Newsletter no. 96-3R1, Flexible Pension Plans

November 25, 1996

In this newsletter, we outline conditions that we are applying to flexible pension plans under the authority of subsection 147.1(5) of the Income Tax Act (Act). The conditions are in addition to those imposed by the Act and the Income Tax Regulations (Regulations) that have to be satisfied for a pension plan to qualify for registration under the Act.

In general terms, a flexible pension plan is a pension plan that allows members to make voluntary defined benefit contributions to acquire or improve ancillary benefits provided in connection with basic pension benefits accruing under the plan. A flexible pension plan allows members to improve their pension benefits to address their individual needs. Since ancillary benefits are disregarded in computing pension adjustments (PAs) and past service pension adjustments (PSPAs), members can improve their benefits without reducing the amount of deduction room available for registered retirement savings plan contributions.

Some examples of ways in which benefits might be improved under a flexible pension plan are as follows:

• lowering the age at which an unreduced pension can be paid or decreasing the early retirement reduction factor;
• indexing pensionable earnings, reducing the number of years used to calculate average earnings or replacing career average earnings with best or final average earnings;
• providing bridging benefits;
• indexing lifetime retirement benefits; and
• improving survivor benefits.

We define a flexible pension plan in the following section. A pension plan may provide for voluntary defined benefit contributions, without being a flexible pension plan. Only plans that fit the definition are subject to the additional conditions imposed in this newsletter.

Definitions

In this section, we define some terms we use in this newsletter. The appendix to this newsletter lists terms defined under the Act or Regulations.

Flexible pension plan - This means a pension plan the terms of which provide for optional ancillary benefits.

Optional ancillary benefit - This means any benefit (other than an exempt benefit) provided in respect of a pension plan member under a defined benefit provision of the plan as a consequence of the member having made optional contributions under the provision.

Exempt benefit - This means any of the following benefits provided under a defined benefit provision of a pension plan as a consequence of a member having made optional contributions under the provision:

a) lifetime retirement benefits provided to the member for a post-1989 period, to the extent that:

• the lifetime retirement benefits give rise to a pension credit or a provisional PSPA of the member that is greater than nil; or
• the lifetime retirement benefits increase the amount of a pension credit or a provisional PSPA of the member,
• or the lifetime retirement benefits would so give rise to or increase a pension credit or a provisional PSPA of the member if:
  • the amount determined under paragraph 8301(6)(b) of the Regulations and amount C in the formula in subsection 8303(3) of the Regulations were nil; and
  • paragraph 8301(7)(b) and subsection 8304(5) of the Regulations were disregarded;

b) lifetime retirement benefits provided to the member for a pre-1990 period that was not pensionable service of the member under the provision immediately before the benefits became provided;

c) additional lifetime retirement benefits provided to the member for a pre-1990 period that was pensionable service of the member under the provision immediately before the benefits became provided, to the extent that:

• the benefits are provided by increasing the effective benefit accrual rate under the provision; or
• at the request of the plan administrator, we have accepted in writing the benefits as exempt benefits;

d) benefits (such as indexing and survivor benefits) that are associated with exempt lifetime retirement benefits described in any of paragraphs a) to c), when the optional contributions as a consequence of which the benefits are provided are made together with the optional contributions as a consequence of which the associated lifetime retirement benefits are provided.

Optional contribution - This means the part, if any, of a contribution that a member of a pension plan makes under a defined benefit provision of the plan that, by exercising (or not exercising) a right in connection with the plan, the member could have prevented from being made under the provision.

Example

At the beginning of each year, members of a non-contributory plan are given the option of contributing 3% of earnings to the plan in that year. In return, the pension accrued to the member for the year is indexed. Such contributions are optional contributions since members can choose not to contribute to the plan in the year.

However, under certain circumstances, contributions that a member could have prevented from being made will not be considered to be optional contributions. This will be the case when the following conditions are satisfied:

• a member enters into a commitment to make regularly-scheduled contributions under a defined benefit provision of a pension plan;
• the contributions are to be made at a fixed rate determined no later than the time the commitment is entered into;
• the contributions are to be made for at least as long as the member accrues benefits on a current service basis under a defined benefit provision of the plan (or for a shorter time that we accept in writing);
• the benefits to be provided as a consequence of the member having made the contributions are established on a once-and-for-all basis at the time the commitment is entered into; and
• the employer does not participate in any other registered pension plan under which benefits could be provided to the member under a defined benefit provision (except to the extent that, at the request of the plan administrator, we have waived in writing this condition).

Example

New members of a pension plan are given the option, on a once-and-for-all basis, of contributing 3% of earnings to the plan each and every year in return for which the pension payable to the member is adjusted for increases in the cost-of-living. Members who choose not to contribute receive non-indexed pension benefits. Contributions made by a member as a result of this decision are not optional contributions.

Optional ancillary contribution - This means an optional contribution that a pension plan member makes under a defined benefit provision of the plan as a consequence of which optional ancillary benefits are provided under the provision in respect of the member.

