Newsletter 20-1, Registered Pension Plan Annuity Contracts
This newsletter is for registered pension plan (RPP) administrators, consultants, and licensed annuity providers. It was developed as a result of consultations between the Canada Revenue Agency (CRA) and RPP industry representatives on the issue of annuity contracts purchased outside of an RPP.
The newsletter is intended to clarify the meaning of “not materially different” in relation to annuity purchases that are subject to section 147.4 of the Income Tax Act. It does not address any regulatory or compliance issues that might arise under either federal or provincial pension benefits standards legislation when an annuity is purchased outside of an RPP. Any questions related to pension benefits standards legislation should be brought to the attention of the government regulator for the particular RPP.
This newsletter does not apply when an individual acquires an annuity contract using RPP funds that were transferred first to a registered retirement savings plan (RRSP) or a registered retirement income fund (RRIF). The transfer of RPP funds to an RRSP or a RRIF is subject to section 147.3 of the Act. For example, a lump-sum transfer from a defined benefit RPP to an RRSP is subject to subsection 147.3(4) of the Act. For more information on that topic, see our Newsletter 04-1.
When does Section 147.4 of the Act apply
Section 147.4 of the Act applies when an individual acquires ownership of an annuity contract in full or partial satisfaction of their entitlement to benefits under an RPP. A purchase of an annuity can occur either before or after lifetime retirement benefits have commenced to be paid from a particular RPP. Often referred to as a buy-out annuity, it occurs when a plan administrator pays a premium to a licensed annuity provider to purchase an annuity contract on behalf of the member or their survivors. The member (or survivor) is both the annuitant and the owner of the contract.
If the conditions below are met, subsection 147.4(1) of the Act deems that the individual has not received an amount from an RPP by acquiring the annuity. It also deems amounts received under the contract to be amounts received under the RPP. As a result, the individual is not immediately taxed when they acquire the annuity, and they must include the annuity payments in their income in the year received. For subsection 147.4(1) of the Act to apply, the following conditions must be met:
- the rights provided under the contract are not materially different from those provided under the RPP,
- no further premiums will be paid after the contract is acquired, and
- unless waived by the Minister, at the time of the acquisition, the registration of the RPP is not revocable.
Subsection 147.4(1) of the Act applies if the rights provided under the annuity contract are not materially different from the rights provided under the RPP. In determining whether the rights under the annuity contract are not materially different from the RPP, consideration must be given to the terms of the RPP based on the plan as registered. Plan as registered is defined in subsection 147.1(15) of the Act, which means the terms of the plan under which the CRA has registered the plan. It also includes amendments that have been accepted by the CRA, as well as those that have been submitted for acceptance but have not been accepted or refused and it is reasonable to expect that the CRA will accept them.
Annuity purchases, therefore, must not allow for a reconfiguration of the amount or form of benefits that are provided under the particular RPP. For example, an annuity provided from a licensed annuity provider cannot provide payments that have a greater guarantee period than what was available under the RPP.
If the annuity contract is materially different from the RPP
If an individual acquires ownership of an annuity contract under an RPP that is not in accordance with subsection 147.4(1) of the Act, the individual is considered to have received a payment from the RPP and is required to include the value of the contract in income under paragraph 56(1)(a) of the Act.
Differences that are considered immaterial
Given the potential adverse tax consequences of differences in annuity purchases, it is important to understand what adjustments the CRA considers to be immaterial when compared to the plan as registered. The following is intended to provide guidance only on what is acceptable under subsection 147.4(1) of the Act.
Many RPPs provide cost-of-living adjustments that are based on the full Consumer Price Index (CPI). However, in general, licensed annuity providers do not offer life annuities with this feature. Provided that the annuity contract matches all other benefits provided under the RPP, the CRA will accept one of the following fixed-rate adjustments in lieu of a full CPI indexation adjustment:
- the midpoint of the Bank of Canada’s inflation-control target range at the date of purchase,
- the spread between the yield of Government of Canada long term bonds and real return bonds in the month of or the month preceding the date of purchase, or
- a fixed rate that is between these two alternatives.
Some RPPs provide indexation that is less than CPI, such as CPI less 1% or 40% of CPI. To make sure the annuity is not materially different from the RPP in this situation, you have to modify the fixed-rate adjustment appropriately.
Similarly, some RPPs include cost-of-living adjustments for specific periods of service, while others have, or may have, different adjustments for different periods of service. You also have to adjust appropriately for these situations.
If you use a method that differs from the ones above, we recommend that you send us a written request that outlines your rationale. We review each request on a case by case basis.
