Consultation session - Questions from the Industry
November 22, 2000

Questions and Answers

1. Using the Ontario smoothed solvency valuation rules
2. Reduction of employer contributions when funding approval has been given
3. The Agency's position with respect to deductibility of solvency deficiencies
4. Receiving a maximum pension benefit from two different defined benefit provisions
5. Allocation of Surplus in a flexible pension plan
6. Information Circular 72-13R8
7. Proportionality condition and the 50/50 test
8. Distribution of Surplus to a terminated employee
9. Written enquiries via e-mail
10. Higher priority for certain written enquiries
11. Amending a pension plan when the plan is winding up due to bankruptcy
12. Foreign service and the three-year limit
13. Bank or credit union as fund custodian
14. Contracting a payroll company to make payments to plan members
15. Periodic distribution of an actuarial surplus to retired members
16. Retroactive contributions to a defined contribution pension plan
17. Return of a member's contribution that was transferred from another defined benefit plan
18. Allowing exceptions when a member has a shortened life expectancy
19. Post-reform terminally funded plans
20. Is a prior employer considered a participating employer?
21. Actuarial increase after age 60, instead of age 65, for public safety occupations
22. Use of "banked hours" to increase benefits
23. Amendment to subparagraph 8502(d)(iv) of the Regulations
24. The payment of related fees or reimbursement to the employer

Question 1 - If an employer uses the Ontario smoothed solvency rules in its actuarial valuation and the resulting solvency deficiency is greater than the amount determined under an "unsmoothed" approach, can the employer amortize the solvency deficiency resulting from the use of the smoothed approach under subsection 8516(8) of the Income Tax Regulations (the Regulations)?

Answer 1

If an actuary uses the Ontario smoothed solvency valuation rules in its actuarial valuation report and the valuation discloses a solvency deficiency greater than that which would be determined under an unsmoothed approach, the employer cannot amortize the larger solvency deficiency under subsection 8516(8) of the Regulations. The Pension Benefits Act of Ontario permits, but does not require, the use of smoothing techniques to minimize fluctuations in funding.

In a market upswing environment, the use of an asset smoothing method could artificially reduce the market value of assets as at the valuation date, with the result being the amount of funding recommended could be in excess of the amount required to make the plan fully solvent. On the other hand, during a market downturn, the use of an asset smoothing method could result in an overvaluing of the assets, resulting in benefit insecurity for the plan members, as they would not have the protection that is implied by a solvency valuation. Therefore, we do not consider this to be a reasonable asset valuation method for solvency valuations. However, the Canada Customs and Revenue Agency (the Agency) will not object administratively to this practice as long as the resulting contributions are less than those that would be required using an unsmoothed approach.

The CIA professional standards require consistency in the choice of assumptions and methods. The methods selected should be appropriate for the purposes and circumstances of the work. The Agency does not prescribe methods or assumptions to use when performing a solvency valuation. However, the methods and assumptions used must be reasonable, the valuation must be performed using generally acceptable actuarial principles and the resulting contributions must be limited to the payments required to amortize the amount needed to make the plan fully solvent at the valuation date.

Question 2 - Please indicate under what circumstances, if any, employer contributions would need to be reduced during the three-year period for which the Agency's funding approval has already been given.

Answer 2

If an actuarial valuation report is prepared during the three-year period for which the Agency's funding approval has already been given, and the results show that an excess surplus has emerged, either the plan must be improved to use up some of the surplus, the surplus must be refunded to the employer or members, or the surplus must be offset against the employer's funding obligation.

If no plan improvements or surplus withdrawals are made, employer contributions based on the old recommendation, made after the effective date of the new recommendation that do not take into account the extent of the excess surplus are not technically eligible because the surplus retention limit condition applicable to the new recommendation would not be satisfied.

The Agency has given administrative relief to employers that have stopped remitting contributions immediately after becoming aware of the existence of an excess surplus. In these cases, the employer has justified that the ineligible contributions had been made based on the previous actuarial recommendation and prior to becoming aware of the existence of the excess surplus.

Question 3 - In cases where the solvency deficiency is greater than the unfunded liability, it appears that the Agency is allowing the deductibility of the entire solvency deficiency under subsection 8516(8) of the Regulations when, in fact, the pension standards legislation only requires that the amortization payments be made. This seems to contradict the explicit provisions of subsection 8516(8) of the Regulations that indicate the approval should be limited to the amortization payments.

Please confirm our understanding of subsection 8516(8) of the Regulations and clarify the Agency's position with respect to deductibility of solvency deficiencies.

