 2003 federal budget modified the existing rules for calculating past service pension adjustments under defined-benefit RPPs in order to provide an exclusion for benefit increases that arise directly from increases to the maximum pension limit. Within limitations, the Income Tax Act provides for the transfer of benefits accrued under a defined-benefit RPP to a money-purchase RPP, RRSP, or RRIF. Likewise, the proceeds of a money-purchase pension plan can be transferred to another money purchase RPP, RRSP, or RRIF. Beginning January 1, 2004, money-purchase RPP proceeds are allowed to pay out pension benefits using the same income stream permitted under an RRIF (i.e., minimum payments beginning no later than age 71). Furthermore, funds previously transferred from a money- purchase RPP into an RRSP or RRIF can be transferred back into the money purchase pension plan, where they are subject to the same payout requirement as the RRIF. An employee may also deduct, within limits, additional voluntary contributions (AVC) under a money-purchase plan. The amount deducted will, however, affect their RRSP limit the following year. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 27 The CRA now recognizes registered pension plans that provide survivor benefits to same-sex partners. The money in a Defined Contribution Plan is invested by the Pension Company (Insurance Company, Trust Company or Investment Firm to name a few), and when the employee retires, the large lump sum is annuitized or otherwise invested to provide a pension. The plan itself may contain pension options or the proceeds can be “rolled over” to another pension provider. The good news is that both parties know exactly what the costs are. The bad news is that nobody knows what the pension will be until retirement takes place. The Pension provider will create illustrations based on various compounded interest returns, but does not guarantee the outcome. The funds may be invested in fixed interest returns, or a variety of securities or any combination. Most RPPs sold today are Money Purchase Plans. Both RRSP and DPSP are types of Defined Contribution Plans. Some disadvantages of Defined Contribution Plans Pension benefit is unknown. Subject to economic fluctuations. Individuals will probably need guidance with their choices. This is an obvious choice for many employers, as they have no liability to assume. 2. Defined Benefit Plan (Unit Benefit Plan) A defined benefit RPP is like going into the gas station for gas. You tell the attendant that you want $20.00 worth, so therefore you are going to know how much gas you are going to get. These types of plans provide for a Guaranteed Retirement Benefit. A defined benefit RPP provides for a specified pension benefit unrelated to contributions. 28 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 The maximum pension limit for defined-benefit registered pension plans (RPP) increased to $2,646.67 in 2012 from $2,552.22 in 2011; these amounts are indexed on an annual basis to reflect increases in average wage growth. The Defined Benefit Plan has two known and one unknown factor(s). The employee’s contribution and the Pension benefit are known, but the employer’s cost to fund the retirement benefit is not known. The plan may call for a 2% contribution by employer and employee, but if this is not sufficient, the employer must make additional lump sum payments to create the necessary funds. The Pension Act provides for an Actuarial evaluation on a regular basis (3 years). The pension provides for a “formula” that defines what the retirement pension would be. An example of Unit Benefit Plan: The Retirement Benefit Formula may provide for a unit of benefit for each year of service times the average salary. 2% X $3500 X 30 years = $2100 per month Retirement Benefit. The following formula illustrates the costs incurred: Plan Cost = Plan Benefits – Income Earned The formula may provide for several variations of the qualifying theme. a) Best five years. b) Best five of the last ten years. c) Final Average. d) Career Average. e) Flat Benefit Plan – (usually associated with Union Negotiated plans). The contribution and/or benefit can be integrated with the CPP contribution and retirement benefit. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 29 Advantages of Formula Retirement Benefits: Career Average Easy to understand. Encourages loyalty and long service. Employer’s contribution less for younger employees. Pensions may not track income increases in later years. Final Average Easy to understand. Unknown cost to employer but pensions could parallel final year’s income. Flat Benefit Easy to understand, all members treated equally when they qualify. Usually Union negotiated and paid by employer. Does not encourage individual endeavor. Disadvantages of Defined Benefit Plans An individual does not know what their salary will be 20 –40 years down the road. The person could be promoted late in life and have a big increase in salary. Inflation and interest rates cannot be accurately reflected. Changes to Pension Legislation cannot be predicted. The Companies own success cannot be predicted accurately 20 – 40 years down the road. An example of a Defined Benefit Pension Plan could be as follows: The contribution into this type of plan is known. 30 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Can be one or a combination of the following: A set amount of dollars per month OR % of wages can either be all Employer contributions OR Employer / employee shared contributions. Employer contribution IS eligible only if employee contributes as well. FUNDING THE PENSION Both Money Purchase and Defined Plans require the following four points to qualify as a Registered Pension Plan. A. Record Keeping Employers and Pension Providers must keep detailed records of contributions, years of service, salary and beneficiary declaration. Regular reports are filed to the Government, Employer and each Employee. B. Investments of Plans are constantly monitored Contributions must be invested as prescribed by regulations. This allows some negotiation of the employer as to how funds are invested. C. Consultant Pension Plans require the services of knowledgeable Advisors in the form of Consultants and/or Agents. Only Defined Benefit Plans may require Actuarial Services. The Actuary provides an initial assessment of plan and regularly spaced assessments thereafter. This is to guarantee the pensions that have been contracted for the employees. The employer, every three years, is advised as to surpluses or deficiencies and what additional contributions may be required to keep the plan current as provided by law. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 31 D. Funding Vehicles In the past, individual plans and group annuities were popular, but due to current legislation, they have fallen into disuse. There are however, many paid up plans in existence. Deposit Administrations and Segregated/Mutual Funds are the most chosen investment vehicles today. ACTUARIAL ASSUMPTIONS Defined Benefit Pension Plans require ongoing Actuarial Evaluations to be completed every three years. The purpose is to test the plan solvency and to adjust the contribution levels required to meet future liabilities. The ultimate cost of a pension plan is dependent on years of service; salary levels and plan earnings generated by the contributions. Actuarial assumptions are simply educated guesses, based on three-year projections, as to what contributions are required to fund the plan. The actual evaluation follows three separate steps: Prepare assumptions based on past experience and actual plan experience using present value assumption of cost of future benefits. Based on these assumptions, calculate future cash flow into and payments out of the fund on a yearly basis, until all plan members have retired. Prepare a valuation statement that consolidates all the information on a balance sheet. This will show whether the contributions need to be increased, held at current levels or whether contributions can be decreased (or benefits improved). 32 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 PENSION PLAN LIABILITIES AND ASSET ASSUMPTIONS Liabilities The Actuary is going to make rather conservative estimates in preparing present value assumptions for future payments. To do this they will use: Conservative rates of funding earnings such as Interest, Capital Gains and Dividends Rise in levels of salary - The relationship between salary increases and the assumed rate of earnings is a key calculation. Their best estimates about the future of CPP levels of benefit of the pension are integrated. Future mortality of participant and pensioners to fund the death benefit. Consider the rate of employee terminations. Assets The Actuary will provide an assumed value of future income using the same rate of interest assumption used on the fund payouts. This will give us a much more accurate assumption than if we were to calculate them using Book Value or Market Value (what it costs to buy them and what they are worth today). REGISTRATION OF PENSION PLANS The Federal and Provincial Government set out pension Plan Regulations. Pension Plans registered with Canada Revenue Agency (CRA), qualify for tax deferral. Employer and employee contributions are tax deferred until received as pension, at which time they are fully taxable. Likewise, any revenue generated by the contributions is tax deferred. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 33 The ITA defines a Registered Plan as “an employee’s superannuation or pension fund or plan accepted by the Minister for registration for the purposes of this Act in respect of its constitution and operations for the taxation year under consideration.” In fact, once registered, a plan does not require annual registration. Ground Rules for Registration Terms must be set out in writing and be communicated to all concerned. Since its purpose is to provide pension for life it is to be a definite arrangement established as a continuing policy. The Pension Plan is designed to provide pension benefits only. It may not have loan privileges, nor be treated as a savings vehicle, which could provide for withdrawal of funds. The Pension Plan must be provided by the employer for the benefit of employees who have provided service to the company. It requires contributions by the employer and employee. It must provide periodic payments to the employee upon retirement and may provide payments to the estate or a named beneficiary in the event of death. The employer must be party to the plan and a plan is not acceptable without employer contributions. The employer must contribute each year for future service benefits representing each year’s current obligations. The required amount may vary, but for tax purposes, each year requires employer contribution. Future contributions cannot be prepaid in one lump sum. All employer contributions are irrevocable, with only surplus employer contributions being returned in the event of a pension wind-up. Any contributions released by the termination of an employee before vesting (2 years) may be used as an employer contribution credit. The plan must provide a definite formula for pension benefits for returned employees. Prior service benefits may be provided under the plan. 34 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Maximum Pension Benefits Generally, the maximum retirement age is 60 years. The maximum defined benefit allowed by current service formula is the lesser of: 2% X average of best 3 years of earnings X number of years-pensionable service. The defined benefit limit ($2,646.67 for 2012) X the number of years of pensionable service. Past service pension, benefits and upgrades must be valued and integrated with other retirement savings contributions. They are subject to some restrictions and may require reporting of a Past Service Pension Adjustment (PSPA) to Canada Revenue Agency (CRA). Money Purchase Plans are restricted to the amount that can be purchased based on the individual employee’s total contributions. Additional benefits such as spousal benefits, enhanced guarantee periods or indexing all reduce the benefit accordingly. Defined Benefit plans are not affected by these additions. PENSION ADJUSTMENTS (PAs) A PA is the total amount of contributions made to an employer sponsored pension plan, (Defined Benefit, Money Purchase or Deferred Profit Sharing plans), on your behalf by your Employer (s) in the preceding year in accordance with the terms of any Collective Agreement. A pension credit is a measure of the value of the benefit you earn. In laymen’s terms, the Pension Adjustment represents value of benefits accrued during the years for an employee enrolled in any of the above mentioned pension plans regardless of whether the employer or employee or both contributed. The P.A. is reported to Canada Revenue Agency (CRA) and the Employee on the T-4 slip. The P.A. reduces the Employee's Contribution Limit. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 35 Tax-assisted retirement savings arrangements are designed and administered to provide income to individuals at retirement. Using these arrangements, Canadians can get tax assistance to build their retirement savings. The system is based on an overall limit of 18% of an individual's earned income, to a dollar maximum. The overall limit applies to total retirement savings under employersponsored registered pension plans (RPP’s), and deferred profit sharing plans (DPSPs), and registered retirement savings plans (RRSPs). Each DPSP and each provision of an RPP produce a pension credit for the member. The pension credit is a measure of the value of the benefit earned or accrued during the calendar year. The method you use to calculate pension credits depends on the type of plan and provision. A member's pension adjustment (PA) is the total of that member's pension credits from all plans in which the member's employer participates in the year, excluding RRSPs. The PA reduces the maximum amount that a member can deduct for contributions to an RRSP for the following year. The first year in which PAs had to be calculated was 1990. There are no PAs for earlier years. The first year that RRSP deduction room was reduced by PAs was 1991. RRSPs do not generate pension credits or PAs. All employers who sponsor or participate in an RPP or DPSP must calculate a PA for each of their employees that participate in the plan. In some situations, the RPP's administrator must calculate the PA. For example, this would be the case if, while on a leave of absence from employment, the member makes RPP contributions directly to the administrator. A union or employer association may also share responsibility for calculating a PA. This would be the case if the RPP is a specified multi-employer plan and the union or employer association receives multi-purpose payments, a portion of which is then contributed to the RPP. Generally, the employer has to report the PA for each employee to CRA on a T4 or T4A information slip by the last day of February each year. In some situations, the RPP administrator has to report the PA. 36 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Since the PA has to be calculated according to the plan as it is registered, it is important that the administrator file amendments to a plan within the 60-day filing requirement under the Regulations. The employer should also ensure that the plan(s) in which it participates would not provide benefits that cause a member's PA to be more than the specified limits. This is important because CRA may have to revoke the plan(s) if the limits are exceeded by any member. You can find the limits for single-employer plans and multi-employer plans in subsections 147.1(8) and (9) of the Act. There are no limits for a specified multi-employer plan, unless the plan contains a money purchase provision. The limit in this case is found in subsection 8510(7) of the Regulations. Deferred profit sharing plans (DPSPs) and registered pension plans (RPP’s) both generate PAs. The designs of these plans usually vary to suit the nature and size of the employer's business, the philosophy of the employer, and legislative requirements. Some arrangements allow or require members to contribute, some do not. An Example of Pension Adjustments for 2012 The example below shows the YMPE and salary cap for 2012. This information will be useful when speaking to your corporate clients. The 2005 PA is based on the following information: 1. The PA limit for 2012 is $23,820; 2. The 2012 YMPE is $51,100; 3. The PA formula is: (9 x Annual Benefit Entitlement) - 600 = PA Annual Benefit Entitlement Example Generally, the Annual Benefit Entitlement (BE) is the amount of pension 'earned' in the year. Find the BE by applying the pension formula to the member's 2012 annualized pensionable salary and service. For example, a member working fulltime earning $50,000 with a 2% entitlement would have a BE of $1,000. