2007 Federal Budget: Retirement Plans

Proposed Changes an Effort to Address Labour Shortages and an Aging Workforce

Written By Deron Waldock and Sean Maxwell

On March 19, 2007, Finance Minister Jim Flaherty tabled his second federal budget which contained some unexpected proposals aimed at helping seniors achieve semi-retirement while, at the same time, beginning to address potential workforce shortages and aging population issues faced by Canadian employers.

Approval of the budget in the House of Commons is not assured, as the minority Conservative government requires the support of at least one of the other parties. Early indications, however, suggest that the budget will be approved with the support of a majority of members of Parliament.

The following is a summary of the key budget proposals that will impact retirement.

Phased Retirement

The budget includes a proposal to encourage older workers to stay active in the labour market by granting sponsors of defined benefit (DB) registered pension plans (RPPs) the ability to give qualified members the option to receive partial pension payments while continuing to work and accrue further pension benefits. This type of “phased retirement” is currently not permitted by the Income Tax Regulations, which specifically prevent a member of a DB RPP from collecting pension benefits while continuing to accrue pensionable service under the same plan or another DB RPP of the same or a related employer.

The proposal set out in the budget will apply to plan members who are 55 years of age or older and eligible for an unreduced pension. DB RPPs will be permitted (but not required) to allow any such qualified member to receive a partial pension payment of up to 60% of their accrued DB pension, including both lifetime pension benefits and bridge benefits, as if the member were fully retired. At the same time, the member would continue to accrue additional pension benefits based on actual service with the employer. Members who elect phased retirement would not, however, accrue additional pension benefits during periods of absence or reduced pay.

The budget proposal does not tie the ability to offer phased retirement to a reduction in work time or salary, as is currently required by existing phased retirement provisions in Alberta, Manitoba and Québec. Similarly, the budget proposal does not provide guidance as to when or how often the member's pension benefit may be recalculated to take into account additional pensionable service and increased annualized earnings.

The government anticipates that the proposed changes will come into effect beginning in 2008, following a period of consultation on the technical aspects of the proposed changes.

The prohibition on accruing additional pension benefits while receiving a pension will continue to apply to “designated plans” as well as to “connected persons”. Designated plans are generally plans set up for an individual (i.e., an individual pension plan or IPP) or for a group of senior managers or other high-income earners. A member will generally be considered to be a “connected person” if he or she has a non-arm's length relationship with the plan sponsor or, in the case of a corporate plan sponsor, the member owns at least 10% of the shares of the plan sponsor or an affiliated company.

Plan sponsors who wish to offer phased retirement will need to carefully consider how to draft the necessary plan amendments and communicate the program to employees. The budget proposal, for example, does not appear to impact the eligible “class” requirements in pension benefits standards legislations and thus may not permit plan sponsors to offer phased retirement to specific employees or groups of employees.

Maximum Deferral Age Increased for Registered Plans

Canadians must currently cease contributing to a registered retirement savings plan (RRSP) and, in fact, must terminate the RRSP or initiate a withdrawal program through a registered retirement income fund (RRIF) or a qualifying annuity, by the end of the year in which the individual turns 69 years of age. Similarly, RPP payments must currently begin no later than the end of the year in which the member turns 69. Effective for 2007 and subsequent years, the budget proposes to extend the maximum age limit to start payment of benefits earned under an RRSP or an RPP to the end of the calendar year in which the individual attains age 71.

Under transitional rules, individuals with an RRIF turning age 70 or 71 in 2007 may waive the minimum withdrawal requirement for 2007 (individuals turning 70 in 2007 may also be exempted from the minimum withdrawal requirement for 2008). In addition, such individuals will be allowed to make RRSP contributions for 2007 and 2008 to the extent that they have available RRSP deduction room. Members of an RPP will be allowed to continue to accrue benefits until the end of the year in which they reach 71, subject of course to existing limits on years of service and annual pension benefits.

In order to take advantage of the proposed higher age limit, plan sponsors will need to prepare and file plan amendments incorporating the higher age limits. While the ITA will not require plan sponsors to raise age limits, plan sponsors may want to consider whether maintaining existing age limits will expose them to the risk of age discrimination complaints from older plan members.

Pension Income Splitting

The budget restates a promise made by the Minister of Finance on October 31, 2006, by including measures to allow pension income splitting. If enacted, the proposal will allow qualified pensioners to allocate up to 50% of their pension income to their spouse or common-law spouse each tax year, beginning in 2007. Both the pensioner and the spouse or common-law partner must agree to the allocation on their tax returns in order for the pension income splitting to occur.

Should both individuals agree to the pension income splitting, the allocated amount will be deducted from the income of the pensioner making the allocation and included in computing the taxable income of the lower income spouse or common-law partner. As such, the proposal will reduce the total tax payable by couples who are in separate tax brackets.

It should be noted that amounts received from a government pension program (i.e., CPP/QPP, OAS, GLS) are not subject to the proposed pension splitting rules, although existing CPP credit splitting will remain. Similarly, amounts payable from an unregistered supplemental retirement plan are not included in the budget proposal.

The budget did not contain any details concerning how pension income splitting will be administered and reported on personal tax returns, or how withholding tax requirements for pension benefit administrators will be affected.

Qualified Investments

The budget proposes that the list of “qualified investments” for RRSPs and RPPs be expanded, effective March 19, 2007, to include:

• any debt obligation that has an investment grade rating from a recognized credit rating agency and is part of a minimum $25 million issuance; and
• any security that is listed on a “designated stock exchange” other than derivatives or futures contracts where the holder's risk of loss may exceed the holder's cost.

Designated stock exchanges will include all stock exchanges currently listed in the Income Tax Regulations and any stock exchanges designated in the future by the Minister of Finance.

The Conservative government believes that these changes will provide registered plan investors with greater investment choices and diversification opportunities by, for example, permitting investments in foreign-listed trusts and partnership units and in Canadian dollar denominated bonds issued by foreign entities (i.e., “Maple Bonds”).

Canada-U.S. Tax Treaty

The budget also commented on the status of a number of other future proposals. Most notably, the budget suggests that an updated Canada-U.S. Tax Treaty has been agreed to in principle, which will include provisions to better harmonize the tax treatment of pension contributions between Canada and the United States and clarify the treatment of stock options.

Conclusion

While none of these budget proposals has elicited great attention or controversy, the prospects of each proposal being introduced into law are likely connected to the passage of the budget as a whole. At the time of writing, the budget appears likely to pass as tabled, although the minority status of the Conservative government and media speculation regarding the possibility of a spring election combine to suggest that the budget's passage is by no means guaranteed. We will continue to monitor developments with the budget and will advise you if and when these proposals are enacted into law.