13 July 1995 Internal T.I. 9515006 - PENSION ADJUSTMENT AND EARNINGS EXCLUSION RULE

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

When pension benefits are based on remuneration and are capped at a specified level are they still considered to be benefits based on remuneration. Also various discussions on the interaction of the defined benefit limits on pension benefits and the determination of the Pension Adjustment for full and partial years of employment. Resulting from an adverse decision in the Tax Court, 20 Oct. 94, re: David J. Cooper.

Position TAKEN:

Pension benefits are still based on remuneration even when they are subject to a limit, if they are based on remuneration up to that limit.

Reasons FOR POSITION TAKEN:

Legislation

			July 13, 1995

	HEADQUARTERS						HEADQUARTERS
	Registered Plans Division			D. Duff
	Stella Black						(613) 957-8953
	Director
	Attention:  Sharon Yetts
									7-951500

Earnings Exclusion Rule; Paragraph 8302(3)(g)

This is in reply to your memorandum of May 31, 1995 requesting our opinion on the interaction of those provisions determining the normalized pension and those limiting the benefits under a defined benefit plan.

Maximum Benefit

Generally, subparagraph 8504(1)(a)(ii) of the Regulations provides for a maximum lifetime retirement benefits in the year of commencement of the pension equal to the product of F times G, where basically, F is the lesser of 2% of compensation and the "defined benefit limit" and G is the number of years of pensionable service. The "defined benefit limit" is defined in proposed subsection 8500(1) of the Regulations to equal $1,722.22 for years prior to 1996 and will be 1/9 of the money purchase limit for the years thereafter.

Pension Adjustment ("PA") and Benefit Accrual

The greater the PA, the smaller the RRSP deduction limit. The PA is defined in proposed paragraph 8301(1)(a), subsection 8301(6) and section 8302 of the Regulations, and for the purposes of this memorandum, it is sufficient to define it as the amount by which 9 times the Benefit Accrual exceeds $1,000. The Benefit Accrual is defined in proposed subsection 8302(2) of the Regulations for the years 1990 to 1994, basically as the lesser of paragraphs 8302(2)(a) and (b). Paragraph 8302(2)(a) is the portion of the Normalized Pension accrued in the year as discussed in the following paragraph. Paragraph 8302(2)(b) lists various stated amounts for each year. These are, for 1990, $1,277.78, for 1991 and 1992, $1,388.89, for 1993, $1,500.00 and for 1994, $1,611.11. These provisions will reduce the PA below the benefit actually earned in order to keep it in line with the money purchase limits. Our discussions will focus on the Benefit Accrual.

The Normalized Pension is determined in subsection 8302(3) of the Regulations under the assumptions as stated therein. Proposed paragraph 8302(3)(g) provides that "where the amount of the individual's lifetime retirement benefits depends on the individual's remuneration and the particular year is after 1989 and before 1995, benefits, to the extent that they can reasonably be considered to be in respect of the following range of annual remuneration, were excluded:". You referred to this as the Earnings Exclusion Rule. These ranges are, for 1990, $63,889 to $86,111, for 1991 or 1992, $69,444 to $86,111, for 1993, $75,000 to $86,111, and for 1994, $80,556 to $86,111.

Your question relates to whether these provisions should apply when, in accordance with subsection 8504(1), lifetime retirement benefits are capped at the defined benefit limit of $1,722.22, regardless of the member's remuneration. It is your view that where the defined benefit limit applies, the amount of the lifetime retirement benefits does not "depend on the individual's remuneration", so the Earnings Exclusion Rule would not apply.

Discussion

Normalized Pension and the Earnings Exclusion Rule

Full Year's Employment

Firstly, it is our opinion that, where the actual benefit is based on the individual's remuneration and the defined benefit limit has been reached, the lifetime retirement benefits still "depend on remuneration".

As indicated above the Benefit Accrual is the lesser of paragraph 8302(2)(a), the Normalized Pension accrued in the year, and the stated amount in paragraph 8302(2)(b). Where lifetime retirement benefits are based on remuneration, paragraph 8302(3)(g) requires the application of the Earnings Exclusion Rule in determining the Normalized Pension. Where there is a 2% benefit accrual rate, the reduction in the Normalized Pension corresponds with the reduction from the defined benefit limit of $1,722.22 to the amounts stated in paragraph 8302(2)(b). For example, in 1993, the excluded range is from $75,000 to $86,111, equal to $11,111. The 2% benefit related to this amount is $222.22, which also is the difference between the maximum benefit of $1,722.22 and the paragraph 8302(2)(b) amount of $1,500.00. We get the same results for all the other years. The reduction in applying the Earnings Exclusion Rule will only exceed the stated reduction to the paragraph 8302(2)(b) amount where the benefit accrual rate exceeds 2%.