Imposed conditions

In this section, we set out the additional conditions that we are imposing on flexible pension plans under the authority of subsection 147.1(5) of the Act.

Coming-into-force

Except as noted below, these conditions apply to all contributions made, and benefits provided, under a flexible pension plan after 1989.

These conditions do not apply to contributions made, or benefits provided, under a flexible pension plan before 1998 to the extent that they are made or provided under plan terms accepted by us before November 25, 1996. We would usually indicate our acceptance by registering the plan with the terms in it, or accepting a plan amendment with the terms in it.

These conditions also do not apply to contributions made, or benefits provided, under a flexible pension plan before 1998 to the extent that we have waived their application in writing.

Conditions

1. The terms of a flexible pension plan have to establish, on a once-and-for-all basis each time an optional contribution is made to the plan, whether or not the contribution is an optional ancillary contribution. This means that optional ancillary benefits can be provided as a consequence of a member having made an optional contribution only if the contribution is established as being for such benefits at the time it is made (although the specific benefits to be provided need not be established at that time). It also means that, when a contribution is established as being for optional ancillary benefits, it cannot subsequently be used to provide exempt benefits.

2. A flexible pension plan must not apply the 50% employer funding rule in subsection 21(2) of the Pension Benefits Standards Act, 1985, or any similar rule in provincial legislation, on a stand-alone basis to optional ancillary contributions and optional ancillary benefits.

In general terms, this rule requires that, when a member's contributions plus interest under a defined benefit pension plan exceed 50% of the value of the benefits provided to the member under the plan, the member's benefits have to be increased by the amount that can be provided with the excess.

Example

It is not acceptable for a flexible pension plan to provide additional benefits to a member simply on the basis that the member's optional ancillary contributions plus interest exceed 50% of the value of the member's optional ancillary benefits. However, it is acceptable to provide additional benefits when a member's total contributions (including optional ancillary contributions) plus interest exceed 50% of the value of the member's total benefits (including optional ancillary benefits).

3. The terms of a flexible pension plan have to clearly establish that, if the amount of optional ancillary contributions that a member makes under a defined benefit provision of the plan, plus the earnings on those contributions, exceeds the value of optional ancillary benefits that are provided under the provision in respect of the member, neither the member nor any beneficiary of the member has any entitlement in respect of the excess. For example, the excess could not be paid as a lump sum or in the form of additional lifetime retirement benefits.

However, this condition does not apply when such an excess arises only as a result of applying the 50% employer funding rule referred to in Condition 2. Also, it does not apply to prevent a refund of contributions under a defined benefit provision of a pension plan, as permitted under subparagraph 8502(d)(iv) or (ix) or paragraph 8503(2)(h) or (j) of the Regulations.

4. If the terms of a flexible pension plan allow members to make optional ancillary contributions that are not current service contributions, i.e., not subject to the requirements of subparagraphs 8503(4)(a)(i) or (ii) of the Regulations, the plan must restrict the total optional ancillary contributions that a member is allowed to make in a calendar year (including those for current service) to the amount, if any, by which

a) the lesser of:

• 9% of the member's compensation for the year from employers participating in the plan; and
• $1,000 + 70% of the member's defined benefit pension credits for the year under the plan,

exceeds

b) the amount of current service contributions (other than optional ancillary contributions) that the member makes in the year under defined benefit provisions of the plan.

5. The terms of a flexible pension plan have to clearly set out the manner in which specific optional ancillary benefits provided in respect of a member are to be established for purposes of determining amounts payable on retirement, death, termination of membership, and full or partial wind-up of the plan.

Note

A plan could satisfy this condition in any number of ways. For example, it could indicate the specific optional ancillary benefits that are to be provided or it could require or grant authority to one or more individuals (such as the plan administrator, the member or the member's beneficiary) to make the optional ancillary benefit selection.

6. A flexible pension plan must not allow a member to commute optional ancillary benefits, except to the extent that the lifetime retirement benefits with which the benefits are associated are also being commuted.

7. A flexible pension plan must not allow optional ancillary benefits to be provided for pre-1990 periods unless the optional ancillary contributions as a consequence of which the benefits are provided are established, on a once-and-for-all basis at the time they are made, as being for benefits for pre-1990 periods (although the specific benefits to be provided do not have to be established at that time). This condition ensures the proper application of the deduction provisions in subsection 147.2(4) of the Act.

8. A flexible pension plan has to prohibit optional ancillary contributions from being made in any year that the plan is a designated plan. It must also prohibit optional ancillary benefits from being provided for any period in a year in which the plan is a designated plan.

9. Any information (such as employee booklets) made available to members of a flexible pension plan explaining how the plan works must also be provided to us. It must be submitted to us by the time it is made available to members or, if later, when the plan (or an amendment making the plan a flexible pension plan) is submitted to us for approval. However, if the information was made available to members, and the plan (or amendment) was submitted to us, before November 25, 1996, the deadline for submitting the information to us is extended to February 3, 1997.