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 37 To Calculate the PA: (BE x 9) - 600 = PA → ($1,000 x 9) - 600 = PA. (Note: the PA is rounded to the nearest dollar.) $9,000 - $600 = $8,400. The PA for 2012 is $8,400. Here is an example of how to calculate the PA for a period of pensionable service of less than one year. The example can also be used to compare the PA calculation for reasonableness. Annualize the member's pensionable salary by dividing the pensionable salary earned by the pensionable service for that year. Follow the PA calculation instructions (above). Multiply the PA for the annualized salary by the length of pensionable service. This figure is the prorated PA which is used when service is less than one year. Example of a Prorated PA: Pensionable salary = $25,050; pensionable service = 0.7842. 1. $25,050 ÷ 0.7842 = $31,943 2. PA adjustment = $5,150 3. $5,150 x 0.7842 = $4,039 Calculating Pension Credits for Deferred Profit Sharing Plans (DPSPs) To calculate pension credits: Include all employer contributions made in the year for the member. Treat contributions made by the end of February that relate to the previous year as contributions for that year. Include any forfeited amount(s) and related earnings allocated in the year to the member, except for cash payouts to the member. Any further reference in this chapter to forfeited amount(s) means allocated forfeitures and related earnings. 38 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Also, the legislation requires that the employer limit its annual contributions to a DPSP for an employee in the three ways outlined below, as they apply. The legislative limit may or may not be detailed in the plan text. Moreover, the plan text may limit employer contributions in a way that is more restrictive than the legislation. The following describes the legislative limit: An employer's contributions to one or more DPSPs for a year must not cause the employee's DPSP pension credit (or the total of the employee's DPSP pension credits) calculated by that employer to be more than one-half of the money purchase limit or 18% of the employee's actual earnings in the year, whichever amount is less. If two or more non-arm's length employers participate in the same DPSP or different DPSPs, each employer's contributions to the DPSP(s) for the year must not cause the total of the employee's DPSP pension credits calculated by all the employers to be more than one-half of the money purchase limit. If the employee is also a member of another DPSP or an RPP in which the employer or a non-arm's length employer participates, each employer's contributions to the DPSP for a year must not cause the total of the employee's PAs reported by all the employers (the sum of all DPSP and RPP pension credits) to be more than the money purchase limit or 18% of the employee's total earnings from the employers, whichever amount is less. In Example 1, we assume that the employer is the only participant in the DPSP and participates in no other registered plan. We also assume the year is 2007 and combined contributions and forfeited amounts are restricted to one-half the money purchase limit or 18% of member earnings, whichever amount is less. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 39 Example 1 Member's earnings $ 60,000 Legislative limit = lesser of: 1/2 of money purchase limit ($20,000) = $ 10,000 18% OF $60,000 = $ 10,800 Formula for contributions 1% of net profits Net profits $ 900,000 Forfeited amount $ 110 Employer's contribution: 1. (1% OF $900,000) = $ 9,000 2. Pension credit = Employer's contribution plus the forfeited amount = $ 9,110 If two or more employers participate in the same DPSP for a member, each employer has to calculate and report that part of the member's pension credit that arises from working for that employer. Calculating Pension Credits for Defined Contribution Plans (Money Purchase) Pension credits include: All employer contributions made in, and relating to, a year for the member (treat contributions made by the end of February that relate to the preceding year as contributions for the preceding year); All member contributions made in, and relating to, a year, excluding amounts transferred directly to the plan from an RRSP, RPP, or DPSP; Any forfeited amount, and related earnings, allocated in the year to the member, except for cash payouts of these amounts [other references in this section to forfeited amount(s) means allocated forfeited amount(s) and related earnings]. Any surplus allocated to the member, whether it remains in the plan or is transferred directly out of the plan to another RPP or an RRSP. 40 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 (A surplus in a money purchase provision may arise if a defined benefit provision is converted to, or replaced by, a money purchase provision.) Do not include in the pension credit certain contributions that were made in the year, but that are for an earlier year(s). In Example 2, we assume that the employer is the only participant in the plan and participates in no other registered plan. The year is 2007. Note that while contributions are based on a percentage of earnings, the legislation requires the plan to have an overriding limit on total contributions and allocated forfeitures of 18% of member earnings or the money purchase limit, whichever amount is less. Example 2 Forfeited amount allocated to the member $ 100 Formula for contributions: By employer 5% of earnings By member 5% of earnings Member's earnings $ 40,000 Legislative limit on contributions and forfeitures = lesser of: 18% OF $40,000 = $ 7,200 Money purchase limit $ 20,000 (2007) Pension credit components: Member contributions (5% of $40,000) $ 2,000 Employer contributions (5% of $40,000) $ 2,000 Forfeited amount $100 Pension credit = $ 4,100 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 41 If two or more employers participate in the same money purchase provision for a member, the plan administrator may have to calculate the portion of the member's contributions, or the amounts allocated to the member, that are to be included in the pension credit for each employer. This is important in some cases to avoid exceeding the PA limit. The following is an example of such a determination assuming that: The member made a lump-sum AVC during the year; and according to the plan, forfeited amounts are allocated equally among all the members. Calculating Pension Credits for Defined Benefit Contribution Plans Calculate pension credits based on the benefit earned by the member in the RPP during the year. Use the full amount of the benefit earned, even if the benefit is not yet vested. The first step to determine the pension credit is to calculate the benefit earned during the year by doing the following: Calculate the annual amount of retirement pension that would be payable based on all years of service up to and including the year for which the PA is being calculated. Then subtract the annual amount of retirement pension that would have been payable based on all years of service up to, but not including, the year for which the PA is being calculated. Generally, you can use your plan's pension benefit formula, based on one year's service, to determine the benefit earned. OR If benefits are determined as a percentage of earnings, multiply the member's pensionable earnings for the year by the benefit rate; OR 42 For flat benefit plans, take the flat benefit amount for the year. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 The final step is to apply the pension credit formula: If the calculation results in a negative amount, the pension credit is nil. To calculate the benefit earned, you should apply the following rules: Current year's earnings In final, best, or career average provisions, you have to use the earnings for the year the pension credit is being calculated, even when benefits are based on earnings in other years. Excluded benefits Do not include the following benefits when calculating the benefit earned: Bridging benefits (temporary benefits ending at a fixed date that was known before they started), even if paid; Any indexing of earnings to reflect the increase in average wages and salaries between the year of earnings and the year in which benefits are determined; Early retirement reduction, even if it applied to a member who has actually retired during the year; Amounts resulting from the deferred commencement of a pension past age 65, when the increased pension is not more than the actuarial equivalent of the pension payable at age 65 (see "Postponed retirement" below if the increased pension is more than the actuarial equivalent payable at age 65); or Cost-of-living adjustment made before the end of the year for a member whose pension starts in a year, if the increase is not more than the greater of 4% per annum and the increase in the Consumer Price Index between the date of retirement and the date of the increase. Note If the increase is more than the greater of the above amounts, you have to include the entire adjustment when you calculate the benefit earned. If this applies to you, contact Income Tax Registered Plans Division for information on how to calculate the benefit earned. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 43 Adjustments to a member's pension income that depend on whether the member is totally and permanently disabled when pension payments start; and Additional benefits provided because a plan member has contributed more than 50% of the value of his or her pension (as required by most provincial pension legislation). This applies to all members, if the plan covers members in a jurisdiction requiring such additional benefits. Postponed retirement If a member continues to accrue benefits under the provision beyond age 65, you calculate the benefit earned for the year in the usual manner. An increased pension may be provided to a member who has stopped accruing benefits and postpones receiving a pension beyond age 65. If the increased pension is more than the actuarial equivalent of a pension payable at age 65, you have to include the extra amount when you calculate the benefit earned for the year. This applies to members over age 65 who earned such additional pension in the year. You can use any reasonable method to estimate the amount of the excess. Year's maximum pensionable earnings (YMPE) Use the YMPE for the year that the pension credit is being calculated, even if the benefit formula requires the use of the YMPE for other years. The following examples show how to calculate the benefit earned and pension credits for several types of defined benefit provisions. Flat benefit To calculate the benefit earned in the year, multiply the fixed amount by either the number of months or the fraction of the year worked during the year, depending on how the flat rate is expressed. A couple of examples are looked at. 44 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 1. Pension formula: $25 per month for each complete year worked Benefit earned: 12 months AT $25 = $300 Pension credit: (9 X $300) - $600 = $2,100 Percentage of contributions: Calculate the benefit earned by multiplying the percentage defined under the plan by the member's contributions made in the year. 2. Pension formula: 40% of member's contributions per year Member's contribution: 5% of earnings per year Member's salary: $40,000 Benefit earned: 40% OF (5% X $40,000) = $800 Pension credit - (9 X $800) - $600 = $6,600 Final, best, or career average earnings To calculate a member's benefit earned, multiply the plan's benefit rate by the member's pensionable earnings. Pension formula: 2% average of final 3 years of earnings Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 45 Member's earnings: $40,000 Benefit earned: 2% of $40,000 = $800 Pension credit: (9 X $800) - $600 = $6,600 Deduction Carry Forward (Carry over Provision) Any portion of contribution limit not used in prior years can be carried forward indefinitely. This replaces the old rule, which limited the carry forward to a period of seven years. In general terms, an individual’s unused RRSP deduction room available at the end of a year is the difference between the RRSP deduction limit for the year less the deductible contributions made in respect of the year. This will allow an individual to catch up on contributions to which the individual was entitled in a year but was unable to make for some reason, such as not having the cash. Example using the above figures: Assuming a $1,200 allowable RRSP contribution limit, But Only a $700 contribution by the member, there is an allowable carryover of $500 to be used in another taxation year. This carry over is allowed for an unlimited time span. Pension Adjustment Reversals Under a defined benefit provision, a PAR is an amount that will restore registered retirement savings plan (RRSP) contribution room to an individual. This applies when the individual receives a termination benefit that is less than the individual's total pension adjustments (PAs) and past service pension adjustments (PSPA’s). 46 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Under a deferred profit sharing plan (DPSP) or a money purchase provision, an individual's PAR is the amount included in his or her pension credits but to which the individual ceases to have any rights at termination. An individual will only have a PAR under a DPSP or a money purchase provision if he or she is not fully vested at termination. Canada is tax-assisted saving for retirement system allows individuals to get tax assistance to build their retirement savings. The system limits total retirement savings under RRSPs, registered pension plans (RPP’s) and DPSPs to 18% of an individual's earned income to a dollar maximum for the year. Individuals who are members of RPP’s or DPSPs have a pension adjustment (PA) reported each year. This reduces the amount that they can deduct for contributions to RRSPs in the following year. Members of RPP’s can also have past service pension adjustments (PSPAs) reported that reduce the amounts they can save for retirement through RRSPs. The PAR will restore individuals' RRSP contribution room in cases where their PAs and PSPAs are more than the benefits they received from the RPP or DPSP on termination. By restoring RRSP contribution room, PAR’s will make the system for tax-assisted saving for retirement more fair and more effective for those who change jobs or move in and out of the workforce. Administrators of RPP’s and trustees of DPSPs will have to determine PAR’s for individuals who terminate from a plan provision in 1997 and later years. When an individual terminates from a provision, he or she is no longer entitled to benefits under the provision. An individual need not have to end employment, only to stop participating in the provision. The date of termination is generally the date on which the termination benefit is paid from the provision. This can be a cash payment to the individual or a transfer to the individual's RRSP. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 47 For example, if an individual left employment in 2010 but did not receive his or her termination benefit until 2011; a PAR will have to be determined for the individual. Usually, a plan administrator will have to report a PAR shortly after termination. A PAR will be added to an individual's RRSP contribution room for the year of termination. When an individual terminates from a plan in 2010, the PAR rules deem, for the purposes of reporting the PAR that the individual had terminated in 2011. The PARs for 2010 and 2011 are not due until March 31, 2012. 2. CORPORATE GROUP REGISTERED RETIREMENT SAVINGS PLAN One of the fastest growing retirement vehicles today is an employer-sponsored group RRSP. RRSP Contribution Levels RRSP Limits Year Formula Actual 2005 $16,500 $16,500 2006 $18,000 $18,000 2007 $18,000 indexed $19,000 2008 $18,000 indexed $20,000 2009 $18,000 indexed $21,000 2010 $18,000 indexed $22,000 2011 $18,000 indexed $22,450 2012 $18,000 indexed $22,970 2013 $18,000 indexed indexed 48 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 The Group RRSP can be either Structured or Voluntary The Structured Group RRSP is similar to a Defined Contribution Plan (Money Purchase). The employer arranges for a plan for the employees, and source deducts the contributions. The employer may match or contribute to the employee’s contributions. The employer may “opt out” in low or non-profit years. Their contributions will sometimes vary to reflect length of service. This can lead to a higher cost of pension benefits for the older employees. The company may also pay all the plan costs. While the employer’s contribution is taxable income to the employee, it is offset by their deduction for the contributions made on their behalf. Contributions are limited to 18% of a member’s earnings (combined total of employer & employee contributions). The only drawback to the employer is that they lose control of the funds and the RRSP may not provide sufficient retirement income. The Voluntary Group RRSP A Voluntary Group Registered Retirement Savings Plan (RRSP) is a collection of individual RRSPs where routine administration is centralized. Plan Sponsors are not required to con-tribute to the Voluntary Group RRSP. It offers members special benefits such as favourable interest rates and lower investment minimums which they would not normally receive individually. There is no Employer contribution, with immediate vesting and the contributions are not locked-in. At retirement the proceeds may be taken in cash, or choice of a RRIF or an annuity. Cash withdrawals are subject to tax. Spousal RRSP Whether the Group RRSP is Structured or Voluntary, there are definite advantages of contributing to a spousal Group RRSP. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 49 An individual may contribute to an RRSP of which he or she is beneficiary and/or to a spousal plan. The spousal plan provides a means of splitting retirement income between spouses. However, if an amount is withdrawn from a spousal RRSP within two years from the year in which the last contribution was made, the withdrawal will be taxed in the hands of the contributing taxpayer. A spousal RRSP may also be advantageous where the spouse is younger, since a longer accumulation period will be available. It should be noted that a taxpayer’s ability to contribute to a spousal RRSP will not be reduced if the spouse has earned income and has made a contribution to his or her own RRSP. The receiving spouse is the applicant, owner and annuitant and signs the request for registration. The tax deductions certificate issued may or may not include the spouse contributor’s name, but can be used by them regardless. Instant Tax Savings with a Group RRSP The big difference with a group plan is that the contributor realizes the tax savings immediately, instead of having to wait until the end of the tax year. With an individual RRSP contribution, the tax break comes as a refund after taxes are filed the following year. This means of course, the government gets to enjoy an interest free loan of the contributor’s money. On the other hand, Group RRSP contributions are made on a pre-tax basis, so the amount of tax withheld by the employer is calculated after the group RRSP contribution is deducted from taxable income. Result - an instant tax saving to the employee. With a group RRSP, you will not over pay your taxes during the year and then have to wait until your income tax return is processed to receive a refund. A Group RRSP cuts taxes instantly at source and provides the difference as extra take-home pay to be spent or saved as the employee pleases. 50 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Illustrating the Difference with a Group RRSP (25% Tax Rate) No Group RRSP Group RRSP Monthly Salary $5,000 $5,000 Group RRSP Contribution $0 $500 Taxable Amount $5,000 $4,500 Tax Deducted At Source $1,250 $1,125 Non Group RRSP Contribution $500 $0 Remaining Income $3,250 $3,375 The above table compares an employee who contributes to a Group RRSP to one who does not. For every $500 monthly contribution to a Group RRSP, tax deducted at source is $125 less. Each dollar invested in a Group RRSP will cost this employee only 75 cents (cost will vary according to salary, amount of contribution, province and personal situation). The $125 difference, when multiplied by 12, equals the tax refund normally received in the following year - assuming the employee saves $6,000 ($500x12) in after tax dollars during the year and deposits it in a single lump sum into a regular RRSP at the end of the year. Reasons why Companies want to implement a Group RRSP. Establishes a formal corporate policy with respect to length of service and old age. Provides for a positive influence on employee culture and attitude. Shows a definite concern for the employees. Most flexible registered retirement plan available. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 51 The Group RRSP is often perceives as a pension plan. Employer contributions are not required. Executives and owners can participate. Inexpensive method of setting up a retirement plan. Tax deductible administration expenses, and tax effective form of compensation. If the plan is no-load, there are no expenses. Employers know what the cost is to fund this retirement vehicle. Advantages for the Employee Convenience of automatic payroll deductions to facilitate retirement savings. Immediate tax relief through payroll deductions. Creditor protected assets with a named beneficiary. Investments are secure through enhanced CompCorp protection on the assets. An employee can have greater peace of mind knowing that their money is safe and will be there when they retire. Competitive compound interest rates on the growth of assets. Easy administration, with regular statements provided from the carrier. Employers will respond positively to the employer. One on One retirement planning advice from an investment professional, who will provide the employee with a wide choice of options such as: Lump sum transfers from other institutions. Spousal RRSP. Conversion to an annuity or RRIF privileges. Can access employee contributions at any time 52 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Still More Reasons Why an Employer Should Consider a Group RRSP 1. Low cost: Unlike many bank GICs or mutual funds, some Group RRSPs require only a minimum contribution of $25 per month. The more you save and the longer you can do so, the bigger your retirement income will be. 2. Defer taxes: All RRSP contributions reduce the income tax you pay. Investment earnings grow tax-free until you withdraw them. 3. Immediate tax relief: A $25 contribution only costs you $15 off your net pay (assuming a 40% tax bracket) because you get your tax break when each contribution is made. 4. Payroll deduction: Your contribution is deducted from your paycheque before you have a chance to spend it somewhere else. This can be a painless way to save. 5. No front or back end loads: There are no fees charged for moving assets from one investment to another. There are no hidden administration costs - the investment management fees you pay are negotiated between Group carrier and your employer. 6. Access to competitive investment options: Group RRSPs offer you investments from a variety of top managers. The fund management fees are usually much lower than what you would pay yourself, because you’re part of a larger group. 7. Contribute on behalf of your spouse (if offered in your plan): If the income levels between you and your spouse differ significantly, the higher earner should make the RRSP contributions to get the biggest tax break. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 53 At retirement, the lower earner makes withdrawals from the Spousal RRSP at a lower tax rate. 8. Online or toll-free phone services: Most Group carriers use web-sites, automated telephone inquiry systems or Customer Call Centres to: obtain account information monitor investments & process transactions 9. Retirement planning tools: A variety of tools are available from the online or telephone services to help you monitor your contribution amounts and investment returns. 10. Regular updates: Through your member statements, newsletters, and reference materials, you receive regular updates to help you plan for your retirement. Advantages & Disadvantages of a DC Money Purchase Plan vs a Structured RRSP Item Defined Benefit Plan Structured Group RRSP Registration of contract and plan document Federal and Provincial Canada Revenue Agency (CRA) only. Future amendments simple Filing of Annual Information Returns Yes, Ontario and Federal No, less paperwork Annual Fees Yes. Dollar amount per member per year. Fees are higher for late filing No annual fees (cost savings) Filing of amendments on plan documents Yes, each member must be notified of amendments when filed and again when approved. Not required. Members in other Provinces Plan documents must reflect complex regulatory provisions in each province. Not required 54 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Dictated by government (maximum of 2 years service and eligible employee must be allowed to enroll) As dictated by employer. Employer can decide who joins the plan and who does not (flexibility) Must part-time employees be allowed to join? Yes, as dictated by legislation. No, as dictated by employer. Is there a minimum employer contribution each year? Yes, minimum of 1% of earnings. No, contributions are flexible at discretion of employer. Formation of pension investment committee for investment input. Yes. If the majority of members (and former members) request one. Not required. (No executive time required for meetings. Filling Annual Investment Objectives with Ontario Yes, for certain plans. Not required. (cost and time savings) Retirement options Life Annuity and LIF only Life Annuity, RRIF, Term Certain, cash or combination (flexibility) Retirement dates Anytime prior to age 69 Anytime prior to age 69. Can bonuses be paid directly to the plan (to obtain a source deduction of tax) No Yes, bonuses can flow directly to the plan with no source deduction of Income Tax. Administrative costs Higher than Group RRSP because of Government compliance / documentation requirements. Lower because of simpler administration. Remittance of employee and employer contributions Must be done monthly Monthly or any other frequency determined by employer. Impact of Workers’ Comp Act, 1989 Amendments If member cannot work, employer must continue contributions to plan for up to one year. Not applicable. Vesting of employer contributions. Usually after two years of plan membership (forfeitures before two years) Immediate vesting. Impact of payroll taxes on employer contributions No impact. Yes, extra costs for CPP, EI, Health Taxes, WSIB etc. Contributions Limit is based on current year’s earnings. Limit is based on the previous year’s earnings. Eligibility requirements Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 55 3. PROFIT SHARING PLANS These types of plans are also money accumulation plans where all or part of the plan is funded based on profits of the employer. They can often be combined with Group RRSP’s. The Group RRSP being funded with the employee’s money while the Profit Sharing portion is made with the Employer’s money from profits. Unlike Defined contribution plans, employees generally will have the option of withdrawing all or part of their account balance while continuing in the employment of that company. Profit Sharing plans can take many forms, but there are two main types. 