You questioned whether the Earnings Exclusion Rule should be used in situations where we have a maximum benefit of $1,722.22. Paragraph 8503(3)(g) requires that the benefit accrual rate not exceed 2%. Also, it is our understanding that, where the defined benefit limit applies, the rate used in determining the Normalized Pension for PA purposes would never exceed 2%. Where there is a full year of employment, the reduction in the Benefit Accrual resulting from applying the Earnings Exclusion Rule can never exceed the stated reduction in paragraph 8302(2)(b). Therefore, your concern about applying the excluded range of remuneration where the maximum benefit is earned is unwarranted when a full year of benefits have been earned. A different result would only arise if the accrual rate exceeded 2% which cannot be the case.

As stated above, where benefits are based on remuneration and the defined benefit limit has been reached, it is our view that the lifetime retirement benefits still depend on remuneration. This is illustrated in your Example 1 which we have further analyzed and attached.

Full Year's Employment-Example 1

Example 1 deals with a full year's employment where the defined benefit limit of $1,722.22 has been reached. We have analyzed the Benefit Accrual and as indicated, it relates to a salary of $94,781. For purposes of determining the Benefit Accrual, this salary includes the full range to be excluded under the Earnings Exclusion Rule. The reductions under both paragraph 8302(2)(a) and (b) are identical so we get the same Benefit Accrual under both. Note that this should have been done according to the rules in subsection 8302(3) for determining the Normalized Pension, however, for this example the results would be the same.

Partial Year's Employment-Example 2

Where an employee terminates during the year the results are different because the defined benefit limit is effectively prorated over the portion of the year worked. Consequently, the Benefit Accrual resulting from the application of the Earnings Exclusion Rule can be less than the stated amounts in paragraph 8302(2)(b) because the defined benefit limit and the reduction from the application of the Earnings Exclusion Rule get prorated over the portion of the year worked, while the paragraph 8302(2)(b) amount does not.

This is illustrated in your Examples 2 & 3 which we have combined and further analyzed. The amount in Clause 8504(1)(a)(ii)(F) is the same as for a full year, which in this case is the defined benefit limit of $1,722.22. This amount gets prorated to $1,004.50 by the application of Clause 8504(1)(a)(ii)(G) which is the portion of the year employed. The yearly benefit would be based on a salary of $94,781 as in Example 1.

The Benefit Accrual would be the lesser of paragraphs 8302(a) and (b). Paragraph 8302(a) is the portion of the Normalized Pension reasonably considered to have accrued in 1990, with the Normalized Pension determined using the assumptions in subsection 8302(3). The first step is to determine the Normalized Pension based on the years of pensionable service. Subparagraph 8302(3)(e)(ii) would apply to require the remuneration on which the pension is determined to be the "rate" of remuneration for the current year, which in this case is $150,000. With a maximum benefit of $1,722.22, the actual remuneration on which the benefit is based is still $94,781. Since this includes the excluded range in paragraph 8302(3)(g), the Earnings Exclusion rule applies. For four years and seven months of pensionable service the Normalized Pension would be $5,856.49, and dividing this by 4 7/12 results in the portion that accrued in 1990. This is the paragraph 8302(2)(a) amount of $745.37 which is the Benefit Accrual as it is less than the paragraph 8302(2)(b) amount of $1,277.78.

The results differ from those in Example 1, because the paragraph 8302(a) amounts effectively get prorated over the part of the year employed. If the paragraph 8302(2)(b) amount was also prorated, we would get the same amount as in (a): (1,277.78 x 7/12 =) $745.37.

Unused RRSP Deduction Room

Conceptually, this result seems appropriate when we consider the reduction in the unused RRSP deduction room resulting from the pension benefits accrued in the year. The maximum Benefit Accrual is tied directly to the money purchase limits, and the PA determination is designed to provide $1,000 in unused RRSP deduction room where the maximum defined benefit pension benefits have been earned. The money purchase limit for 1990 is $11,500 which is equal to 9 times the maximum Benefit Accrual of $1,277.78. Where the maximum Benefit Accrual was earned for 1990 the PA would be $10,500 ((9 x $1,277.78) - $1,000). This would result in unused RRSP deduction room of $1,000 ($11,500 - $10,500). Where there is no pension benefit earned and remuneration is $63,889 or greater, the unused RRSP deduction room earned in 1990 would be the money purchase limit of $11,500.