Individual annuity purchases using commuted values
In the case of a defined benefit RPP, the terms of the plan as well as applicable pension benefits standards legislation might allow a member to use their commuted value to buy a life annuity from a licensed annuity provider. A commuted value is a lump-sum payout equal to the present value of a member’s earned benefits under the plan. A commuted value cannot be used to purchase an annuity that is materially different from the RPP, based on the plan as registered.
In some cases, the commuted value is not enough to provide an annuity that equals the benefits that would have been provided under the RPP. In this case, the lifetime retirement benefits or ancillary benefits are reduced. The individual can choose to receive a reduced lifetime retirement benefit, a reduction in one or more ancillary benefits, or a combination thereof, as long as no element of the benefits under the annuity exceed the amount of that element under the RPP. An annuity that provides less benefits than what would have been provided from the RPP will have the protection afforded under subsection 147.4(1) of the Act, on the understanding that the payment of the commuted value is in full satisfaction of the member’s benefits under the RPP.
If a member only receives a partial commuted value from an RPP because of the plan’s solvency rate, the member can purchase an annuity and choose the manner of the reduction as described in the preceding paragraph.
If the commuted value is greater than the cost to buy an annuity that replicates the RPP benefits, the excess commuted value cannot be used to provide higher annuity payments under the annuity contract. The member can use the portion of the commuted value to purchase an annuity that replicates the benefits provided under the RPP. Under subparagraph 8502(d)(ix) of the Income Tax Regulations, the portion of the commuted value that is in excess of the annuity acquisition cost can be paid in cash to the individual and must be included in income for tax purposes. It cannot be left in the RPP or transferred directly to a pooled registered pension plan, RPP, RRSP, RRIF, or specified pension plan.
Using individual pension plan assets to buy an annuity
Certain RPPs, such as individual pension plans, might wish to purchase an annuity contract from a licensed annuity provider that is based on the assets in the plan. However, as noted above, the annuity purchase must still be based on the plan as registered.
If there are not enough RPP assets, the employer can make additional RPP contributions to make sure that the promised benefits under the plan as registered can be paid directly from the RPP. Then the RPP benefits can be settled by buying an annuity outside of the plan. Alternatively, if the annuity contract provides lower benefits than what was available under the RPP (in the manner previously described), it will meet the conditions set out in subsection 147.4(1) of the Act.
If there are excess assets in the RPP, to the extent that lifetime retirement benefits and ancillary benefits are not at the maximum allowable under the Act, benefits can be enhanced through a plan amendment before being settled by an annuity purchase.
Do these rules apply to money purchase plans?
Section 147.4 of the Act applies for annuity contracts that replace benefits provided under RPPs; both defined benefit and money purchase plans. A money purchase plan is also called a defined contribution plan. Similar to defined benefit plans, when buying an annuity outside of a money purchase RPP, the annuity must be based on the plan as registered in order to satisfy subsection 147.4(1) of the Act.
We recognize that the terms of some money purchase RPPs might not have specific forms of retirement benefits and can have general portability provisions. However, upon retirement or termination of employment, the plan terms must allow members the opportunity to purchase an annuity from a licensed annuity provider using their account balances. As such, this newsletter also applies to money purchase plans.
A buy-in annuity policy is issued by an annuity provider to an RPP administrator in order to de-risk certain liabilities under the RPP. Under the annuity policy, the annuity provider deposits the total periodic annuity payment to the pension fund. The responsibility to pay the pensions to individual retired members rests with the pension plan administrator and no individual certificates of insurance are provided to the retired members whose retirement benefits are subject to the buy-in annuity policy. In these situations, subsection 147.4(1) of the Act has no application as the contract is issued to and owned by the RPP and not any individual plan members. The buy-in annuity contract is an investment of the RPP.
CRA inspections of supporting documents or information
Under subsections 231.1(1) and 231.2(1) of the Act, the CRA can inspect any information or document relating to the enforcement or administration of the Act and can require any person to provide the information or documents. Therefore, we suggest you retain information for all RPP annuity purchases.
Where to get help
Registered Plans Directorate
You can find more information at Savings and pension plan administration.
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.
Registered Plans Directorate
Canada Revenue Agency
Ottawa ON K1A 0L5
Information Holdings Operation Section – Registered Plans
Registered Plans Directorate
Canada Revenue Agency
875 Heron Road, B70
Ottawa ON K1A 1A2
We welcome feedback on this newsletter. Send comments by email to RPD.LPRA2@cra-arc.gc.ca.
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