1) Deferred Profit Sharing Plans (DPSP) Deferred Profit Sharing Plans are plans that are registered under the Income Tax Act, with only the employer contributing on behalf of the employee. These contributions are based on profits of the company. A Trustee usually controls the DPSP. The maximum annual employer contribution is the lesser of 18% of the salary or wages paid by the employer to the employee and the annual dollar maximum limit. Deferred Profit Sharing (DPSP) Limits Year Formula Actual 2005 $9,000 $9,000 2006 $9,000 indexed $9,500 2007 $9,000 indexed $10,000 2008 $9,000 indexed $10,500 2009 $9,000 indexed $11,000 2010 $9,000 indexed $11,225 2011 $9,000 indexed $11,485 2012 $9,000 indexed $11,970 56 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 For employees who belong to an RPP and a DPSP, special rules apply to ensure that the contributions made under both plans do not exceed overall limits as prescribed in the retirement savings legislation. All employers’ contributions to a DPSP must vest immediately if the individual has been a beneficiary under the plan for two years. In any other case, the contributions must vest within two years. These contributions are tax deductible to the employer, while not immediately taxable to the employee. The benefits become taxable to the employee when they are received. DPSP money can be rolled into an RRSP or an RPP. Employee contributions to a DPSP are prohibited. Employer contributions must be considered in computing the individual’s pension adjustment amount used in establishing the following year’s RRSP limit. These types of plans can compare to Defined Contribution Pension Plans. RPP/RRSP/DPSP COMPARISON ACTION RPP DPSP RRSP Income Splitting No Yes Eligibility Proprietors Partners excluded Payout Options at Retirement Life Annuity Life Income Fund No Proprietors (Partners and Shareholders excl.) Life Annuity Cash 10 year payout RSP/RRIF Payment Flexibility During Calendar Year, Payroll Deducted, Employer Contributions within 120 days of fiscal year end Yes Transfer by spouse Life Annuity Life Annuity Locking-In Death Benefit Past Service Employer Contributions Employer Only Minimum 1% of earnings Tax Reduction at Source Yes Any Taxpayer Life Annuity Cash Term, Certain RRIF No No Transfer by spouse Transfer by spouse None Carry Forward Out of profits. Not officially No minimum recognized Yes - if payroll N/A deduction but prior approval required Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 57 2) Employee Profit Sharing Plan (EPSP) These types of plans are also registered under the Income Tax Act. The employer’s contributions are not subject to any limits. They are deductible to the employer with immediate taxation to the employee. An EPSP is an arrangement whereby an amount is paid to a trustee (or trustees) to be held for the benefit of some or all of your employees. Although such plans are often used to share profits with key employees, you can also establish one of these plans exclusively for your benefit and the benefit of your family members who are employed in the business. What are the tax implications of EPSP? The company accrues a payment to the EPSP trust which is fully deductible by the company if paid within certain timeliness. The EPSP trust is exempt from tax and is not required to file a return. However, there are certain nominal compliance requirements that must be managed. Each year, the amount allocated to a particular employee is included in the respective employee's taxable income for the year. No source deductions are required with respect to the amount allocated to the employee. When would an EPSP be beneficial? If the employer can answer 'yes' to the following questions, an EPSP may be beneficial to them. Do they routinely follow a policy of "bonusing-down" to the small business limit (currently $300,000 federally)? Are they expecting a large one-time increase in income (possible due to a sale of a division or business resulting in significant recapture or gain on the sale of goodwill)? Do regulatory requirements or their current business structure prevent them from effectively income splitting with other family members? 58 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Under certain circumstances, an EPSP can be used as an alternative to traditional remuneration strategies to effectively defer tax and facilitate income splitting. What about tax deferral? An EPSP can potentially provide an initial tax deferral of one year beyond that which can be achieved through a bonus accrual. This deferral aspect works best for corporations with a fiscal year ending after September 3rd (generally, September 30th, October 31st, November 30th and December 31st.) For example, consider a situation where a company's pre-tax income is expected to be approximately $2,000,000 and the company's year-end is September 30, 2012. The company is planning on declaring a bonus to the owner-manager to reduce its taxable income to $300,000. An EPSP could be established so that the amount that would otherwise be paid as a bonus to the owner-manager is paid to the EPSP. Although the company can claim the amount as a deduction for its fiscal year ended in 2012, the amount does not have to be paid to the EPSP until January 28, 2013. The EPSP will then allocate the amount to the beneficiaries of the plan in 2013 as determined by the trustees. If the timing of the transactions is appropriately managed, the approximately $750,000 in source deductions that would otherwise have to have been remitted to the CRA on the bonus can be deferred for approximately 12 months. This amount can continue to be invested for an extra year, generating additional after-tax income. Does an EPSP allow income splitting? Under the right circumstances, an EPSP can also be used to enhance income splitting opportunities. The result is the ability to spread taxable income among individuals, utilizing lower marginal tax rates. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 59 Based on current marginal tax rates, if $100,000 of income can be allocated from one individual who is otherwise subject to the highest marginal rate of tax, to one or more individuals with nominal income (say $6,000), the income tax savings can be anywhere from approximately $8,000 to over $25,000 (the actual savings will vary by province and the number of beneficiaries of the plan). This benefit could be obtained each year. Note The initial costs of setting up one of these plans could in most cases be easily recovered in one year. 4. EMPLOYEE STOCK OPTION PLANS Stock options are an important way of motivating employees, especially in the high-technology industry where many start-up companies have grown rapidly into multinational businesses. Because Canada is a relatively high-tax jurisdiction in close geographic proximity to the world’s dominant high-technology player (the U.S.), the effective use of employee stock options is particularly critical to Canadian high-tech companies seeking to attract and retain the services of key employees. Some firms offer these stock option plans. The dividends earned can boost retirement income or the stock can be sold at retirement and used to provide additional income from the capital. When an individual is granted a stock option by virtue of his or her employment, there are no immediate income tax consequences. At the time the option is exercised, however, the excess of the fair market value of the stock over the option price is fully taxable as an employment benefit, subject to the two exceptions noted below. For purposes of calculating capital gains (or losses) on a subsequent disposition of the shares, the tax cost of the shares acquired will be the fair market value at the time of exercise. 60 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 The decision to exercise stock options is motivated primarily by investment criteria. However, it should be noted that growth in the stock value subsequent to exercise would be taxed on a future sale as a capital gain. If the shares are qualifying small business corporation shares, the gain can be reduced using the enhanced capital gains Tax Rules on Employee Stock Option Plans Stock option plans are quite often an integral part of an employee’s compensation package to create long term capital use in retirement. Companies implement these plans to attract, reward and retain highly skilled employees. What is a stock option? A stock option allows the employee to purchase a certain number of shares at a specified price (‘the option price’) for a specified period of time. Often there is a holding period during which the employee cannot exercise the option. Once this holding period is over, the option is considered ‘vested’ and the employee can exercise the option any time thereafter until the expiry date, if any. This article will review the different tax rules associated with option plans for Canadian-controlled private corporations (CCPCs) and non-CCPCs i.e. Canadian public corporations. Taxation of stock options from Canadian public companies While there are no tax consequences when such stock options are granted, at the time the employee exercises the option they trigger an ‘option benefit’. This benefit is equal to the difference between the market value of the stock and the ‘option price.’ This benefit must be included in the employee’s income from employment in the year in which the option is exercised. The employee can claim a tax deduction equal to one-half of the ‘option benefit’ if the shares are common shares and the exercise price, at the time the options were granted, was equal to the fair market value of the shares. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 61 For example: You have options to acquire 3000 common shares of ABC Company at $30 per share (equal to the fair market value of the shares on the date the options were granted). Current market value of ABC’s common shares is $75. All options are vested. If all 3000 shares are exercised, the taxable ‘option benefit’ is $67,500 ($75$30 = $45 x 3000 shares x 50%). Taxation of stock options from Canadian controlled private corporations Employees of CCPCs do not need to include the ‘option benefit’ in income until the year in which the employee disposes the shares. As with non-CCPC shares, the option benefit may be reduced by one-half as long as the exercise price at the time the options were granted was equal to the fair market value of the shares. If it does not meet these criteria, an employee may be able to access another one-half deduction as long as the shares have been held for at least two years at the date of sale. Deferring the ‘Option Benefit’ The 2000 Federal budget introduced a deferral of the ‘option benefit’ for nonCCPCs until the employee sells the shares, or is deemed to have disposed of the shares on death or on becoming a non-resident of Canada. This deferral applies to options exercised after February 27, 2000, regardless of when the options were issued. The amount that may be deferred is limited to the benefit arising on $100,000 worth of stock options vested in a particular year. While the $100,000 amount is based on the fair market value of the shares at the time the option is granted, the actual benefit that can be deferred can be much greater. 62 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 This can best be illustrated by example: In January 2010, an employee received 10,000 qualifying shares at an option price of $25 per share equal to the fair market value at the time of grant. Of the 10,000 options, 5,000 vested in January 2011 and the remaining 5,000 in January 2012. On December 1, 2012, all options were exercised. The fair market value of the shares on that date was $60. In 2014, the employee sells all 10,000 shares at a fair market value of $65 per share. Tax Calculation Step One Calculate the number of shares that can be deferred. The $100,000 maximum deferral is based on the $25 fair market value. Therefore the income benefit that the employee can defer in our example is based on 4,000 shares per vested year ($100,000 / $25). Step Two Calculate the income deferral. (Number of shares * benefit per share) 2011 deferral = $140,0000, (4,000 shares * $35 ($60-$25)) 2012 deferral = $140,0000, (4,000 shares * $35 ($60-$25)) Total deferral - $280,000 Step Three Calculate the income benefit. 2011 income inclusion = $175,000, (5,000 x ($60-$25 = $35)) 2012 income inclusion = $175,000, (5,000 x $60-$25=$35)) Total income before deferral - $350,000, less deferral (from Step Two) = $280,000 Total income reported in 2012 = $70,000 Of this $70,000 only 50% is taxable at the employee’s marginal tax rate. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 63 2014 Tax Calculation The employee now pays the tax on the $280,000 option benefit that was deferred and the gain on the shares from 2012 to 2014 ($65-$60 x 10,000 shares = $50,000). The total income reported when the shares are sold is $215,000 ($330,000 x 50%) General Comments on Employee Stock Options & Canada Revenue Agency (CRA) A few points are relevant to federal income taxation of all employee stock options: Where employers do not withhold from employees’ salaries any amounts relating to stock option benefits, it is important for employees to be aware of how much will be added to their income for tax purposes from the stock option benefit, and they should set aside an appropriate amount of cash to fund the tax on this amount (whether from the sale of the acquired shares or from other sources); Whenever the employee exercises stock options at a time when she owns other shares of the employer, she cannot assume that it is possible to immediately sell the newly acquired shares without realizing a capital gain. This is because the ITA averages the tax cost of all identical shares held by a person at one time. As such, if an employee buys 10 shares at $2/share, and later exercise options to acquire another 10 identical shares at a strike price of $8/share while still holding the first 10 shares, she cannot sell the 10 newly acquired shares for no gain. Instead, the ITA deems each of the 20 shares to have a $5 tax cost, such that an immediate sale of 10 shares will produce a $30 capital gain. While a recent announcement by tax authorities indicates a willingness not to apply this averaging rule in some circumstances, it remains a potential trap for employees exercising employee stock options; and 64 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 When an employee claims a very large amount in a year under one of the one-third deductions for employee stock option benefits described above, the possibility of triggering “alternative minimum tax” levied under the ITA must be considered. While the ITA rules dealing with the taxation of employee stock options are not simple, they do offer significant tax advantages for many employees, especially when the appropriate planning takes place to ensure that the optimum benefits arise. The stock option rules in the ITA represent one of very few tax advantages in the ITA available to employees. Employee stock option benefits may qualify for Research and Development (R&D) tax credits Employees who exercise stock options are required to include an amount in income as a taxable benefit to the extent the exercise price is less than the fair market value of the shares at the time the option is exercised. Employees of Canadian-controlled private corporations (CCPC’s) can generally defer reporting this taxable benefit until the year the shares are sold. Employees of other corporations are required to include the amount in income in the year the option is exercised, unless an election is made to defer the reporting to the year of sale. In a recent tax case, Alcatel Canada Inc. v. The Queen, the Tax Court held that a company could include a portion of the value of its R&D employees’ taxable stock option benefits as a qualified expenditure for purposes of calculating its R&D Investment Tax Credits (ITC’s). Although it is not yet known if this case will be appealed, it could open significant opportunities for increasing R&D investment tax credit (ITC) claims. If your company is involved in R&D and compensates its R&D employees with stock options, consider including the value of taxable employee stock option benefits as an eligible expenditure when filing this year’s ITC claim. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 65 Restricted Stock Plans Equity compensation plans that include the awarding of shares by an employer to an employee that are subject to certain restrictions are referred to as restricted stock plans. The employee receives legal title and assumes most other risks and benefits of ownership at the award date, but is generally subject to restrictions with respect to selling, voting, and/or pledging of the shares. The restrictions are normally eliminated over time provided the individual remains employed with the company. The employment benefit is generally calculated when the employee has many of the rights and benefits of ownership; namely, on the date the restricted stock is awarded. The taxable employment benefit is equal to the fairmarket value of the stock at that date. For shares of non-CCPCs, the fair market value is included in the employee's income at that time. For CCPCs, the benefit is automatically deferred until the year the shares are disposed of similar to the deferral under stock option plans. There is no 50-per-cent stock benefit deduction for non-CCPC share awards since the conditions for such a deduction cannot be met. In the CCPC situation, the 50-per-cent stock benefit deduction may be available if the shares are held for two years or more before disposal. Again it is the employer's responsibility to properly report the employment benefit and, if applicable, the deduction on the employee's T4 supplementary. Employee withholding responsibilities must also be considered. Here too, a few points should be highlighted: As previously mentioned, the employment benefit is based on the fair-market value of the stock at date of award. Such stock is not freely tradable at that date. For this purpose, an appropriate discount should be applied in arriving at fair-market value, one that takes into account the stock restrictions that exist at the date of the award. While there are a number of methods that may be applicable in determining the appropriate discount, to date, none have been prescribed by the Canada Revenue Agency. 