We live in uncertain economic times and pensions are no exception. Employers looking to bring some certainty to their pension plans are opting to convert their Defined Benefit (DB) plans to the more predictable Defined Contribution (DC) plan at an alarming rate – in a recent survey, 51% of private sector employers admitted to switching their DB plan to a DC plan.
With pension plans constantly changing, it’s important to understand the impact they can have on your personal financial situation – let’s take a look at three important aspects of pensions: Pension Adjustments (PAs), Pension Adjustment Reversals (PARs) and Past Service Pension Adjustments (PSPAs).
Pension Adjustments (PAs)
If your employer has switched to a less generous DB plan requiring higher contributions or a DC plan, you may consider opting out of the pension plan altogether. If you’re a younger worker and you don’t plan to stay with your employer long-term, opting out of your company’s pension plan and instead investing and managing your RRSP may make sense.
That’s because a PA, which is the value of your accrued benefit assigned by CRA, reduces your RRSP Contribution Room and is generally higher for younger works. CRA assumes that your employer is providing a generous 2% DB plan, which isn’t usually the case – if your employer is offering a lot less, your PA is being overvalued, leaving you with less RRSP Room. If you plan to max out your RRSP Room each year, it may be beneficial to opt out of your company’ s plan and use the extra RRSP Contribution room to invest. Learn how to calculate your PA here.
Depending on your province of employment and the generosity of your pension plan, your plan may offer immediate vesting or you may have to wait up to two years. Again, this takes away unnecessary RRSP Contribution Room if you don’t plan to stay long-term with your employer.
Pension Adjustment Reversals (PARs)
As I mentioned in my previous article, a PAR restores the lost RRSP contribution room that the PA has taken away in past years. This seems simple enough, but this can be complicated by how your employer administers its pension plan. If your pension plan has a transfer deficiency and you terminate employment, your PAR could be held back for up to five years, prolonging the time it takes to restore lost RRSP Room.
A transfer deficiency is when your employer’s pension plan is not fully funded (there are insufficient assets i.e. investments to cover liabilities i.e. member pensions if the plan were to end today). Also, if your employer offers a Flex Pension Plan (a pension plan that offers ancillary benefits like bridge benefits or indexing) or a DC plan, your PAR will be held back until you withdraw the full amount from those plans. This can cost you years of tax-free compound growth inside your RRSP.
Past Service Pension Adjustments (PSPAs)
The trend as of late has been for employers to reduce pension plan benefits, but if you’re part of a union where pension plan improvements are negotiated or your employer is really generous, they may make retroactive improvements to your pension plan. This is when Past Service Pension Adjustments (PSPAs) come into play.
PSPAs only affect years of service after 1990 for DB plans – while PAs reduce RRSP Contribution Room for the subsequent year, PSPAs reduce unused RRSP Contribution Room carried forward from previous years. For example, if your employer decides to retroactive improve your DB plan from a 1.3% final average earnings plan to a 2% plan then you will most likely be subject to a PSPA. The PSPA accounts for the fact that you should have received a higher PA in past years and thus been able to contribute less to your RRSP. The formula is quite complicated for PSPAs and your employer must obtain CRA approval, so it’s best to discuss with a financial advisor if this occurs.
As you can see, there is a lot to consider before joining your company’s pension plan. In most DB pension plans you’re automatically opted-in, so be sure to ask your employer all the details on your company pension plan before deciding if it’s worth joining. Most of the time it’s worth joining since it’s essentially “free money.” Speak with your financial advisor to see if your company’s pension plan is right for you.
About the Author: Sean Cooper is a single, 20-something year old, first time home buyer located in Toronto. He has experience in the financial sector as a Pension Analyst, RESP administrator and Income Tax Preparer. He holds a Bachelor of Commerce in business management from Ryerson University.