Whether you’re a member of a defined benefit (DB) or defined contribution (DC) pension plan, you’ll receive a pension adjustment (PA) each year. It’s important to understand what a PA is because it affects the maximum amount you can contribute to your RRSP each year. Let’s explore the PA, how it affects RRSP room and how it’s calculated.
What is a Pension Adjustment?
If you are a member of a Registered Pension Plan (RPP) or a Deferred Profit Sharing Plan (DPSP) your PA amount will appear in Box 52 of your T-4 slip. The PA is the value assigned by Canada Revenue Agency (CRA) to your accrued pension in a year. It is an estimation of the value of your pension.
The PA was introduced by CRA to create a level playing field for employees saving for retirement by reducing the RRSP contribution limit for employees with RPPs. Your PA from the previous year is used to reduce your RRSP contribution limit for the current year. For example, your PA from 2010 is used to lower your RRSP contribution limit for 2011.
How Do I Calculate my PA?
Calculating your PA is different depending on whether you have a DC or DB pension.
If you have a DC pension, calculating your PA is rather simple: it’s the sum of the employer and employee contributions to the plan. For example, if you contribute 2% of your earnings on a yearly salary of $40,000 ($800 = 2% x $40,000) and your employer matches that ($800), then your PA for the year will be $1,600 ($800 + $800).
If you have a DB pension there is a formula for calculating your PA:
(9 x annual accrued benefit) – 600
The annual accrued benefit depends on the formula of your pension plan. For example, if your plan has an accrual rate of 2%, and you have a yearly salary of $50,000, then your PA would be: [9 x ($50,000 x 2%)] – 600 = 8,400.
How did CRA come up with this formula for DB plans? The formula assumes that every DB plan offers employees a generous 2% benefit. This isn’t always the case, which is why the Pension Adjustment Reversal (PAR) was introduced.
What is a Pension Adjustment Reversal (PAR)?
If you terminate your employment during a year, you may receive a PAR. A PAR restores the lost RRSP contribution room that the PA has taken away in past years.
Whether you receive a PAR depends on a number of factors. For non-vested members, you will receive a PAR if a PA has been reported on your T4 slip. For vested employees a PAR is calculated in the following way: Total PAs – Commuted Value = PAR.
For example, if the sum of your PAs from 2007 to 2010 was $12,000 and your Commuted Value was $10,000, then your PAR would be: $12,000 – $10,000 = $2,000. $2,000 would be restored to your RRSP contribution room for the following year.
Understanding the PA is important if you have an employer-sponsored pension plan, as you’ll need to know how much it reduces your RRSP contribution room each year. The easiest way to do that is to file your income tax and find out from your notice of assessment how much you can contribute to your RRSP. With good tax planning you can still maximize your RRSP without over contributing, you just have to be careful.
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.
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