Answer 3

Subsection 8516(8) of the Regulations is generally relevant in the unusual situation where pension benefits legislation requires contributions that will more than fully fund a plan on both a wind-up basis (eligible under subsection 8516(7)) and a going concern basis (eligible under subsection 147.2(2)).

Subsection 8516(8) of the Regulations permits contributions to be eligible contributions only to the extent that they're required by pension benefits legislation. Most jurisdictions presently require (as a minimum) that any solvency deficiency be amortized over 5 years and that current service contributions be remitted. Therefore the solvency deficiency amortization payments and the current service contributions until the next actuarial valuation report would be prescribed contributions under 8516(8) and therefore eligible under subsection 147.2(2) of the Act. It should be noted that in some cases the funded status of the plan is such that the province requires the employer to amortize the solvency deficiency over a 1-year period, thereby allowing the deductibility of the entire solvency deficiency under 8516(8).

In addition, the prescribed contribution rule under subsection 8516(7) would permit (if the conditions of that subsection are met) the employer to contribute amounts equal to the wind-up deficiency at the valuation date as well as additional wind-up shortfalls emerging at the end of years 1, 2 and 3.

The actuary's recommendation often contains a minimum and maximum contribution statement based on the results of the valuation on a going concern, solvency and wind-up basis. If the actuary's recommendation is less than the maximum that would be eligible under subsection 147.2(2) of the Act, the recommendation is approved. It is possible that we have approved, under subsection 147.2(2) by virtue of subsection 8516(7) of the Regulations, the maximum eligible employer contribution recommended by the actuary to liquidate the wind-up deficit and it was greater than the contributions required to amortize the solvency deficiency.

Question 4 - Can a member who participates in two defined benefit provisions receive a maximum pension benefit from each of the two provisions?

Answer 4

Subsection 8504(8) of the Regulations ensures that the benefit limit in subsection 8504(5) applies to the total pre-age 65 benefits provided to the member under associated defined benefit provisions. This limit on pre-age 65 retirement benefits is equal to the defined benefit limit times years of service plus 25% of YMPE prorated if the member has less than 35 years. Therefore, a member would not, at least for benefits payable before age 65, be permitted to receive two maximum pensions.

Furthermore, subsection 147.1(8) of the Act deems a plan to be a revocable plan where the pension adjustment (PA) limits are exceeded. The PA limits the pension credits for a member in respect of an employer. The total of the pension credits for the two provisions is limited to the money purchase limit for the year and 18% of the member's compensation from the employer for the year. Therefore, a member who participates in two defined benefit provisions of the same employer is unlikely to receive a maximum pension benefit from each provision.

However, subsection 8504(1) of the Regulations limits "the lifetime retirement benefits provided to a member under a defined benefit provision of a pension plan". This limit does not apply to lifetime retirement benefits payable under a combination of provisions of the same plan or under a combination of plans. As a result, a member who participates in two separate (not associated as determined by subsections 8504(8) & (9)) defined benefit provisions can receive a maximum pension benefit from each of the two provisions.

Question 5 - In a flexible pension plan, can a surplus be allocated to provide optional ancillary benefits (OAB)?

Answer 5

Allocating surplus toward the purchase of OABs while respecting defined benefit rules is somewhat problematic. Direct allocations of surplus to OAB accounts would result in the creation of a money purchase provision that would take the plan outside of the flexible pension plan rules. To retain their defined benefit character, surplus allocations have to be based on plan liabilities with respect to the additional OABs that are to be paid. These additional liabilities have to be determined by taking into account all of the plan's assets (including optional ancillary contributions) and all of the provision's other liabilities. However, plan actuaries will have difficulty determining exact liabilities with respect to OABs, given that in some types of flexible pension plans members do not elect their OABs until retirement, and given that members can adjust the level of their optional ancillary contributions from year to year. For funding purposes, liabilities with respect to the OABs have to be tied to the actual value of OABs and not to the maximum value of OABs that could be provided under the provision. Otherwise, the provision would be assuming liabilities without regard to the OABs actually to be paid which violates subparagraph 147.2(2)(a)(ii) and the plan would enjoy excessive tax sheltering. We also understand your need for a practical mechanism to arrive at the liability that would keep actuarial costs to a minimum.

Question 6 - Is Information Circular 72-13R8 going to be revised?