In the present situation where 7/12 of the maximum unused RRSP deduction room is used up by the pension benefits it would seem that there should be 5/12 available for RRSP contributions. Therefore, (5/12 x 11,500 =) $4,791 plus the $1,000 guaranteed amount gives unused RRSP deduction room of $5,791. The actual unused RRSP deduction room earned is:

Money Purchase limit..................................$11,500.00
less PA
Benefit Accrual.............$745.37
Multiply by .........................9
6,708.33
less 1,000.00 5,708.33
Unused RRSP Deduction Room earned...............$5,791.67

Therefore, conceptually this would seem to give the correct result.

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

Example 1

Facts: Salary and FAE are $150,000 for 1990 and the benefit formula is 1.4% to YMPE($28,900) and 2% earnings in excess of YMPE, subject to the defined benefit limit of $1,722.22.

Benefit

With no defined benefit limit .014 x 28,900 = 404.60
(150,000 - 28,900) = 121,100 x .02 = 2,422.00
Total........................................$2,826.60

Per 8504(1)(a)(ii)(F) the maximum is the lesser of:

2% x $150,000 = $3,000.00,
and $1,722.22,

therefore it is $1,722.22.

Working backwards we can determine that this benefit is based on a salary of:

Total benefit...................................$1,722.22
Less Benefit to YMPE of 28,900.....................404.60
Balance.........................................$1,317.62

Balance is based on a salary of: $1,317.62 /.02 = $65,881

Therefore, the benefit of $1,722.22 is based on the following salary amounts:

On the first $28,900 x .014 = $404.60
On the next $65,881 X .02 =$1,317.62
Total........$94,781.........$1,722.22

In determining the PA:

Reg. 8302(2)(a) Benefit Accrual:

Normalized pension* accrued in the year is....$1,722.22
Earnings Exclusion for 1990
($86,111 - $63,889 =) $22,222 x .02 = $444.44**
8302(2)(a) amount.............................$1,277.78

8302(2)(b) amount is stated to be ............$1,277.78

We can arrive at the 8302(2)(a) amount as follows:

Salary from $0.00 to $28,900 = $28,900 x .014 = $404.60
Salary from $28,900 to $94,781 = $65,881
less
Salary from $63,889 to $86,111 = $22,222
Balance..........................$43,659 x .02 = $873.18
Total benefit accrual per 8302(2)(a)...........$1,277.78

* The normalized pension should actually be calculated pursuant to the assumptions in subsection 8302(3), but, for our purposes, the results will be the same.

** As noted previously, this is the maximum reduction under the Earnings Exclusion rule as it is at the maximum rate of 2%. If the rate for this range was less than 2% the Benefit Accrual under (a) would be greater than the stated amount under (b) and the latter would be used.

Example 2

Facts: Same as example 1, but employee terminated after 7 months so earnings in 1990 were 7/12 x $150,000 = $87,500. Total pensionable service is 4 years and 7 months.

Benefit
With no defined benefit limit
.014 x 28,900 = 404.60 x 7/12 = 236.02
(150,000 - 28,900) = 121,100 x .02 = 2,422.00 x 7/12 = 1,412.83
Total...............................$2,826.60 x 7/12 = 1,648.85

Per 8504(1)(a)(ii)(F) is the lesser of:

2% x $150,000 = $3,000.00
and $1,722.22,

Therefore it is $1,722.22.

8504(1)(a)(ii)(G) is 7/12, therefore the maximum benefit for 1990 is 7/12 x 1,722.22 = $1,004.50

As in Example 1, the yearly benefit was based on the following salaries:

On the first $28,900 x .014 = $404.60
On the next $65,881 X .02 =$1,317.62
Total........$94,781.........$1,722.22

PA

For PA purposes, the Benefit Accrual is determined as the lesser of Reg. 8302(2)(a) and (b):

(a)The normalized pension accrued in 1990, based on the assumptions in Reg. 8302(3):

Reg.8302(3) requires the determination of the total lifetime retirement benefits that would be payable based on the assumptions therein. Paragraph 8302(3)(e)(ii)

would require the current years's "rate" of salary to be used, which is $150,000. As indicated above the benefit would be based on a maximum salary of $94,781. Paragraph 8302(3)(g) would apply to remove the benefit related to the excluded earnings, which would be 2% x ($86,111 - $63,889) = $444.44. The normalized pension pursuant to Reg. 8302(3) would be:

0.014 x 28,900.............................404.60
0.02 x (94,781 - 28,900).................1317.62
1722.22
less
0.02 x (86,111 - 63,889)..................444.44
1,277.78
Years of pensionable service: 4 7/12
Normalized Pension ......................5,856.49

Reg. 8302(2)(a): The portion of the Normalized Pension accrued in 1990 is 7/12 of one year, which is $745.37.

(b)the stated amount of $1,277.78.

Therefore the Benefit Accrual for 1990 would be $745.37.