We do not intend to review this material for approval. However, we wish to be able to assure ourselves that members are not inadvertently left with the impression that they may have an entitlement to the part (if any) of their optional ancillary contributions plus earnings that exceeds the present value of their optional ancillary benefits (see Condition 3 above).

Pension Benefits Standards Legislation

When an individual is no longer an active member of a flexible pension plan, pension benefits standards legislation may give the member a right to receive a payment of optional ancillary contributions, while still retaining a right to receive other benefits from the plan. This would violate paragraph 8503(2)(h) of the Regulations, which requires that lump-sum payments in respect of a member’s contributions be the last payments made from a defined benefit provision of a registered pension plan.

However, subparagraph 8502(d)(ix) of the Regulations permits, as a permissible distribution, the payment of a single amount that is required to be made under the Pension Benefits Standards Act, 1985, or similar law of a province. Under these circumstances, we will allow a flexible pension plan to make a lump-sum payment of the optional ancillary contributions. The lump-sum payment is not eligible for a direct tax-free transfer to another registered plan, and must be brought into taxable income in the year it is received.

Regulatory limits

As well as satisfying the conditions that are imposed in this newsletter, a flexible pension plan has to satisfy all requirements of the Act and Regulations that apply. Since optional ancillary contributions are made to a defined benefit provision, they must comply with all of the conditions that apply to defined benefit contributions. Similarly, optional ancillary benefits have to comply with all of the conditions that apply to defined benefits. The following examples illustrate this point.

Example 1

A flexible pension plan provides that, when a member retires before age 60, the member's benefits are reduced by 0.5% for each month between the month of retirement and the month in which the member attains age 60. As an optional ancillary benefit, the plan allows the member to elect a decrease in the early retirement reduction factor. To qualify for registration, the plan must ensure that the benefits are reduced at least by the amount required by paragraph 8503(3)(c) of the Regulations.

Example 2

A flexible pension plan provides for a terminating member who is vested to receive a lump sum payment equal to the greater of:

• the present value of the member's benefits (including optional ancillary benefits); and
• the amount of the member's contributions (including optional ancillary contributions) plus earnings.

Since the payment of either of these amounts is a permissible benefit under the Regulations - the former under paragraph 8503(2)(m), the latter under paragraph 8503(2)(h) - this benefit is an acceptable benefit and does not disqualify the plan from registration.

Example 3

A flexible pension plan provides non-contributory basic benefits. Deferred pensions are adjusted to reflect increases in the average wage. Pensions-in-pay are adjusted to reflect increases in the Consumer Price Index. A terminating member who is vested can elect to receive, instead of a deferred pension, a lump sum payment equal to the total of:

• the present value of the member's basic benefits, i.e., excluding optional ancillary benefits; and
• the greater of the present value of the member's optional ancillary benefits and the amount of the member's optional ancillary contributions plus earnings.

There may be circumstances when a member's optional ancillary contributions plus earnings will be greater than the present value of the member's optional ancillary benefits. If so, the resulting termination benefit payable under this plan would not be a permissible benefit under paragraph 8503(2)(h) because it is greater than the member's total contributions under the plan (assuming that subparagraph 8503(2)(h)(iii) does not apply). It is also not a permissible benefit under paragraph 8503(2)(m) because it is greater than the present value of the member's total benefits under the plan. Since there is no other provision in the Regulations that would support the payment of the benefit, it is not a permissible benefit and the plan does not qualify for registration.

Valuations and funding

Since flexible pension plan members can have no entitlement to any portion of their optional ancillary contributions that exceeds the present value of their optional ancillary benefits (see Condition 3), such excesses have to be considered to be available to fund other defined benefits provided under the plan. This must be reflected in any valuation of a flexible pension plan under which such excesses may arise.

If specific optional ancillary benefits to be provided under a flexible pension plan are not known when a valuation is prepared, the actuary must make assumptions as to what the benefits will be. Paragraph 8502(j) of the Regulations requires that the assumptions be reasonable and acceptable to the Minister of National Revenue. We will accept any assumptions that we consider to be reasonable. In order for us to make this assessment, the assumptions have to be clearly described in the valuation report, and the actuary has to be prepared to justify their suitability when asked to do so.

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.

Cross references

In this section, we identify the provisions in the Act and the Regulations which contain definitions of terms we use in this newsletter.

• Administrator, Act 147.1(1)
• Average wage, Act 147.1(1)
• Bridging benefits, Regulations 8500(1)
• Compensation, Act 147.1(1)
• Consumer Price Index, Regulations 8500(1)
• Defined benefit provision, Act 147.1(1)
• Designated plan, Regulations 8515
• Lifetime retirement benefits, Regulations 8500(1)
• Member, Act 147.1(1)
• Participating employer, Act 147.1(1)
• Past service pension adjustment (PSPA), Regulations 8303
• Pension adjustment (PA), Regulations 8301
• Pension credit, Regulations 8301
• Pensionable service, Regulations 8500(1)