Answer 6

We understand that we may have introduced the possibility of revising the Information Circular 72-13R8 in prior meetings. However, after further review we no longer feel that this would be a meaningful exercise nor a productive use of our resources. Any new rules covering pre-system service have been communicated through newsletters. We propose to continue issuing newsletters whenever the rules covering pre-system service are affected by changes

Question 7 - The proportionality newsletter restricts the rate at which lifetime retirement benefits can accrue. Does the 50/50 test apply each time the employer wants approval for contributions to the plan?

Answer 7

Not each time. The 50/50 test only applies when benefits in respect of pre-reform service are purchased for (or accrued to) connected persons.

Benefits provided for pre-reform years must be acceptable to the Minister. The proportionality condition (announced on March 31, 1999) is an additional test that must be performed before lifetime retirement benefits (LRBs) in respect of pre-1990 service can be credited. This new condition does not eliminate any of the previous requirements applicable to pre-reform benefits.

To better coordinate the administration of these rules, a plan administrator could send us the following documents together:

• the triennial actuarial valuation report, submitted when requesting the approval of the actuary's recommendation for the employer's contributions;
• the detailed calculations specifically identifying the years of service for which the LRBs are provided, and clearly demonstrating compliance with the present-value test in view of satisfying the proportionality condition;
• the 50/50 demonstration, taking into account only the present value of benefits provided for pre-reform service based on pre-reform earnings.

Our approval of the 50/50 demonstration, the actuary's recommendation and the crediting of pre-1990 LRBs (for each of the 3 years) will be given at the same time.

Question 8 - When an employee terminates from a pension plan, can the employee receive a portion of a surplus that is distributed at a later date?

Answer 8

Under a defined benefit provision, if the plan terms provide for it, a terminated employee may receive a distribution of surplus at a later date since it is a permissible distribution permitted under subparagraph 8502(d)(vi) of the Regulations. Such a distribution would be considered to be a taxable benefit and could not be transferred on a tax-free basis.

Rather than distributing the surplus as cash, the surplus could be used to improve member benefits. This could take the form of increased ancillary benefits, lifetime retirement benefits, or a combination of both.

The improved benefits may be commuted and transferred subject to subsection 147.3(4) of the Act and subsection 8517(1) of the Regulations. In the case where only ancillary benefits are improved, a tax-free transfer is not permitted since the prescribed limit is nil.

Subsection 8517(3.1) of the Regulations does allow an additional prescribed amount to be determined only if the benefit includes ancillary benefits that are permitted solely because of subsection 8501(7) of the Regulations. However, in addition to other conditions under subsection 8501(7), paragraph (b) requires that the benefits be provided as a consequence of an allocation of surplus on full or partial wind-up of the plan.

Consequently, subsection 8501(7) has no application if there is no partial or full wind-up of the plan, and therefore an allocation that includes only ancillary benefits cannot be transferred under subsection 147.3(4) since the prescribed limit would be nil.

Question 9 - Will written enquiries via e-mail be accepted?

Answer 9

At present we do not have a general e-mail account to accept questions. On occasion, questions have been forwarded to specific officers. We treat such an e-mail as a written enquiry. It is handled on a first-in-first-out basis as any other written enquiry and it will be responded to in writing and will not be replied to by e-mail. The Directorate is looking at a broad solution to receiving and responding to e-mail enquiries to address our concerns with issues such as security, inventory control, etc.

Question 10 - Will priority be given to requests for waivers and approval of "catch-up" payments?

Answer 10

All written enquiries are given priority, including waivers. All efforts are made to complete written enquiries within 60 days of receipt. If a strong consensus is shown, we could give consideration to reviewing approval of "catch-up" payments and requests for waivers ahead of other written enquiries. It should be noted that this would affect the response time to all other types of written enquiries.

Question 11 - What is the procedure for amending a pension plan when the plan is winding up due to bankruptcy and the plan administrator is appointed by the courts?

Answer 11

In most bankruptcy cases, the pension supervisory authority appoints an independent firm to act as the plan administrator for the purposes of winding up the plan.

If the plan is basically acceptable and there are outstanding minor amendments, we would accept a statement from the appointed plan administrator confirming that the registered pension plan has been administered in accordance with the Act. We would also accept a statement in respect of upgraded ancillary benefits such as CPI for all pensions in pay.

If lifetime retirement benefits are upgraded due to surplus allocation, we will require the plan to be formally amended. This would result in a past service pension adjustment (PSPA) and affect the prescribed amount described in section 8517 of the Regulations. In this case we may require a copy of the formal agreement or court order regarding the surplus allocation. We would review situations on a case-by-case basis where the appointed administrator does not have the legal authority to amend the plan.

