Actuarial Bulletin No. 2

October 2010

The Registered Plans Directorate (RPD) presents its second in a series of actuarial bulletins. These bulletins are intended to clarify the provisions of the Income Tax Act and the Income Tax Regulations relating to actuarial issues in defined benefit (DB) pension plans.

This bulletin specifically elaborates on funding issues of DB plans that meet the definition of designated plans under subsection 8515(1) of the Regulations and expands on the following points:

• what constitutes an eligible employer contribution to a designated plan;
• differences between the funding restrictions that apply to restricted-funding members and to individuals who are not restricted-funding members;
• allowable funding after a termination of membership from a designated plan;
• issues regarding methodologies used in an actuarial valuation of a designated plan; and,
• additional disclosures required by the RPD in an actuarial valuation report (AVR) for a designated plan.

Eligible employer contributions to a designated plan

As set out in subparagraph 8502(b)(iii) of the Regulations, a permissible contribution is an "eligible contribution" paid in respect of a DB provision of a plan. Subsection 147.2(2) of the Act defines an "eligible contribution" and applies to all DB plans (with the exception of a Specified Multi-Employer Plan).

Under subsection 147.2(2) of the Act, an employer contribution to a DB provision of the plan is an eligible contribution if it is a prescribed contribution, or if it complies with prescribed conditions and is made on the recommendation of an actuary, in whose opinion, the contribution is required to fund the benefits in accordance with the plan terms as registered. The recommendation must also satisfy the conditions described in the paragraphs of that subsection.

For a designated plan, subsection 8515(5) of the Regulations prescribes additional conditions for the purpose of an eligible contribution under subsection 147.2(2) of the Act.

Therefore, a contribution made by an employer to a designated plan is eligible only if it meets the following two conditions: 1) it is based on an actuary's recommendation, stating that the contribution is required for the plan to have sufficient assets to meet the obligations under the DB provision of the pension plan as registered, and 2) if it does not exceed the maximum amount determined under the provisions of subsections 8515(6) and 8515(7) of the Regulations.

Therefore, the maximum eligible contribution with respect to a designated plan, during the period covered by the recommendation in an AVR, will be equal to the lesser of the funding results from the going-concern valuation and the maximum funding valuation (MFV). For the purpose of the MFV, subsection 8515(6) of the Regulations requires the assumption that certain "specified benefits" were provided to restricted-funding members in lieu of the benefits actually provided under the plan.

Subsection 8515(8) of the Regulations defines a restricted-funding member, at the time the MFV is prepared, as a member whose retirement benefits have not started to be paid or for whom the payment of retirement benefits has been suspended.

"Specified benefits" of a restricted-funding member means, for the purpose of the MFV, retirement benefits that are assumed:

• to be paid monthly in advance;
• to start no earlier than the day on which the member reaches 65 years of age;
• to be adjusted annually after commencement, at the annual rate of increase in the Consumer Price Index minus 1 percentage point; and,
• to be guaranteed for five years after commencement and, after the death of the member, 66^2/3 percent of the amount of retirement benefits will be payable to the member's surviving spouse, if any.

Please note that for a designated plan established before 1991, under paragraph 8515(5)(b) of the Regulations, the last three of the four provisions mentioned above for restricted-funding members can be applied only in respect of benefits that become provided after 1990 (including pre-1991 benefits credited on a past-service basis). This alternative rule is intended to grandfather the funding of benefits that became provided before 1991 under a designated plan that includes generous benefits.

If the benefits provided under the plan are substantially similar to those specified for the purpose of the MFV, the RPD will accept a statement in which the actuary certifies that a going-concern valuation would produce a higher funding requirement than the one produced by the MFV. In cases where the benefits provided under the designated plan are less generous than those specified for the MFV, valuation results on both the going-concern and MFV bases must be shown separately.

For a designated plan in a surplus position, a separate calculation must be done on the MFV basis to determine the amount of surplus that can be disregarded for funding purposes. This calculation, called the excess surplus calculation, should be performed on both the going-concern basis and the MFV basis, when applicable, to determine the amount of eligible contributions. Please refer to Example 1 in the Appendix.

In addition, contributions to fund a solvency deficiency are not permitted as prescribed contributions under subsections 8516(2) and 8516(3) of the Regulations in determining the eligible contributions for a designated plan under subsection 147.2(2) of the Act. However, contributions to fund a solvency deficiency not exceeding the eligible contribution determined in the manner explained above may be eligible. Please refer to Example 2 in the Appendix.

