Registered Pension Plan (RPP) - Income Replacement Benefit
Pensions Benefit Formulas
A pension benefit formula that multiplies a certain percentage (maximum 2%) of the final average or best average earnings for a stated period before retirement by the years of service (i.e. monthly pension = 1.5% x average monthly earnings of last 5 years x years of service).
Career Average Earnings
A pension benefit formula that multiplies a certain percentage (maximum 2%) of the average earnings by the years of service (i.e. monthly pension = 2% x average monthly earnings x years of service).
A pension benefit formula that multiplies a certain amount of benefits by the years of service (i.e. monthly pension = $20 monthly x years of service).
A pension funding formula that specifies the schedule of contributions for each members' investment account (i.e. contribution = 5% of earnings as the employee contribution + 5% of employees' earnings as the employer contribution). The maximum contribution (employee plus employer) is 18% of earnings for the current calendar year up to the annual maximum specified by Canada Revenue Agency.
A pension funding formula that specifies the schedule of contributions for each members' investment account according to a calculation based on profits (i.e. contribution = ( gross profit - 10% of capital employed) x 25% / number of shares x (1 share x years of service + 1 share x annual earnings / $1,000)). The maximum contribution (employee plus employer) is 18% of earnings for the current calendar year up to the annual maximum specified by Canada Revenue Agency.
Combination or Hybrid
Two or more of the above noted formulas can be combined to arrive at a benefit and/or contribution formula.
The greater of two or more of the above noted formulas can be used to determine a benefit and/or contribution formula.
Flexible Defined-Benefit Pension Plan
The pension adjustment (PA) formula that Revenue Canada developed is a rough estimate of average pension costs. The principle is that contributions to company pension plans and private RRSPs together must not exceed 18 percent of a person’s annual salary subject to the annual maximum specified by Canada Revenue Agency.
If the cost of the pension plan is less than the PA then employees may be able to contribute to an ancillary account (voluntary side fund) and decide what frills to use the fund for when they retire.
This arrangement is consistent with the intention of making sure that members of different kinds of plans have equal ability to save for retirement through tax-sheltered vehicles. There are no interpretation bulletins on this topic and Revenue Canada has not officially commented on this issue.
Pension Plan Rules
Classes of Employees
The eligibility rules and funding formula can be unique for various classes of employees based on their position in the organization or earnings. However, no distinction is permitted based on age, gender, marital status or any other prohibited discrimination.
Employees should be eligible to participate in the pension plan within two years of employment. The eligibility requirement for part-time staff may consider the number of hours worked in a year or the level of earnings (i.e. 35% of the Year's Maximum Pensionable Earnings under the CPP/QPP or worked 700 hours).
Required Employee Contributions
It is common to require employees to contribute 5% of earnings, less the employee portion of CPP/QPP, toward the cost of a pension plan.
Voluntary Employee Contributions
A pension plan may accept voluntary employee contributions that do not affect the pension formula. Group Registered Retirement Savings Plan are a less restrictive method of accepting voluntary contributions.
Normal Retirement Age
The pension plan must specify the age at which a member can retire with a full unreduced pension. This can be an absolute age or expressed as a formula (i.e. when the age + years of service = 80).
It is common to provide an actuarial equivalent of the pension at normal retirement date for members that retire up to 10 years earlier than then the normal retirement date.
It is common to provide an actuarial equivalent of the pension at normal retirement date, plus the value of any employee contributions after that date for members that retire later than then the normal retirement date.
Normal Form of Pension
The pension plan must specify a normal form of pension. A common form is a pension that continues for the life of the retiree with a guarantee period of 10 years.
Most Pension Benefit Acts require that the actual form of the pension be a joint and survivor pension that provides a pension for the life of the retiree and a reduction to no less than 50-66.67% (depending on jurisdiction) after the first death. The amount of the pension can be the actuarial equivalent of the normal form. Both the member and spouse must waive the joint and survivor option in writing if it is not chosen.
Optional Forms of Pension
Members can often choose the actuarial equivalent pension in another form by adding guarantees, integrated with government programs, indexing and enhancing the survivor options.
Since 1988, the Pension Benefits Act of Ontario has stated that pension benefits must be increased after retirement in relation to inflation. The regulation required to enforce this provision has not yet been enacted. The risk associated with providing inflation protection is a reason to avoid defined benefits pension plans.
The plan design should address the issues of continuing contributions during disability and counting disability toward the service requirement.
Withdrawal Prior to Retirement Age
The pension plan must specify the rights of a member upon termination of employment other than by death or retirement. It is common to provide full rights (vesting) to benefits at the normal retirement age for members with two years of plan membership. Terminating employees may transfer the commuted value of the vested pension to another RPP or prescribed RRSP (with limited settlement options and locked in until they reach retirement age less 10 years).
Members who terminate before vesting should receive their contributions plus reasonable interest. Employer contributions may be refunded or remain within the plan to increase benefits or reduce future contributions.
The pension plan must specify when the rights of a member vest. Vesting may be immediate or delayed up to 2 years in most jurisdictions.