Question 12 - If an employee left Canada on a foreign service assignment on January 1, 1996 (so that the three year limit expired on December 31, 1998) and the employee is still outside Canada, can the plan credit two more years of service on a current service basis for 2000 & 2001?

Answer 12

Yes, the years 2000 and 2001 could be recognized as pensionable service. The third paragraph of Newsletter 00-1 provides transitional relief to those individuals that were previously affected by the three year limit, provided that an overall limit of five years is respected and the service is credited on or before December 31, 2001.

Question 13 - Individual trustees usually hire an agent to be the custodian of the plan assets and to fulfill some accounting responsibilities. Does the Agency permit the individual trustees to hire a bank or a credit union (caisse populaire) to be the fund custodian?

Answer 13

The Agency would permit a bank or credit union to act as fund custodian. However, the individual trustees would remain ultimately responsible to ensure that all areas of the trust agreement are respected. The individual trustees would be responsible for the filing of returns.

Question 14 - The trustees of a pension plan will often contract out to a payroll company the responsibility for producing payments to plan members. The fund will remit payments out of the plan to the payroll company, who then process the payments. Is this arrangement acceptable to the Agency?

Answer 14

This type of arrangement is acceptable. However, the trustees would remain ultimately responsible to ensure that all areas of the trust agreement are respected.

Question 15 - Subparagraph 8502(d)(vi) of the Regulations allows the payment to any person of the person's share of an actuarial surplus. If an individual already receives the maximum level of lifetime retirement benefits permissible under the Act, could the employer use subparagraph 8502(d)(vi) to add an amount to the regular pension payable to those retired members by way of a periodic distribution (annual or monthly) of part of the actuarial surplus?

Answer 15

If surplus is paid out as periodic payments, this by definition is a retirement benefit and therefore must comply with the rules and regulations of the Act. Please refer to the definition of "retirement benefit" in subsection 8500(1) of the Regulations. Since the individual's lifetime retirement benefits are already at the maximum, it is unlikely that these additional retirement benefits would be a permissible benefit. If the employer wishes to pay the surplus to the retired members, the employer could withdraw the surplus and contribute to a Retirement Compensation Arrangement or make payments from the plan to the employees in the form of a single lump sum payment.

Question 16 - An employer sets up a defined contribution pension plan for its employees. Membership is mandatory. After three years, for example, the administrator of the defined contribution plan realizes that some employees were not informed that they had to join the defined contribution plan and contributions were not withheld from their salary. Under a defined contribution plan it is not permissible to make contributions for past service. Assume that contributions for current service are already at the maximum level permissible under the Act. Would it be acceptable to the Agency if the employer were to issue revised pension adjustments (PA) for those three years and allow the employees to pay the contributions they would have paid had they joined the defined contribution plan at the time they were required to do so?

Answer 16

It would not be acceptable for an employer to issue revised PAs for the members and make past service contributions for the previous years. Revised PAs are appropriate only where a PA has been reported incorrectly. In this case, there was no error in the PA calculation, since no contributions were made to the plan in respect of these members.

Subsection 8502(b) of the Regulations permits contributions to a defined contribution pension plan if they are in accordance with the plan as registered. Past service contributions are not permitted. In addition, the member would have additional RRSP room for those three years. If the plan permits additional voluntary contributions, the member may be able to make additional contributions in future years when not at the maximum contribution level.

Question 17 - Subparagraph 8502(d)(iv) of the Regulations permits, under certain circumstances, the return of all or a portion of a member's contributions made to the provision. Does this subparagraph also permit the return of member contributions that were made to another defined benefit plan but subsequently transferred to the current plan?

Answer 17

Paragraph 8502(d)(iv) of the Regulations is very specific in that it provides for a return of contributions made by a member of the plan under a defined benefit provision of the plan where the defined benefit provision is amended to reduce future contributions by a member. This would exclude amounts that were contributed to a prior plan and transferred to the current plan.

Although the Department of Finance has confirmed that this is an accurate interpretation of the Regulations, we are both of the view that this will not produce an appropriate result in all cases. As a result, the Department of Finance has agreed to examine this issue further and may make legislative changes if required.

Question 18 - Is the Agency or the Department of Finance considering allowing exceptions to areas of the Regulations (such as section 8504, paragraph 8503(2)(f), paragraph 8503(2)(g)) for cases where a member has medically proven their shortened life expectancy to allow an alternative to commuting the benefit, such as allowing the pension benefit to be paid from the pension plan?