For many years, some actuaries have contended that some of the assumptions prescribed under subsection 8515(7) of the Regulations are not realistic, result in insufficient funding for designated plans, and should be revisited. However, the assumptions for the MFV were not devised to reflect current market conditions; rather, they were intended to establish a cap on the contributions to designated plans and therefore expressly limit their funding.

Differences between the funding restrictions that apply to restricted-funding members and to individuals who are not restricted funding members

Some of the paragraphs under subsections 8515(6) and 8515(7) of the Regulations only apply with respect to restricted-funding members, as defined and explained above.

Examples of individuals who are not restricted-funding members at the time the MFV is prepared include terminated members whose only entitlement is a lump-sum payment that remains to be paid and members who are receiving pension benefits.

Once an individual is no longer a restricted-funding member, some of the provisions under subsections 8515(6) and (7) no longer apply or are different:

• It is no longer necessary to assume that his or her retirement benefits are payable monthly in advance. The benefits actually provided under the plan must be used for this individual.
• The assumptions specified in paragraph 8515(7)(e) are no longer used. Therefore, neither the minimum requirement of age 65 for the pension commencement nor the assumption that the member will be married to a person who is the same age as the member applies.
• The provisions of paragraph 8515(6)(b) do not apply. As a result, the actuary must reflect the cost-of-living adjustments provided under the plan terms, if any.
• The actual death benefit elected by the individual and/or the spouse under the plan terms must be valued instead of the benefits specified in paragraph 8515(6)(c).
• The mortality rates to be used in the MFV are specified under subparagraph 8515(7)(f)(ii) and are, therefore, sex-distinct as opposed to unisex mortality rates.

Allowable funding after a termination of membership from a designated plan

This section pertains to designated plans with more than one member, where one of the members terminates his or her employment and elects a transfer value during the inter valuation period. For the purpose of this discussion, it is assumed that the funding requirements under the going-concern basis are higher than those under the MFV basis.

RPD officials have been asked many times, in situations where an AVR indicates that the plan has a surplus on the MFV basis and a solvency ratio lower than 1, whether funding would be allowed to cover the solvency deficiency. The answer is no.

However, a cost certificate can be prepared and filed with the RPD to reflect the impact of this transfer on the plan's financial position for the remaining plan members. A deficiency revealed on the MFV basis in the cost certificate as a result of the commuted value payment could be funded, and the contributions would be eligible if they comply with the conditions explained earlier.

Issues regarding methodologies used in an actuarial valuation of a designated plan

Paragraph 8515(7)(a) of the Regulations requires that the projected accrued benefit method be used to determine actuarial liabilities and current service contributions in the MFV. Under this method (also known as the projected unit credit method), actuarial liabilities are based on benefits accrued to the date of valuation.

Therefore, the RPD does not accept for the purpose of the MFV the use of the projected unit credit with any proration method. For example, the projected retirement benefits cannot be evenly distributed over a member's total (past and future) eligible service.

In calculating a member's age for the purpose of the MFV, age must be calculated as "exact" age (calculated in years and either completed months or age-nearest month).

The RPD will no longer accept the use of age-nearest birthday or age-last birthday, and the RPD has never accepted the use of age-next birthday except in some limited and exceptional circumstances. The requirement to use the exact age methodology will apply to AVRs with an effective date on or after December 31, 2010.

Additional disclosures required by the RPD in an AVR for a designated plan

To facilitate an accelerated turnaround time for the review of designated plan funding requests, the following information, for each plan member, should be contained and specified in the AVR submitted to the RPD:

• the normal cost (current service contribution) for each year, expressed as a dollar maximum and as a percentage of earnings;
• the DB actuarial liability and other liability items (such as the additional voluntary contributions) shown separately;
• the gross-up past service pension adjustment (PSPA), if applicable;
• the method elected by each participant to offset the PSPA;
• the amount of a qualifying transfer, if any;
• the amount of a certified PSPA or qualifying withdrawal filed with the Canada Revenue Agency, if any; and
• membership data (for example, name, date of birth, date of entry, and salary history).

