Why it pays to know your PA

Employer-sponsored plans shrink your RRSP room.

Matthew Elder 9 January, 2015 | 6:00PM

Making the most of a registered retirement savings plan and its powerful tax deferral means being aware of your RRSP contribution room. That means totalling any unused contribution amounts from past years and adding that to what you are permitted to put in for 2014. The deadline for making an RRSP contribution that is deductible on your 2014 income-tax return is March 1, 2015.

For many Canadians, a key component of the contribution-room calculation is the pension adjustment (PA). An individual's maximum RRSP contribution for 2014 is the lesser of $24,270 or 18% of his or her earned income during the previous taxation year -- in this case, 2013. From that total you must subtract any PA you had during 2013 from your participation in an employer-sponsored pension plan or deferred profit-sharing plan (DPSP).

Under a defined-contribution (also known as money-purchase) pension plan, your PA is simply the amount that you and your employer contributed. (DPSPs are funded solely by employers.) If you were not a member of a pension plan or DPSP, or no contributions were made to one of these plans during 2013, your PA for 2014 RRSP contribution purposes is zero and there is no reduction in your contribution limit.

If you are a member of a defined-benefit pension plan, your PA is an amount that approximates the value of the pension benefit you earned during the previous year (2013). This is equivalent to the amounts you paid into the plan plus the deemed value of what the employer would have to contribute to fund the eventual specified pension income to you after retirement. This amount is calculated by the pension-plan manager.

There are three basic types of defined-benefit plan, based on the method used to calculate the eventual pension income paid after retirement. Here are brief descriptions of each, and how the pension benefit for the year --and thus the PA -- is calculated, with examples provided by the Canada Revenue Agency (CRA). In all cases, the pension benefit is calculated as nine times the benefit earned, less $600.

  • Flat benefit plan: This is based on a dollar amount paid for each month or year of the member's employment. For example, if the pension formula is $25 per month for each complete year worked, the annual benefit earned for 2013 would be $300. Thus the 2013 pension benefit affecting the 2014 RRSP contribution limit would be $2,100 ($300 x 9, less $600).

  • Career-average plan: Also known as a percentage-of-contributions plan, this is calculated on the average amount of the member's earnings over the entire period of employment. Say the pension formula is 40% of the total annual contributions to your pension and you paid 5% of a $40,000 annual salary into the plan. For each complete year worked, the annual benefit earned for 2013 would be $800 (40% × (5% × $40,000). The 2013 pension benefit affecting the 2014 RRSP contribution limit would be $6,600 ($800 x 9, less $600).

  • Final/best average plan: This is based on the member's average income during the final few years of employment, or, alternatively, on the member's best three or five years of service. For example, if the pension formula is 2% of the average of the final three years' earnings, based on a $40,000 average salary during that period, the annual benefit earned for 2013 would be $800 (2% × $40,000). Thus the 2013 pension benefit affecting the 2014 RRSP contribution limit would be $6,600 ($800 x 9, less $600).

Using the above example of the final/best average plan, and assuming no RRSP contribution room carried over from previous years and earned income in 2013 of $40,000, the maximum contribution for 2014 would be $800. (This is based on 18% of earned income of $40,000, or $7,200, from which you subtract the $6,600 PA).

Another factor that can affect RRSP contribution room is a past-service pension adjustment, which occurs when a defined-benefit plan improves its benefits retroactively. Past-service PAs are triggered by a transaction or other event that causes a plan member's benefits (in regard to 1990 and later) to increase. Typically, this would occur if you are credited with additional post-1989 pensionable service, or where a plan is being amended to increase retroactively the benefit formula from 1990 onward -- say, from 1% of earnings to 1.5%.

Fortunately, there's no need to pull out a calculator and figure all this out. The CRA computes your RRSP contribution room each year when it prepares your notice of assessment -- the statement you receive after your income-tax return has been processed.

Pension-adjustment reversal

A further complexity can arise in the calculation of your RRSP contribution room if you leave a pension plan before retirement. In many cases, your PAs are based on the assumption you will remain a plan member right through to retirement. Should you leave that employer and, upon departure, take a lump-sum payment representing your pension benefit, you may be entitled to a pension-adjustment reversal. The PA reversal is designed to restore your ability to contribute to your RRSP, now that your employer pension will be smaller than anticipated.

A PA reversal normally applies when the individual receives a termination benefit that is less than his or her total PAs and any past-service adjustments. Note that if your defined-benefit plan is of the specified multi-employer plan (SMEP) variety, no PA reversal would be available. A PA reversal stemming from a defined-contribution plan or a DPSP would be the amount included in your pension credits but to which you cease to have any rights when you leave the employer. You will have a PA reversal under a defined-contribution plan or DPSP only if you are not fully vested in the plan upon termination of your employment.

For more information, consult the following CRA guides:

Pension Adjustment Guide
Online: http://www.cra-arc.gc.ca/E/pub/tg/t4084/t4084-08-e.html
PDF: http://www.cra-arc.gc.ca/E/pub/tg/t4084/t4084-08e.pdf

Past Service Pension Adjustment Guide
Online: http://www.cra-arc.gc.ca/E/pub/tg/t4104/t4104-08-e.html
PDF: http://www.cra-arc.gc.ca/E/pub/tg/t4104/t4104-08e.pdf

Pension Adjustment Reversal Guide
PDF: http://www.cra-arc.gc.ca/E/pub/tg/rc4137/rc4137-09-e.html
Online: http://www.cra-arc.gc.ca/E/pub/tg/rc4137/rc4137-09e.pdf

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Matthew Elder

Matthew Elder