retirement_crossword_pension

With tax time upon us, advisors are looking to squeeze every last drop of tax-advantaged savings and investment for their clients. Understanding the number in box 52 of your clients’ T4 slips will help you do just that.

Nuts and bolts

If your client participates in a company-sponsored registered pension plan (RPP) or deferred profit-sharing plan (DPSP), he or she will have a pension adjustment (PA) entered in box 52 of the T4 slip. The PA represents a mandatory deduction applied to the taxpayer’s RRSP contribution room for the next calendar year.

The purpose of PAs is “to equalize the tax advantages available to all of us for retirement savings,” says Ashley Crozier, an independent actuary based in Toronto.

Take, for example, the case of two taxpayers who both earn $65,000 a year, but only one is a member of an RPP through his employer. Without the PA system, both would have the same RRSP contribution room for the following year, but the taxpayer with the employer-sponsored RPP would have a significantly higher level of tax-deferred savings than the taxpayer with no plan.

For those enrolled in a defined-contribution or deferred profit-sharing plan, the PA is simply the total amount contributed for the year. Coming up with the PA for those with a defined-benefit plan is more complicated (see illustration below, “PA calculations”).

PA calculations

Under a DC plan,
PA = amount contributed for the year by employer and employee.
Under a DB plan,
PA = 9 times benefit accrued during year less $600
Example 1
A person earns $50,000. Under no pension plan: is able to contribute $9,000 (18%) of earnings to the RRSP. PA = $0
Example 2
Under DC plan: If employer contributed $1,000, PA = $1,000
Max allowable RRSP contribution: $8,000
Example 3
Under DB plan: If accrued benefit is equal to $500, PA = $3,900 [(9 x $500) – $600]. Max allowable RRSP contribution: $5,100

The defined-benefit PA calculation

Assume a case where two employees, one aged 20 and one 50, make the same salary and are enrolled in the same defined-benefit plan with the same employer. They both contribute the same amount and have a PA of, say, $6,000.

Ian Genno, senior consultant in Towers Watson’s retirement practice in Toronto, explains that an employee’s age makes a difference when it comes to the true value of the pension in any given year. Yet the factor of nine used to calculate the PA for defined-benefit plans does not reflect this.

“If I have a 20-year-old employee and a 50-year-old employee, and if they’re the same in all other respects, the value of the pension this year for the 20-year-old is going to be a lot less than it is for the 50-year-old,” he says.

That’s because the 50-year-old is only 10-to-15 years away from wanting that pension. A 20-year-old, by contrast, is decades away from ever seeing it. So the economic value of a defined-benefit plan is greater for someone who’s closer to actually receiving the benefits.

“As an actuary I would say this factor-of-nine theory should differentiate between people based on their age,” Genno says. “Theoretically, it should be a factor that goes up with time or age.”

Now, the federal government doesn’t want to set up something that appears age-discriminatory. Imagine the furor if 50-year-olds had less RRSP contribution room than 20-year-olds, purely because they’re 50. “The government has to make a simplifying approximation,” notes Genno. “But in pure actuarial or economic terms, there should be a distinction based on age.”

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