Answer 18

It is the view of both the Agency and the Department of Finance that with the 15-year guarantee period available under the law and the commutation rules, the issue of benefits paid as a result of shortened life expectancy is adequately covered. Any suggestions for legislated changes in this area should be forwarded to the Department of Finance.

Question 19 - Are post-reform terminally funded plans (plans set up and wound-up as at the same date) permissible if they contain post-reform service only?

Answer 19

The explanatory notes to paragraph 8502(a) of the Regulations indicate that such a plan would not qualify for registration. As a result, our initial presumption would be to deny registration to a plan that intends to be collapsed shortly after being registered. However, we will review each case on its own merits.

Question 20 - Where another employer within the plan assumes the liabilities of an employer's employees, is the prior employer still considered to have participated in the plan in respect of the employees for whom such a plan is sponsored? If not, how is the career average indexed earnings test to be applied for the period with the prior employer if earnings with the prior employer cannot be recognized?

Answer 20

Subsection 147.1(1) of the Act defines "participating employer" - in relation to a pension plan, to mean an employer who has made, or is required to make, contributions to the plan in respect of the employer's employees or former employees, or payments under the plan to the employer's employees or former employees. Subparagraph 8504(1)(a)(i) of the Regulations states "the aggregate of all amounts each of which is, in respect of a calendar year after 1990 in which the member was, at any time, connected with an employer who participated in the plan in the year for the benefit of the member". Therefore, your understanding is correct that the maximum is based on earnings from both employers who participated under the provision for the benefit of the member.

Question 21 - For public safety occupations can an actuarial increase occur after age 60 instead of age 65 for regular defined benefit plans if the resulting pension benefit would exceed the maximum pension limit of $1,722.22 per year? This question applies to both postponed retirement and delayed pension commencement.

Answer 21

Subsection 8504(10) of the Regulations excludes certain benefits from lifetime retirement benefits for the purpose of the maximum pension rule in subsection 8504(1). Paragraph 8504(10)(b) excludes additional benefits payable as a consequence of an actuarial increase in the pension to reflect the postponement of payment of the pension after age 65. The regulation clearly refers to age 65 and does not refer to an exception for public safety occupations.

Question 22 - Is it possible to use "banked hours" to increase an individual's retirement benefits in a defined benefit plan?

Answer 22

For purposes of this response, banked hours reflect an individual's working hours in a given year, which are in excess of the normal full time working hours (must be reasonable). The employer maintains a record of these banked hours.

The concept of banked hours can be used to increase benefits in the following manner.

On-going basis while employment continues

• The hours debited from the banked hours are used to provide current service.
• When the hours are used to increase current service, the period meets the definition of a qualifying period under subsection 8507(3) of the Regulations.
• The prescribed amount limits under section 8507 of the Regulations are respected.

On termination

• Determine the increased benefit rate (or flat benefit) that the member's banked hours would support.
• Amend the plan to reflect this increase.
• Apply PSPA when appropriate.

Question 23 - Will subparagraph 8502(d)(iv) of the Regulations be amended so that a reduction in future contributions is not required if the contribution rate is currently at 0%. For example, a plan was contributory until 1997 and then became non-contributory. In 2000, the company decides to make the plan retroactively non-contributory. Subparagraph 8502(d)(iv) presently requires that there will be a corresponding reduction in future required contributions in order to refund past contributions. It is not possible to reduce the future contributions when they are already at 0%, so the past contributions cannot be refunded under the present wording.

Answer 23

As there are no future contributions that would otherwise be required, we would accept the amendment that permitted the return of the prior contributions. As a result, we are of the opinion that no legislative change is required at this time.

Question 24 - Does paragraph 8502(d) of the Regulations permit the payment of related fees or the reimbursement of the employer for the payment of fees?

Answer 24

The Explanatory Notes of July 31, 1991 for subsection 8502(d) of the Regulations state that a plan may provide for the payment of all reasonable administrative, investment and similar expenses incurred in connection with the plan.

Expenses can be paid:

• directly by the employer (with no impact on the plan at all or to be refunded to the employer out of the plan funds where the plan provides that such expenses are to be paid by the fund but were paid by the employer);
• out of the plan's investment earnings;
• if it is a DB plan, out of the plan's funds;
• if it is a money purchase plan
  • out of the member's accounts
  • on or before April 5, 1994, out of an unallocated forfeited amount or related earnings
  • after April 5, 1994, out of forfeited amounts or related earnings