CRA Newsletter imposes new restrictions on individual pension plans and designated plans
On March 16, 2021, the Registered Plans Directorate of the Canada Revenue Agency (CRA) released Newsletter 21-1: Additional Conditions Applicable to Individual Pension Plans and Designated Plans, in which the CRA introduced new conditions applicable to individual pension plans (IPPs) and designated plans (DPs).
The new conditions are imposed in accordance with subsection 147.1(5) of the Income Tax Act (ITA) and aim to prevent such plans from using money purchase (MP) provisions, which are also known as defined contribution provisions, to circumvent certain restrictions imposed by the ITA and Income Tax Regulations (the Regulations).
Excess surplus condition
The ITA restricts DB plan sponsors from making contributions where the plan holds a specified amount of surplus. In effect, this requires the sponsor of a plan with excess surplus to take a contribution holiday and use the excess surplus to cover the plan’s current service costs.
This ITA rule prompted certain IPP and DP plan sponsors to suspend DB accruals once excess surplus was reached and make fresh contributions to an existing or newly added MP provision of the plan. The CRA indicates that it considers such a hybrid design to be a “misuse” of the legislation, because it allows for continued tax-deductible contributions while preserving or increasing a plan’s surplus. Newsletter 21-1 applies this prohibition on additional contributions to all IPPs and DPs, effective March 16, 2021.
Any crediting of amounts to an MP provision of the IPP or DP, or to an MP provision of another pension plan of the employer, may only be made from the excess surplus. The Newsletter points out that surplus may be transferred, under existing rules, from a DB provision to a MP provision of the same or another pension plan of the employer.
Designated plan funding restrictions
The ITA limits the amount of contributions an employer can make to a DB provision of a designated plan. However, plans that would be considered designated plans if their current service benefits were provided on a DB basis have been able to circumvent this restriction by providing past service benefits on a DB basis and current service benefits on a pure MP basis.
According to the CRA, members of such arrangements typically convert their MP benefits into defined benefits, subject only to certification of the associated past service pension adjustment, while the employer covers any additional past service costs. In such cases, the actuarial funding assumptions generate higher DB contributions than would be permitted in the case of a designated plan. In effect, says the Newsletter, this arrangement causes plans to operate as DB plans while circumventing the funding restrictions applicable to designated plans.
The CRA considers this too to be “contrary to the intent” of the ITA, as it allows for higher tax-deductible contributions for the benefit of high income earners and connected persons than the legislation intends.
Therefore, the CRA has indicated it will deem such plans to be designated plans for the purposes of applying the funding restrictions. In particular, for the purposes of applying funding restrictions applicable to designated plans, a plan will be deemed to be a designated plan throughout a calendar year if:
- It provides past service benefits under a DB provision in the year or a previous year for persons who are “specified individuals” within the meaning of the Regulations; and
- More than 50% of the aggregate amount of all DB and MP pension credits for the calendar year are for “specified individuals” (rather than only DB credits, as subsection 8515(1)(a) of the Regulations provides).
The Newsletter asserts that, because of subsection 8515(2) of the Regulations, once a plan is considered to be a designated plan, it will continue to be so considered unless the Minister of Finance waives its status as such.
This condition will be applied to contributions made pursuant to an actuarial valuation report filed after March 16, 2021.
Many new IPPs with a hybrid design have been registered by the CRA. Some of these designs allowed MP contributions while the DB provision was in in excess surplus. Others even avoided the designated plan funding rules. Newsletter 21-1 stops the use of the hybrid design for these purposes, using the broad rule-making power in subsection 147.1(5) of the ITA. Sponsors of these hybrid plans will need to consider the impact on their plans and the adequacy of the grandfathering provisions.