Newsletter no. 92-12, Commutation and Opting Out of a Pension Plan

December 8, 1992

Introduction

The Income Tax Regulations require that all pre-reform benefits provided under a defined benefit provision of a registered pension plan be acceptable to the Minister of National Revenue. This permits the Department to continue to apply a number of restrictions in Information Circular 72-13R8 that have not been included in the Regulations or that differ from the restrictions in the Regulations.

This is the fifth newsletter that explains how to apply the new pension legislation to benefits provided for pre-reform service under a defined benefit or money purchase provision of a registered pension plan. It also explains which administrative rules outlined in Information Circular 72-13R8 will continue to apply. Also see Pension Reform Update 92-5.

This newsletter is not a legal document. It uses plain language to inform plan administrators, employers, and pension consultants of the conditions that pre-reform benefits must satisfy in order to be acceptable to the Minister. The information relates to pre- reform benefits only, and is not intended to interpret how the Regulations apply to post-reform benefits.

This newsletter refers to "pre- reform" and "post-reform" service and benefits. Pre-reform service means pre-1991 service for all plans except grandfathered plans.

A grandfathered plan is a plan which contains a defined benefit provision and which was registered on March 27, 1988 or for which an application for registration was made before March 28, 1988. It is also a plan that was established to replace defined benefits for one or more individuals under another grandfathered plan. Pre-reform service for grandfathered plans means all service prior to the earlier of January 1, 1992 and the effective date of the amendment made to the plan to comply with the requirements of the Income Tax Regulations. All service after those dates is post-reform service. Pre-reform benefits are benefits that accrue in respect of a period of pre-reform service. All other benefits are post-reform benefits.

This newsletter does not apply to benefits provided to connected persons as defined in subsection 8500(3) of the Regulations, or to partners or proprietors and their spouses unless specifically stated otherwise. The rules for these individuals are outlined in Pension Reform Update 91-1.

We wish to remind you that the Regulations cannot be applied to pre-reform benefits in pre-October 1968 and 1980 shareholder plans if doing so will increase the benefits or the costs under the plans.

Commutation of defined benefits

Under the rules of the Circular, pension benefits can generally only be commuted after death, termination of employment, or termination of the plan prior to the retirement of the member.

Paragraph 8503(2)(m) of the Income Tax Regulations allows for the payment at any time of a lump sum from a defined benefit provision where the lump sum does not exceed the present value of the benefits being given up. Where the benefits are not indexed, or only partially indexed, you can determine the present value as if the benefits were fully indexed. It should be remembered that while the Regulations permit benefits to be commuted, other pension benefit legislation may prohibit the commutation.

Members may commute pre-reform benefits before termination of employment and the provisions of 8503(2)(m) may be applied to both pre- and post-reform benefits if the plan provides for it. This also applies to the commutation of benefits which have already begun to be paid. If you want to use the indexing assumptions, please note that the plan must not only allow the benefits to be commuted, but it must also state that the commuted value includes other benefits, namely, the benefits allowed under subparagraph 8503(2)(m)(ii).

We no longer require pre-reform benefits that were transferred to a registered retirement savings plan on retirement under paragraph 9(b) of the Circular to be locked-in.

If members are allowed to commute their pre-reform benefits, the plan must state that the period of pre- reform service cannot be credited again under the plan with that employer or a successor employer. Alternatively, the plan has to say that if the member wishes to buy back the service, the amount necessary to fund the pre-reform benefit must be transferred directly from a registered retirement savings plan, a deferred profit sharing plan, or another registered pension plan. This requirement also applies to a combination money purchase/defined benefit plan, where only the money purchase contributions are paid as a lump sum. In this case, the plan cannot be amended to increase the defined benefits for the years of service relating to the money purchase contributions.

Commuting pre-reform benefits is not, however, permitted for pre- October 1968 and 1980 shareholder plans, nor for pre-reform benefits provided to partners or proprietors or their spouses for service while they were employees.

Wage indexing of benefits for pre- reform service may be assumed for other plans having connected persons as members provided that they can continue to meet the 50/50 present value test as at December 31, 1990, for new plans and December 31, 1991, for grandfathered plans. However, you have to perform the test using only the active members at the time of the commutation, and based on the benefits accrued to those members at December 31, 1990, or December 31, 1991, whichever is applicable.

Payment of a lump sum from a money purchase provision

Paragraph 8506(1)(f) of the Regulations permits the payment from a money purchase provision of a lump sum amount, including additional voluntary contributions, up to the balance in a member's account. There are no conditions restricting these payments.

Members may receive payments of pre-reform contributions before termination of employment and the provisions of 8506(1)(f) may be applied to both pre- and post- reform contributions if the plan provides for it.

We no longer require pre-reform benefits that were transferred to a registered retirement savings plan on retirement under paragraph 9(b) of the Circular to be locked-in.

Opting out of a plan

Under the rules of the Circular, a plan may be terminated by the employer or a plan member may discontinue contributions or participation. The employer, however, may not suspend contributions. A plan can allow members to suspend contributions for a period of not more than two years.

The Regulations do not prohibit employees from opting out of a pension plan by terminating or suspending their participation, nor the employer from suspending contributions to the plan, if the plan provides for it.

Employees may commute their benefits, including pre-reform benefits, when they opt out of a plan. The conditions listed above will apply to any pre-reform benefits that are commuted.

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