66 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Any dividends received before these restrictions are lifted would be treated as dividend income. If at a future date, the employment requirements are not met and the shares are forfeited, the employee will realize a capital loss equal to the difference between the employment benefit and the proceeds received as a consequence of the forfeiture. The resulting capital loss may be applied against capital gains realized in the year. To the extent the capital loss is not utilized in the current year, it can be carried back three years or forward indefinitely to offset capital gains realized in those years. In isolated circumstances for CCPC shares, any resulting allowable capital loss (50-percent of the capital loss) may be available to offset other income in the year. Phantom Stock Plan Phantom Stock plans are designed to provide employees with the ability to participate in the future appreciation of a company's stock without any shares actually being issued to the employee. Generally at the end of the vesting period, employees receive or are credited with an amount equal to the appreciation in the stock over the vesting period. Depending on the design and nature of the plan, it may or may not be considered a salary deferral arrangement ("SDA") for Canadian income tax purposes. An SDA is generally an arrangement under which a person has a right to receive salary or wages earned currently after the year-end and it is reasonable to consider one of the main purposes was to postpone tax. There are some specific exceptions, such as the three-year payout rule, and plans are often designed to avoid being classified as an SDA. If the plan is in fact an SDA, the employee will be required to include in income the value of any benefit as at accrues in the plan. If it is not an SDA, the employee would generally be taxed on any employment income in the year the individual receives the amount or is entitled to enforce payment of the amount. The Retirement Compensation Arrangement rules should be reviewed if the payouts from such a plan are to be made upon or after retirement. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 67 Conclusions The personal tax implications of equity compensation plans for employees can be substantially different depending on the type of plan being implemented and the Canadian tax status of the company implementing the plan. In order to establish an effective equity compensation plan for Canadian employees, it is important that plan designers be fully aware of the personal tax implications for employees. A plan can then be designed to minimize negative personal tax implications and, hopefully, maximize the positive impact such plans are intended to provide. 5. INDIVIDUAL PENSION PLANS (IPP’s) An IPP is a Registered Pension Plan created for a qualifying individual, which is designed to meet his or her needs within the constraints imposed by the retirement savings legislation. In some circumstances, a larger contribution can often be made to an IPP than to an RRSP. If this were the case, a greater amount would be accumulated at retirement. Since IPP’s are more complicated and less flexible than RRSP’s, and may not provide an enhanced retirement fund in all cases, your clients and prospects should consider extensive research before establishing an IPP. The existing RRSP legislation was created in 1957, at which time inflation and indexing were not taken into account. As a result, RRSP contribution limits are woefully inadequate for high-income earners. In 1991, the federal government remedied the situation by enacting the IPP legislation (in the Income Tax Act of Canada, subsection 147.1) to compensate high-income earners disadvantaged by RRSP rules. 68 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 In a nutshell, the IPP is essentially an RRSP upgrade, with three main differences: 1. IPPs have significantly higher limits to contributions. 2. They have creditor proofing, 3. They have restricted collapsibility options. IPPs cannot be fully collapsed unless the plan holder is critically ill, severely disabled or has fallen on financial hardships. In essence, IPPs effectively guarantee the holder an income for retirement. Are IPP’s the Choice for Your Corporate Clients? In recent years individual pension plans or IPPs have become a popular retirement savings tool for many executives. This is due in part to changes in provincial pension benefits legislation and to the active promotion of the potential advantages of IPPs by insurance companies and financial institutions. The primary candidates for IPPs are business owners, company executives and incorporated professionals over the age of 45 with an annual income greater than $100,000 per year. An IPP is a defined benefit registered pension plan established for the benefit of a single employee. The annual retirement benefits funded by the plan are defined by the terms of the plan and are based on a percentage of the employee’s annual employment income. Unlike a group pension plan, the benefits payable can be designed to suit the needs of the individual beneficiary of the IPP. The IPP can be funded by employer and employee contributions or fully funded by the employer. To qualify as an IPP the employer must fund a minimum of 50 per cent of the required contributions. The most significant advantage of an IPP is the allowable contribution limit, which is generally higher than the contribution limits available under an RRSP. This enables the plan beneficiary to accumulate a significantly larger pool of retirement savings than would otherwise be accumulated using an RRSP. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 69 Other potential advantages include: The ability to make pension contributions in respect of past employment service. A guaranteed amount of retirement income if the employer agrees to fund additional contributions should the IPP realize poor investment returns. Participation by the employee in the investment decisions made by the IPP. Protection from creditors of both the employer and the employee (under provincial pension legislation). Multiple retirement income options (annuities may be purchased from an insurance company, funds may be transferred to an RRSP or the IPP may pay an annual pension). Although the advantages related to an IPP are significant, there are several disadvantages that must be fully considered: Unlike an RRSP, the funds will be locked in and access will be restricted until retirement. It is not possible to split retirement income by making a contribution to a spousal plan, as is the case for a spousal RRSP. Defined benefit plans have extensive financial statement disclosure requirements, and determining annual pension costs, asset values and liabilities is complex. Set-up costs and annual operating costs are significantly higher than those associated with an RRSP (an IPP requires an actuarial valuation on set-up and every three years thereafter). An annual filing with Canada Revenue Agency is required for IPPs. However, in recent years the market for IPPs has become more competitive and the costs associated with establishing and maintaining an IPP have been reduced. 70 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Is an IPP right for your client? The answer will depend upon their particular circumstances. You should consider reviewing the IPP option if they are within 15 to 20 years of retirement, have an annual income of over $100,000 and anticipate retiring with their current employer. IPPs versus non-IPPs Imagine you have a 55-year-old client, John Doe, who has owned an incorporated business since 1991 with a T4 income of more than $100,000 and a marginal tax rate in Ontario of 46.41%. This client is serious about saving for retirement and in the next 10 years, when he reaches 65 he plans to retire. By creating an IPP for him this year, your client will be able to defer $114,743 immediately from taxes from his company's and his personal income. This money will then be compound tax-free. The next year John Doe will be able to contribute an additional $24,122 into his IPP and his contribution room will increase by 7.5% annually until he retires (the investment chosen for this example are bonds earning 7%). When John Doe reaches 65, he will have accumulated $632,384 in his IPP. If this client decides not to create an IPP for himself and instead chooses to take this same amount of money out of his business, after having paid the personal marginal tax rate of 46.41%, for the purpose of saving for retirement, then his financial situation becomes much different. The first year after taxes, John Doe will be left with $61,490 to invest. The following year, after taxes, he will make a $12,927 contribution to his nonIPP; and this contribution will grow at 7.5%. At age 65, he will have an accumulated value in his non-IPP of $276,435. Based on the stated assumptions, this particular client's IPP will be $355,949 greater than his nonIPP. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 71 What Does One Canadian Regulator say about IPP’s? FSCO is aware that Canada Revenue Agency (CRA) is concerned that transfers from registered pension plans to Individual Pension Plans (IPPs) may not always comply with the federal Income Tax Act (ITA). There is some concern that some transfers to IPPs do not satisfy the requirement under the Ontario Pension Benefits Act (PBA) that amounts transferred must be administered as a pension or deferred pension. This means that the eventual payment from the IPP must be made only in the form of a pension. Money that should be paid as a pension must not become surplus and subsequently be paid out in cash. FSCO wants to warn individuals who may be considering an IPP, of the possible problems that may occur if the transfer is not done in accordance with pension legislation. Plan administrators should be aware that a transfer of the commuted value to an IPP cannot occur unless the administrator of the IPP certifies that the money transferred will be administered as a pension or deferred pension. ALTERNATIVE DEFERRED COMPENSATION PLANS There are special provisions that exist for “Employee Benefit Plans”. “Salary Deferral Arrangements and “Retirement Compensation Arrangements”, which in generally seek to match the timing of the reporting of income to the claiming of a deduction. Under and EBP, the employer is not entitled to a deduction until such time as the employee receives an amount from the plan and is taxed also at that time. Income earned by the plan is subject of an immediate tax. Under an SDA, the employer is entitled to an immediate deduction. The employee is subject to tax, regardless of whether he or she actually receives payment or not. 72 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 1. RETIREMENT COMPENSATION AGREEMENTS (RCA’s) In the right circumstances a Retirement Compensation Arrangement, or RCA, could save you income taxes, provide golden handcuffs, retirement funding and/or help protect your assets. RCAs are designed to provide supplemental pension benefits for senior executives and owner-managers, and are also used to provide pension benefits to an employee or an employee group in situations where a company does not have a registered pension plan in place. The rules related to the operation of an RCA are less rigorous than the rules related to the operation of a registered pension plan. As such, RCAs are extremely flexible and can provide an employer with a wide range of alternatives related to employee participation, funding methods and timing of benefits. Operationally, RCAs are relatively straightforward. The terms of operation for the RCA are set out in the RCA trust agreement. The employer makes tax-deductible contributions to the trustee of the plan. The plan pays a special refundable tax each year equal to one-half of the contributions received plus one-half of the income and capital gains earned by the plan during the year. This tax is refundable to the plan on a basis of $1 for every $2 of benefits paid out during the year. The employee is taxed on benefits when they are paid out of the plan. An RCA contribution must be reasonable in order to be deductible to the corporation. This is the same test that all corporate expenditures must pass. The contribution limits are often actuarially determined on the basis of providing the employee with a reasonable pension based on a percentage of the employee’s average annual income earned during his or her years of employment. This can result in significant catch-up contributions when you start the plan, particularly if the company has a history of paying large bonuses. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 73 Various funding strategies are available to the company. The funding method is often selected based on the company’s cash requirements and its objectives in establishing the plan. Cash funding The company makes cash contributions to the RCA trust. One-half is used to pay the special refundable tax and the other half is invested. The RCA can loan the after-tax amount back to the company at a reasonable interest rate and with reasonable security. This can be a win-win situation for both parties. The company obtains financing at less than bank rates and the RCA earns interest at better than market rates. In some cases, arrangements can be made by the RCA to borrow against the refundable taxes and loan the proceeds to the company. In such cases the RCA loan arrangement has significant cash flow advantages over the traditional bonus and loan arrangements entered into by many owner–managers. Insurance funding The company funds a split-dollar life insurance policy under which the company is the beneficiary of the insurance policy and the RCA is the beneficiary of the investment component or tax-exempt surplus. Special refundable taxes must be remitted equal to the amount of the annual premium attributed to the tax-exempt surplus. The benefit of this arrangement is that the investment income earned within the insurance policy is tax exempt and not subject to the 50 per cent refundable tax. As such, the investment compounds at pre-tax rates. The death benefit received by the RCA will be subject to tax unless it is paid out to RCA beneficiaries in the year received. Under this arrangement the RCA funds benefit from policy loans and death benefits received. The fact that these investments are secure from business risks is also attractive 74 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Funding from future cash flow The company can undertake to fund the RCA out of future cash flow as the RCA’s benefit obligations come due. This arrangement provides limited current tax benefit to the company and can leave the employees at risk unless the company provides the RCA with some form of security. However, caution must be used when setting the security. The Canada Revenue Agency holds the view that the company has made a contribution if it provides the RCA with a letter of credit under which the bank encumbers specific corporate assets. This will result in a refundable tax liability equal to the amount of the encumbrance. On the other hand, a letter of credit secured by a floating charge on assets will result in a notional contribution equal to twice the annual fee. As noted earlier, RCAs can be a useful component of a company’s retirement package by providing flexibility and cash-flow benefits. Depending on the circumstances, other possible benefits include: Probate fee savings, since pension benefits do not flow through the estate Tax savings if an employee ceases to be a Canadian resident after retirement Flexibility in timing of contributions, allowing contributions to track profitability assistance in succession planning by ensuring retiring shareholders have sufficient retirement income RCAs do have one key disadvantage The refundable tax rate of 50 per cent results in a prepayment of tax because the top personal tax rate in all provinces is less than 50 per cent. This prepayment ranges from a high of 11 per cent in Alberta to a low of 1.4 per cent in Newfoundland. For most provinces the prepayment is approximately 3.5 per cent. Consequently, RCAs are more attractive to Newfoundland residents and less attractive to Alberta residents. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 75 Is an RCA right for your corporate clients? Your clients should consider discussing an RCA if: They are a shareholder in a private company with a history of income above the $300,000 small business deduction. Their company has the liquidity to pay bonuses or RCA contributions. Their company wants access to more capital. Their company wants to reward key employees who have worked for the company for a number of years. They want to create a pension and grow it by reinvesting it in your business. It is important to note that any arrangement for the deferral of employment of income is likely to be caught by provisions relating to “salary deferral arrangements” which in general provide for immediate taxation to the employee and immediate deduction to the employer. 2. LEVERAGED RETIREMENT PLANS (CORPORATE CASH VALUE) Access to the accumulated cash surrender value of a life insurance policy has always been achieved by one of two ways: 1. Taking a policy loan 2. Surrendering all or a portion of the cash surrender value. Both of these ways have been deemed by Canada Revenue Agency (CRA) to be a policy disposition, and therefore subject to income tax on a portion of the gain realized by the policy owner. This income tax would reduce the amount of aftertax money available to the policy owner. Your corporate clients and prospects can now take advantage of large cash values in the life insurance policies owned by them on the lives of the owner(s) and still maintain their insurance protection. This format is today’s way of offering the living benefits of the policy to possibly supplement the retirement of key individuals. 76 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 More income and continued protection. The corporate sector is a major purchaser of permanent life insurance for several reasons, including key-person insurance, business loan insurance and buy-sell funding. Often the corporation to provide a supplemental retirement income to the owner of the business uses the cash values in their policies. Annuitization can result in a significant tax liability if the policy was purchased after December 1981, when the federal government began treating annuity elections as dispositions for tax purposes. This step would also mean the loss of the insurance protection. How it works. Over the past few years, a new concept has emerged, that has effectively provided access to these funds on a tax-free basis. A series of consumer loan or loans advanced by an independent financial institution to the owner of the policy, secured by a collateral assignment of the policy, is currently not considered a taxable benefit. In short, what happens is a series of periodic payments to the policy owner, with the understanding that the total amount of indebtedness cannot exceed the ability of the life insurance policy to provide the adequate security for the loan. If a Universal Life policy were used, the size of the loan and margin would depend upon the nature of the Investment Fund Options selected by the policy owner. As a rule of thumb, 90% of a policy with guaranteed funds and 50% for a policy if non-guaranteed funds were chosen would be acceptable. Both the income paid to the executive of the company, and the interest charged on the loan are deductible expenses to the corporation, as long as the policy stays in force, (and provided the business remains active and profitable and the retirement income is comparable to the final salary of the owner). Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 77 Selling points for your clients and prospects The company can provide additional retirement income to owners / managers over and above that provided by registered plans and other benefits. This would include bridging benefits for early retirement. The benefit to the company (if the company is a Canadian private corporation) is substantial because Canada Revenue Agency (CRA) allows the excess of the death claim proceeds over the adjusted cost basis of the policy to be included in the capital dividend account of the corporation, even though part of the proceeds were used to pay off the institutional loan. The result – more potential for taxfree dividends for corporate shareholders via the capital dividend account. (Note: Capital Dividends are free of income tax in the hands of shareholders if they are residents of Canada). The flexibility of the program allows the loan payments to be paid out over virtually any specified period. In addition, because the loan is tied to the cash values of the life insurance policy, the size and timing of the loan payments van be established immediately. Clients have three options for paying the interest on the loan: 1. Regularly 2. Periodically 3. Capitalized A Win-win situation for everyone! Non-taxable income for the corporation Because loans from financial institutions are not currently taxable, corporations receive extra income tax-free. As well, corporations avoid the tax liability that occurs if the insurance policy is annuitized. The corporation uses the cash available from the life insurance policy to pay retirement benefits or for other purposes. 78 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 More retirement income for the owner or manager The owner or manager can receive additional retirement income, or bridging benefits in the case of early retirement. This is particularly important in view of the limits on tax-assisted retirement savings. (For example, the retirement income limits on Defined Benefit Plans. Also Canada Revenue Agency (CRA) will no longer permit the purchase of a one-shot past service pension benefit on retirement.) Life insurance protection Clients and prospects can still enjoy insurance protection. If the life insured dies while the policy is in force, the policy’s death benefit can be used to repay the financial institution loan. Any balance is paid tax-free to the corporation. Collateral security Since the loan is secured by the life insurance policy, the financial institution faces little risk. The life insurance policy itself is the collateral. Competitive interest rates Interest charges as a rule are the same as those for a regular personal line of credit, minimizing capital erosion. Living benefits It is a unique way for your corporate clients and prospects to take advantage of the benefits of some form of cash value life insurance. Flexibility of premium payments In this day and age, your clients and prospects can have the choice of continuing to pay premiums or using some form of offsetting the premiums, (20 Pay, 10 Pay, Universal Life etc.). Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 79 Who qualifies? Any Canadian corporation owning a cash value life insurance policy contract on the life of an owner or manager qualifies for the Leveraged Retirement program. To receive capital dividend account treatment, the company must also be a Canadian resident, private corporation. The policy must be assigned to the financial institution under its collateral assignment agreement. There are some limitations The leveraging concept can be an effective planning tool, but it may not be the answer for all of your clients and prospects. The effectiveness of this concept requires the lending institution’s eagerness to keep the loan open until the lifeinsured dies. The assigned policy must never lapse or be surrendered in order to repay a called loan. A significant tax liability may occur when either of these situations happens. Sharply rising interest rates could outpace the cash value growth of the policy and may require a reduction in the income that can be paid out. Alternatively, the corporation could pay down the loan. This requires closes monitoring to ensure the required margin between the loan and the cash surrender value of the policy is maintained. It is a good idea in order to demonstrate the risk involved, illustrate different spreads between the loan interest rate and the rate of return within the policy. Compound interest must be paid to be deductible for tax purposes. Where the interest on the loan is capitalized, a portion of the interest representing the compound interest will not be deductible until it is actually paid (i.e. After the death of an insured when the loan plus interest is repaid). A cheque for the compound interest could be paid to the financial institution followed by a corresponding increase in the amount of the loan or advance to ensure this interest is deductible. 80 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 All aspects of this agreement are based on current tax legislation. Tax rules could change. Even though the “consumer loan” is from another financial institution, Canada Revenue Agency (CRA) may apply the General AntiAvoidance Rules (GAAR) and deem the “consumer loan” to be a policy loan. Policy loans are a deemed disposition of the policy and all or a portion of the loan would be subject to taxation. Whereas the corporation owns the policy and is obligated under the terms of a binding commitment to pay future retirement benefits to an executive, the retirement compensation arrangement (RCA) rules under the Income Tax Act may be applicable. For this reason, the program generally will be limited in its application to the owner of the business. To illustrate the mechanics of how the Leveraged Retirement plan works, we have included an example for you. What do the Professionals say about “Exempt Life Insurance”? “Those individuals looking for tax shelters or deferral mechanisms may wish to explore the benefits that may be derived from an “exempt” life insurance policy. While professional advice is usually needed, it is to be noted that a substantial portion of the income from such investments may accumulate free of tax. Such income can also be utilized before death, and the proceeds are not generally subject to tax upon death. If the insurance is surrendered or loses its “exempt” status, tax may be payable. Assuming this can be avoided, such policies may be a powerful tool in the tax planning arsenal, particularly when other tax shelters appear to have been curtailed.” Coopers & Lybrand: 2005=2006 Tax Planning Checklist. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 81 CHANGES IN THE WAY THE TAX DEPARTMENT LOOKS AT RETIREMENT What you should know about employment terminations Each year, many Canadians experience the loss of their jobs due to company closures, downsizing, redundancy or some other cause. An unexpected employment termination can be personally and financially devastating. Planning for a termination is not usually possible, but planning because of termination is essential. The day the pink slip arrives Losing one’s job is traumatic, especially when the termination is unexpected. The decisions the employee is asked to make at the time of termination can be both difficult and, if not approached carefully, costly. Whether the period of unemployment is long or short, planning at the time of termination is essential. Planning opportunities In addition to the need for financial planning for the immediate future, the key areas for planning at the time of termination include the following: What to do with severance pay received upon termination Whether to leave pension funds in the former employer’s registered pension plan (RPP) or move them to a locked-in registered retirement savings plan (RRSP). Conversion of group life insurance coverage Replacement of extended health benefits care and disability coverage previously provided under the employer’s group plan. Payments received on termination While we usually think of a ‘retiring allowance’ as an amount received upon retirement in recognition of long service, the Income Tax Act also treats amounts received in respect of a loss of employment as a retiring allowance. This is important because of the special tax rules relating to retiring allowances. 82 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Payments received on termination of employment that qualify as a retiring allowance include: Severance payments – generally paid as a lump sum amount or a continuing monthly income, with the amount based on the number of years of service. Accumulated sick leave credits (but not vacation pay credits). Damages relating to the termination (e.g. damages for wrongful dismissal). What are the tax rules? For income tax purposes, a retiring allowance is included in income and taxed in the year of receipt. However, there is a rule in the Income Tax Act (paragraph 60 (j.1.) of the Act) that allows the transfer of a retiring allowance into the employee’s RRSP or RPP, subject to a maximum limit. The amount transferred under this provision is deducted from income. As a result, income tax is effectively deferred on the amount transferred. The maximum amount of a retiring allowance that can be transferred to an RRSP or RPP is calculated as follows: Individuals who will receive or have received an amount from their former employers upon dismissal or retirement may be eligible to contribute an extra amount to their RRSP or RPP. These retiring allowances are a key item in personal tax planning. They are attractive because they are also deductible for the payer. In addition, amounts transferred to your RRSP or RPP are not taxable until they are withdrawn from the plan. What amounts are involved? $2,000 times the number of total years (before 1996) of service (note that a partial year counts as a full year); plus $1,500 times the number of years of service prior to 1989 where employer contributions to a RPP or a Deferred Profit Sharing Plan (DPSP) were not vested at the time of payment of the retiring allowance. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 83 It is important to confirm the amount! Calculating the amount of the retiring allowance eligible for transfer can be simple. It becomes complicated if the employee has previously worked with an affiliated company, joined the pension plan after commencing employment, and so on. In every case, it is recommended that the employee confirm the eligible amount of the retiring allowance that can be transferred with the former employer. The employer must report the total retiring allowance on a T4A tax slip and will show the ineligible pension (if any) on the slip. If the actual amount transferred exceeds the eligible amount reported on the T4A, the employee will have made an excess contribution to the RRSP. Excess contributions attract severe penalty taxes if the cumulative excess exceeds $8,000. By confirming the eligible amount with the employer, this problem can be avoided. How to make the transfer The transfer to the employee’s RRSP may be done directly by the employer. In this case, the employer issues a cheque directly to the Insurance Company or other financial institution. The employee can also do the transfer during the year or within 60 days of the end on the year. The advantage of a direct transfer from the employer is that withholding taxes, which normally apply to a retiring allowance payment, can be avoided. Any amount of the retiring allowance that is not transferred directly by the employer (or any amount that exceeds the maximum amount eligible for transfer) is payable to the employee, and withholding tax is deducted. 84 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Considerations For the purpose of these rules, loss of employment can be due to the elimination of a job, a release from employment for any reason, as well as early retirement incentive programs. The employee must have left the employer and not taken a position with an affiliated company. The employee’s normal RRSP contribution, based on earned income, is not affected by the transfer of a retiring allowance into an RRSP. However, the employee must file Canada Revenue Agency (CRA) Form T2097 with his or her tax return to support the additional deduction claimed in the year of transfer. A retiring allowance is not included in the definition of ‘earned income’ for RRSP purposes. The transfer of a retiring allowance must be made to the employee’s own RRSP and cannot be contributed to a spousal RRSP. The possible impact of the alternative minimum tax (AMT) should also be considered when transferring large amounts into an RRSP. The AMT is a separate income tax calculation that taxpayers must complete if they have certain tax preference items in the year. Tax preference items include significant contributions and transfers, for example, to an RRSP. Contributions to an RRSP are not deductible when calculating AMT taxable income and this may result in a minimum tax liability. The AMT will generally not apply if total RRSP contributions in the year do not exceed $40,000, which is a standard exemption allowed under the AMT rules. If they do, the employee should seek professional tax advice to determine if the AMT will apply, and this advice should be obtained before the transfer takes place. Based on the current EI benefit rules, severance pay will be delayed. This is true regardless of whether the severance pay is transferred to an RRSP. The employee should consider this when deciding how much of the severance pay is transferred to an RRSP. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 85 Additional Notes to Registered Pension Plans Plan document may provide past service benefits for those years of employment before Pension Plan commencement. Example: 2% for every year of service before plan start-up, paid by employer. Plan may accommodate additional voluntary employee contribution to boost retirement benefit. Regulations and the Law In Ontario - The Pension Benefits Act. Federal Statues - Pension Benefits Standard Act and Regulations Overseas Pension Plans for Civil Servants, Crown Corporations and Industries that are Federally regulated such as Banks, Broadcasting and Transportation etc. The regulations ensure that: Employees are fully informed concerning their rights under the plan. Benefits vest after reasonable service and age cannot be disposed of except as payments or as death benefits. Plan meets solvency standards. Changes to the Federal Pension Benefits Standard Act (January 1, 1987). 1. Two-year vesting rights for employees. 2. Pension benefits are portable and may be transferred tax free to locked in RRSP’s or new Employers Plan. Alternately the Pension Benefits can be left wholly or in part with their previous employer as a deferred benefit. Any part transferred must be deposited into a locked in RRSP. 3) Pension Plan enrolment must be open after two years of service of full-time employees. Part-time employees are eligible to join if they earn a minimum of 35% of the (CPP) AMPE in two consecutive years with their employer. 4) Early retirement optional at age 55. 86 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Improved Pension Spousal Options: a) No remarriage clause. b) Entitled to a minimum of 60% of spouses’ pension if spouse was currently retired. c) Pension credits may be split between separated or divorced spouses. d) Non-gender specific in pension benefits of equal proportions. Pension reform – over contribution of RRSP’s RRSP Over-Contributions Before 1996, it was possible to contribute up to $8,000 in excess of the normal RRSP contribution limits without incurring a tax penalty. The over-contribution limit was lowered to $2,000 in the 1995 federal budget, effective in 1996. Even though the over-contribution amount is not tax deductible, the investment income from it will accrue free of tax inside the Plan, and the deduction amount can be rolled forward and claimed in future years. This over contribution is to allow for any errors that may be made in calculating your annual limits, or to allow for your pension adjustment. If you go over your limit by more than $2000, you will have to pay a 1 per cent monthly penalty tax on the over-contribution. An over-contribution cannot be deducted off your taxable income, but is allowed to grow tax-free. However, it is subject to tax when you withdraw it at retirement, creating double taxation. Is it a tax planning opportunity? Some taxpayers will want to use the new rules to make excess contributions to an RRSP. From a tax planning perspective, this strategy has certain advantages. However, there are significant risks that must be considered. Advantages Tax sheltered growth on RRSP funds, including the excess contribution. Can be used to fund future contributions, providing a hedge against future cash flow problems. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 87 Disadvantages Over-contribution is taxable when withdrawn even if it is never used as a deduction (for example, emergency cash need or death of the annuitant). One per cent penalty tax per month will apply to any amount of excess contribution exceeding the $8,000 cumulative balance. Added complexity for preparation of tax returns. Who might be interested in over-contribution? Taxpayers with the following attributes may wish to take advantage of the new rules for RRSP over-contributions. A prospect or client who has sophisticated knowledge of the tax rules. A prospect or client who has excess cash flow, and a high marginal tax bracket. A prospect or client who has the expectation of RRSP deduction room in future years. Taxpayers should be encouraged to discuss this strategy with their tax advisors before making an over-contribution. Do these rules apply to RRSP rollovers? The ability to use an over-contribution in an RRSP, as a deduction in a subsequent year is limited to RRSP deduction room based on earned income. An excess contribution cannot be used to fund RRSP rollovers, including retiring allowances. Assume that your client or prospect is 35 years old, and knowledgeable in taxplanning matters. He is in a 40% marginal tax bracket and earns a 10% return on his investments. He has excess funds available to invest. Assuming that he makes an $8,000 over-contribution to his RRSP this year (and eventually uses the excess for a deduction in a future year), he will accumulate an additional $24,000 after-tax for his retirement savings by age 60 compared to simply investing outside his RRSP. He will then have over $97,000 after-tax by age 71, the year his RRSP will mature. 88 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Some useful information for you and your clients: Payments that you can transfer directly or indirectly To be deductible, you have to contribute to the plan or fund in the year you receive the payment or no later than 60 days after the end of that year. If you transfer funds to an RRSP, you must be 71 or younger at the end of the year you transfer the funds. You also have to file with your tax return a completed Schedule 7, RRSP Unused Contributions, Transfers, and HBP or LLP Activities. Type of payment Retiring allowance Can be transferred to your: RPP YES RRSP YES RRIF NO Annuity NO A retiring allowance is an amount you receive on or after your retirement from an office or employment in recognition of long service. It includes payment for unused sick leave, and amounts you receive for loss of office or employment, whether as a payment of damages or a payment under an order or judgment of a tribunal You can only transfer the eligible part of your retiring allowance to your RPP or RRSP. The eligible part is $2,000 for each year or part-year of service before 1996 in which the employer employed you or a person related to that employer from whom you received the retiring allowance. You can also transfer an extra $1,500 for each year or part-year of service before 1989, as long as you were not entitled to receive any benefits you earned under a pension plan or DPSP from contributions your employer made for each such year. Box 26 of your T4A slip shows the eligible portion of your retiring allowance. Box 27 indicates the part of your retiring allowance that is not eligible. On a T3 slip, the eligible part of a retiring allowance appears in box 36. Report the retiring allowance shown in boxes 26 and 27 of your T4A or box 26 of your T3 slip on line 130 of your return. Claim a deduction for the amount you transfer to your RPP on line 207 of your return. Claim a deduction for the amount you transfer to your RRSP on line 208 of your return. Indicate the amount of the transfer on line 240 of Schedule 7. You cannot transfer the amount to your spouse's RRSP. If you transfer the amount to your RPP, you may have a pension adjustment (PA). For more information, contact your plan administrator. Note No tax is withheld if your employer transfers directly the eligible part of your retiring allowance. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 89 Payments that you have to transfer directly If you receive any of the types of payments listed below (e.g., in cash or by cheque), you have to include them in your income for the year you receive them, and you cannot transfer them tax-free. Therefore, if you want to transfer these amounts tax-free to another registered plan or fund, make sure you inform the payer to transfer them directly. If you transfer the amount to your RRSP, you must be 71 or younger at the end of the year you make the transfer. You do not have to use the forms listed in this chart. The institution that transfers your payments may use other forms of documentation to record the transfer. The institution has to provide you with confirmation of the details of the transfer. Type of payment Can be transferred to your: RRP RRSP RRIF Forms Annuity RRP Lump Sum YES YES YES NO T2151 This includes a lump sum payment you receive from your RPP or from your spouse's or former spouse's RPP because your spouse or former spouse died. Do not claim a deduction for the amount you transfer, and do not report any amount on your return. Can be transferred to your: Forms DPSP lump sum RRP YES RRSP YES RRIF NO Annuity NO T2151 This includes a lump sum payment you receive from your DPSP or from your spouse's or former spouse's DPSP because your spouse or former spouse died. You can also transfer this amount to another DPSP. Do not claim a deduction for the amount you transfer, and do not report any amount on your return. Get Interpretation Bulletin IT-281, Elections on Single Payments from a Deferred Profit-Sharing Plan, for exceptions to the direct transfer requirement, and other rules on DPSP lump sums. Can be transferred to your: Forms RRSP commutation payment 90 RRP NO RRSP YES RRIF YES Annuity YES T2030 The commutation payment is shown in box 22 of your T4RSP slip. Report it on line 129 of your return. If you transfer the amount to your RRSP, claim a deduction for the amount you transfer on line 208 of your return. If you transfer the amount to your RRIF or to an issuer to buy an eligible annuity, claim a deduction for the amount you transfer on line 232. Attach official receipts to your return showing the amount transferred. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Can be transferred to your: Property from an unmatured RRSP RRP YES RRSP YES RRIF YES Annuity NO Forms T2030 You receive this payment from an RRSP that has not yet started to pay you retirement income. Do not claim a deduction for the amount you transfer, and do not report any amount on your return. Payments that you transfer directly because of the breakdown of your relationship In all cases, the transfer must be direct. If you receive any of the types of payments listed below (e.g., in cash or by cheque), you have to include them in your income for the year you received them. You cannot transfer them tax-free. Therefore, if you want to transfer these amounts to another registered plan or fund, make sure you inform the payer to transfer them directly. In all cases, you must be entitled to the payment under a decree, order, or judgment of a court, or under a written agreement relating to a division of property between you and your spouse or former spouse in settlement of rights arising from the breakdown of your relationship. If you transfer the amount to your RRSP, you must be 71 or younger at the end of the year you make the transfer Type of payment RPP lump-sum payment Can be transferred to your: Forms RRP RRSP RRIF Annuity YES YES YES NO T2151 Do not claim a deduction for the amount you transfer, and do not report any amount on your return. Can be transferred to your: Property from an unmatured RRSP RRP NO RRSP YES** RRIF YES Forms Annuity NO T2220 You and your spouse have to be living separate and apart at the time of the transfer because of the breakdown of your relationship. Do not claim a deduction for the amount you transfer, and do not report any amount on your return. ** You and the RRSP issuer have to complete and submit Form T2220 for this type of transfer. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 91 QUICK REFERENCE FOR: Canada Customs Revenue Agency Reference Forms FORM NRTA1 RC96 T1-OVP T1-OVP SCHEDULE T746 T1004 T1006 T1007 T1036 T1043 T1090 T1171 T1172 T2019 T2030 T2078 T2151 T2205 T2220 T3012A INFORMATION CIRCULARS 72-22 77-1 78-18 Information sheets RC4092 RC4177 RC4178 92 DESCRIPTION Authorization for Non-Resident Tax Exemption Lifelong Learning Plan (LLP) - Request to Withdraw Funds from an RRSP Individual Income Tax Return for RRSP Excess Contributions Calculating the Amount of RRSP Excess Contributions Made Before 1991 that are Subject to Tax DESCRIPTION Calculating Your Deduction for Refund of Unused RRSP Contributions Applying for the Certification of a Provisional PSPA Designating an RRSP Withdrawal as a Qualifying Withdrawal Connected Person Information Return Home Buyers' Plan (HBP) - Request to Withdraw Funds From an RRSP Deduction for Excess Registered Pension Plan Transfers You Withdrew From Your RRSP or RRIF Death of a RRIF Annuitant - Designated Benefit Tax Withholding Waiver on Accumulated Income Payments From RESPs Additional Tax on Accumulated Income Payments From RESPs Death of an RRSP Annuitant - Refund of Premiums Direct Transfer Under Subparagraph 60(l)(v) Election Under Subsection 147(10.1) in Respect of a Single Payment Received From a Deferred Profit Sharing Plan Direct Transfer of a Single Amount Under Subsection 147(19) or Section 147.3 Calculating Amounts From a Spousal RRSP or RRIF to Include in Income for Transfer From an RRSP or a RRIF to Another RRSP or RRIF on Marriage Breakdown Tax Deduction Waiver on the Refund of Your Unused RRSP Contributions Made in Lifelong Learning Plan (LLP) OR Home Buyers Plan (HBP) DESCRIPTION Registered Retirement Savings Plans Deferred Profit Sharing Plans Registered Retirement Income Funds DESCRIPTION Registered Education Savings Plans (RESPs) Death of an RRSP Annuitant Death of a RRIF Annuitant Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Interpretation bulletins IT-124 IT-167 IT-221 IT-281 IT-320 IT-337 IT-363 IT-412 IT-499 IT-500 IT-528 DESCRIPTION Contributions to Registered Retirement Savings Plans Registered Pension Plans - Employee's Contributions Determination of an Individual's Residence Status Elections on Single Payments From a Deferred Profit-Sharing Plan Registered Retirement Savings Plans - Qualified Investments Retiring Allowances Deferred Profit Sharing Plans - Deductibility of Employer Contributions and Taxation of Amounts Received by a Beneficiary Foreign Property of Registered Plans Superannuation or Pension Benefits Registered Retirement Savings Plans - Death of an Annuitant Transfers of Funds Between Registered Plans The following Information will help you when evaluating the viability of your prospects. Information required on starting a new plan Determine how much the company has budgeted for the retirement program (if not a voluntary plan) On a Voluntary RRSP, ask if the company will pay the operating expenses. What will the expected number of members be? What will the cash flow be? Is there any potential for any asset rollovers? Information required to review an existing plan Plan document and any amendments since inception of the plan. Recent financial report(s), which shows the cash flow, asset balances, and number of members. Copy of Employee Booklet (if available) Note: On a Group RRSP, item 1 will not be available. On a DPSP, the plan document (item 2) is called a Trust Agreement. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 93 Try to determine who was responsible for setting up the original plan. What to look for in a supplier. Good selection of top performing funds. Seasoned administration personnel. Member education and communication support. Flexibility and desire to help you overcome closing problems. Lowest possible investment management fees. Ongoing service provided. Will they help with any prospecting material, sales tracks etc? What is the Broker added support? Comparative investment graphics and charts. Strategy discussions. Preliminary review of prospect viability. Advice to you when benefit payments received. Quick commission payments. Why the Investment Management Fee is important. Fund Annual Deposit for 25 years Gross Return Investment Management Fee Net Return Accumulated value over 25 years Company A $2,000 12.25% 2.25% 10.00% $198,262.56 Company B $2,000 12.25% 1.50% 10.75% $221,177.06 Difference of 23,914.51 or 12% more with the lower management fees quoted by Company B 94 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Problems you may encounter in closing the sale. Current carrier makes impossible promises. Market value adjustment (MVA) penalty. Deferred Sales Charge penalty. Delegation of decision to retirement committee. Existing broker relationship. FOUR KEY QUESTIONS YOU SHOULD ASK ABOUT ANY RETIREMENT PLAN: 1. Is my money safe in the plan? Can it lose value? It depends on the type of savings plan you have. In a defined benefit pension plan: By law, the employer must hire auditors who report on thepension fund every one to three years to pension regulators (government authorities who oversee pension laws). The auditor's report estimates how much money the pension plan has promised to pay out. It also shows how the plan will be funded in the future so that it can meet those promises. It's up to the employer to deliver what they promised when you retire. If a plan doesn’t have enough money, the employer will have to put more money into the fund. In a defined contribution pension plan or Group Registered Retirement Savings Plan (Group RRSP): With a defined contribution plan, your employer puts money into your account every year. With a Group RRSP, both you and your employer may put money into the plan. In either case, a trust company or insurance company holds this money in a separate account for you. You, not the company, own that money. Even if your employer goes bankrupt, your money is safe. Of course, you can always lose some or all of your money if you don't invest it wisely. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 95 2. Can my pension fund run out of money? In a defined benefit pension plan: Your pension plan should not run out of money if the employer manages the fund properly. Even if the worst happens, some of your pension savings may be protected. In Ontario, most employers of defined benefit plans pay a yearly fee to the Pensions Benefits Guarantee Fund. This fund guarantees certain benefits to members of a defined benefit plan if the plan cannot pay the pensions it has promised after the company goes out of business. It is the only fund of this type in Canada. In a defined contribution pension plan or Group RRSP: The question of running out of money doesn't really come up. You know exactly what you and your employer put into your pension account each year. Of course, there's no guarantee what those savings will be worth when you retire. It depends on what you make investing over the years. 3. What if the company is sold? In a defined benefit or defined contribution pension plan: The amount of money saved for you in the company pension plan should be safe if your company is sold. In most cases, your old company will be responsible for paying the pension it has promised to you. A lot will depend on the terms of sale of the company. Some employers will choose to close the plan. They will transfer whatever savings you've got in the plan at the time of the sale into a special retirement account. In a Group RRSP: You can keep your account open and keep on saving. The same financial institution will continue to run your plan unless you make a change. 96 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 4. What if the company shuts down the plan? Companies don't have to offer pension plans. In most cases, your company can choose to shut the plan down at any time. This is called winding up a plan. It tends to happen when a business reorganizes, or fails, or when it doesn't feel it can make the contributions to the plan that it needs to. In a defined benefit pension plan: If the plan winds up, everything freezes. You can't earn any more pension income through the plan, even though you may continue to work for the company. The plan sponsor must distribute all of the savings to the plan members. If this happens, you will receive a notice about your rights and options. If the plan was properly funded, you should get everything you have earned so far. If not, things get quite complicated. In a defined contribution pension plan or Group RRSP: You can keep your account open and keep on saving. The same financial institution will continue to run your plan unless you make a change. Remember: Your pension money is protected in many ways. Still, it pays to ask about the safety of your money before you join any plan. Make sure you understand if there are any situations where you could lose your pension and how big the risk is. Strong, stable companies, for example, are less likely to wind down a pension plan or go bankrupt. YOUR RRSPs AND OTHER INVESTMENTS MAY ALSO BE PROTECTED FROM OTHER LOSES Your retirement savings and investments may also be protected from other losses. For example, what happens if the company holding your Group RRSP goes bankrupt? Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 97 Ask if your plan has extra protection from an outside organization such as: 1. Canada Deposit Insurance Corporation - CDIC The Canada Deposit Insurance Corporation (CDIC) is a federal Crown corporation created by Parliament in 1967 to protect your deposits made with member financial institutions in case of their failure. CDIC is NOT a bank. CDIC is NOT a private insurance company. CDIC helps keep Canada’s financial system strong. We work for Canadians—by insuring their savings in case a bank or other CDIC member institution fails. You don’t need to sign up for our insurance. CDIC deposit insurance is automatic - for eligible deposits in Canadian dollars at its member institutions. You don’t pay for our insurance. CDIC member institutions fund deposit insurance through premiums paid on the insured deposits that they hold. Banks and other financial institutions in Canada can fail. It does not happen often, but it has happened and it could happen again. If your financial institution is a CDIC member and it fails and your savings are eligible for CDIC coverage, you will get up to $100,000 of your savings back. If your savings are NOT covered, you might lose them. For more detailed information please check their website - http://www.cdic.ca 2. Canadian Investor Protection Fund - CIPF Investment dealer insolvency doesn’t happen very often, but if it does, the Canadian Investor Protection Fund (CIPF) is here to ensure your cash and securities are returned to you, within defined limits. If you have an account with a CIPF Member you have CIPF protection. Coverage is automatic for all eligible customers. 98 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 CIPF is sponsored by the Investment Industry Regulatory Organization of Canada (IIROC) and is the only compensation fund approved by the Canadian Securities Administrators for IIROC Dealer Members. All IIROC Dealer Members are CIPF Members. For more detailed information please check their website - http://www.cipf.ca 3. Mutual Fund Dealers Association of Canada - MFDA The Mutual Fund Dealers Association of Canada (MFDA) is the national selfregulatory organization (SRO) for the distribution side of the Canadian mutual fund industry. The MFDA is structured as a not-for-profit corporation and its Members are mutual fund dealers that are licensed with provincial securities commissions. The MFDA is formally recognized as a self-regulatory organization by the provincial securities commissions in Alberta, British Columbia, Nova Scotia, Ontario, Saskatchewan, New Brunswick and Manitoba. An application for recognition is pending before the Superintendent of Securities of Newfoundland and Labrador. The MFDA has also entered into a Co-Operative agreement with the Autorité des marchés financiers and actively participates in the regulation of mutual fund dealers in Quebec. As an SRO, the MFDA is responsible for regulating the operations, standards of practice and business conduct of its Members and their representatives with a view to enhancing investor protection and strengthening public confidence in the Canadian mutual fund industry. The majority of the MFDA's staff, centered in Toronto with offices in Calgary and Vancouver, are actively involved in compliance and enforcement activities. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 99 As of October 31, 2011, the MFDA haD 130 Members. These Members represent approximately $302 billion of mutual fund assets under administration. MFDA Members are registered in every province and territory of Canada and are the sponsors of approximately 73,835 mutual fund sales persons. The MFDA performs no industry representation or trade association activities for its Members. For more detailed information please check their website - http://www.mfda.ca 4. Assuris Assuris is the not for profit organization that protects Canadian policyholders if their life insurance company should fail. Their role is to protect policyholders by minimizing the loss of benefits and ensuring a quick transfer of their policies to a solvent company, where their protected benefits will continue to be honoured. Every life insurance company authorized to sell insurance policies in Canada is required, by the federal, provincial and territorial regulators, to become a member of Assuris. Assuris was founded in 1990. Assuris is designated by the federal Minister of Finance under the Insurance Companies Act of Canada, and specified in the Quebec Règlement d'application de la Loi sur les assurances. For more detailed information please check their website - http://www.assuris.ca GLOSSARY OF PENSION TERMINOLOGY Contributory Plan A plan requiring contributions by the employee. Current Service Service after the employee becomes a member of the plan previously known as Future Service. 100 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 Deferred Annuity (or pension) An annuity or pension the first payment of which is deferred to some future date. Deferred Retirement Retirement, which commences after the normal retirement date. Defined Benefit A pension benefit as a specific amount of pension independent of its cost (sometimes referred to as “unit benefit”). Early Retirement Retirement, which commences before the normal retirement age. Eligibility The conditions that an employee must fulfill before he or she can become a plan member. Experience Deficiencies Under funding of plans resulting from plan fund earnings less than that assumed by the plan actuary. Locked in Benefits Benefits which by law may not be withdrawn in cash before or at retirement. Non-Contributory Plans Plans under which employees are not required to contribute. Offset Integration Adjustments to contributions and benefits to provide total retirement benefits from both private and public plans remain constant. Past Service Service before the employee becomes a member of the plan or before a date to which plan benefits are to be increased in the case of a plan improvement. Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12 101 Pension Trust A trust established for receiving irrevocable contributions from an employer for funding a pension plan. Retirement Age Retirement age established under a plan means the earliest age at which a pension benefit, other than a benefit in respect of a disability is or may become payable to the employee without adjustment for early retirement. Unfunded Liabilities Plan liabilities which have not been purchased or for which provision has not yet been fully made. Liabilities for past service benefits are frequently unfounded. Vesting The acquisition by an employee of benefits provided by employer contributions to the plan. Vesting and Locking In Provisions of federal and provincial pension legislation which require, upon attainment of a defined age and service level, that a plan member must be given absolute right to all the benefits under the plan accumulated up to that date on his or her behalf in the form of a deferred life annuity. (I.e. may not be withdrawn in cash). Voluntary Contributions Contributions made by an employee over and above those required of him or her by plan. 102 Corporate Retirement Plans – SSC #4 Pro-Seminars Limited © 01/12