In addition to the above disclosures:

• For a plan that also contains a defined contribution provision that is intended to accommodate additional voluntary contributions, a separate reconciliation since the last valuation of the assets of the defined-benefit provision and the assets of the defined contribution provision, is required.
• When a member's accrued benefits under the plan have been insured, the annuity contract(s) that sets out the benefit amounts and the form of payment(s) must be provided.
• For a plan with more than one participating employer, a separate balance sheet for each participating entity must be provided, outlining their funded position and respective funding request.
• The actuary should explicitly state the amount of maximum eligible contributions permitted for each year of the period covered by the report. For instance, for the first year, the maximum eligible contribution could consist of the current service contribution and/or the unfunded actuarial liability, and for the subsequent years, the maximum eligible contribution could be the current service contribution of each year.

Where to get help

Registered Plans Directorate

You can find more information at Savings and pension plan administration.

By telephone

Toll-free in Canada and the United States: 1-800-267-3100. 
If you are calling from outside of Canada or the United States, call us collect at 613-221-3105. The Registered Plans Directorate accepts collect calls.

By mail and courier

Due to a building refit spanning multiple years, the Registered Plans Directorate’s mailing address has been temporarily changed. Please use the following address for all correspondence until further notice:

Registered Plans Directorate
Canada Revenue Agency
2215 Gladwin Cres
Ottawa ON  K1B 4K9

We welcome feedback on this bulletin. Send comments by email to RPD.LPRA2@cra-arc.gc.ca.

Appendix 1

The following are results from the balance sheets of an AVR effective December 31, 2009:

The excess surplus calculation as defined in paragraphs 147.2(2)(d) of the Act and 8515(6)(e) of the Regulations was performed and applied to reduce the current service contributions. Since this AVR is effective on or after December 31, 2009, the 25% of actuarial liabilities was applied in the excess surplus calculation. Please refer to question 28 of the frequently asked questions about RPPs on our Web site for more details on this legislative change.

Under the going-concern valuation, the excess surplus of $50,000 is applied to reduce the current service contributions by $22,000 for the first year, $23,000 for the second year, and $5,000 for the third year. The remaining current service contribution to be funded in the third year is $19,000.

Likewise, under the MFV, the excess surplus of $43,750 is applied to reduce the current service contributions by $18,000 for the first year, $19,000 for the second year, and $6,750 for the third year. The remaining current service contribution to be funded in the third year is $13,250.

The current service contributions less the excess surplus in the shaded area represents the eligible contributions, because the total contributions, as of the date of valuation, determined under the MFV ($13,250 in year 3) are less than those determined under the going-concern valuation ($19,000 in year 3).

The following are results from the balance sheets of an AVR effective December 31, 2009:

The amounts in the shaded area represent the eligible contributions, because the total contributions, as of the date of valuation, determined under the going-concern valuation are less than those determined under the MFV.

If the going-concern unfunded liability is to be paid in a lump sum, the maximum eligible contributions that may be made in the years 1, 2, and 3 following the valuation are $100,000 (that is, $80,000 + $ 20,000), $21,000, and $22,000, respectively; no additional contributions toward the funding of the solvency deficiency can be made as eligible contributions.

If the actuary's recommendation provides for the going-concern unfunded liability to be amortized by level payments, such payments are eligible contributions, as long as their present value as of the date of valuation does not exceed $80,000. Therefore, past service payments of up to $28,400 per year ($80,000 amortized over 3 years) could be made. In addition, the annual current service costs of up to $20,000, $21,000, and $22,000, would be permissible contributions.

Assuming the employer wants to pay the minimum contributions required by pension benefits legislation for the three-year period following the valuation, and there are no existing unfunded liabilities before the date of valuation, the recommendation would call for annual past service contributions of $28,000 (a going-concern unfunded liability payment of $8,000 and a solvency deficiency payment of $20,000). Since this does not exceed the maximum allowable past service contributions of $28,400 per year, these past service payments would be eligible in addition to the current service contributions.

As this example shows, to establish contributions to a designated plan as eligible contributions for tax purposes, it may be necessary to "reconstruct" the contribution recommendation. Contributions must be fully justified either on the going-concern basis or on the maximum funding basis (lesser of); they cannot be justified partly on the going-concern basis and partly on the solvency basis.

In the above example, while the actuary has recommended current service contributions of $20,000 in the first year (going-concern basis), annual past service contributions of $8,000 (going-concern basis), and $20,000 (solvency basis), the contributions are justified for tax purposes because they can be viewed as to consist of the current service contributions of $20,000 (going-concern basis) and the past service contributions of $28,000 (going-concern basis).