In November 2010, Ontario Minister of Finance Dwight Duncan tabled Bill 135 as part of the government’s Economic Outlook and Fiscal Forecast for 2010 and the bill received Royal Assent on Dec. 8, 2010. Bill 135 amends the Pension Benefits Act ( PBA) by changing the pension portability rules effective for members who terminate from a pension plan after June 30, 2011. The bill also changes certain annuity purchases before June 30, 2011 that might otherwise conflict with requirements under the Income Tax Act (Canada), (ITA.)
Changes to pension portability options effective June 30, 2011
Following termination from a pension plan, a former member is generally entitled to transfer the commuted value (CV) of his or her defined benefit entitlement or the defined contribution account balance to one of the following three vehicles:
1. another pension plan, if that plan’s administrator accepts such transfers;
2. a prescribed retirement savings account (e.g., a locked-in retirement account (LIRA) or life income fund (LIF)); or
3. an insurance company for the purchase of a life annuity.
Note that these options do not apply to a former member who is eligible for an immediate pension on his or her date of termination, unless the plan explicitly provides such an option. Except in the cases where the former member has a small entitlement and the plan forces it to be transferred, a former member may elect to leave his or her pension entitlement in the plan and receive a deferred or immediate pension.
Effective June 30, 2011, the member’s right to directly purchase an annuity from the plan will be eliminated. Instead, a former member will need to first transfer the funds to a LIF or LIRA and then use the funds to purchase the annuity, requiring the annuity purchase to be conducted as two transactions.
While this may seem an innocuous change, there is one significant ramification for members of defined benefit plans—the CV transfer to a LIF or LIRA is subject to the maximum transfer limits under the ITA, with any excess amounts payable in cash, subject to taxation.
In the current low interest rate environment, many former members are in a situation where their CV exceeds the maximum transfer limits. Thus, these limits will often impair a former member’s ability to purchase the same pension used to determine the CV. This contrasts with the current annuity purchase rules which are not impacted by the maximum transfer limits.
Additionally, when a former member has RRSP contribution room, a plan administrator is permitted, but not required, to allow the transfer of the excess amount directly to an RRSP without withholding tax at source. While this alternative may allow some to maintain the tax-deferred status of the entire amount of the commuted value, it comes at the price of utilizing some or all of the former member’s unused RRSP room, and additional administrative complexity for all involved.
Fortunately, Bill 135 will not impact a plan administrator’s ability to unilaterally settle benefits by way of an annuity purchase, as may happen in a plan wind-up. An annuity purchase that reproduces all or a portion of the benefit provided under the plan is not subject to the maximum transfer limits under the ITA. Upon individual member termination, annuity purchases have not generally been a popular choice for portability option and these changes to the Ontario PBA will simply mean that many terminating members will continue to elect to transfer their entitlements to a LIF or LIRA, subject to the ITA transfer limits.
Changes affecting annuity purchases before June 30, 2011
The second change in Bill 135 addresses an anomaly that has created a potential conflict between the ITA and the PBA. In the current interest rate environment, there have been occasions where the actuarial standards for determining CVs under defined benefit plans have generated amounts that are greater than the purchase prices quoted by insurance companies for identical immediate or deferred pensions.
As a result, some individuals found that their CVs could purchase a larger pension than would otherwise be provided by the pension plan. However, the Canada Revenue Agency (CRA) has taken the position that such a transaction violates the ITA requirements that the rights provided under an annuity contract from a pension plan cannot be materially different than those provided by the plan.
Without legislative change, the ITA would appear to require the former member to forfeit the portion of the CV in excess of the annuity purchase price. However, forfeiture would contravene the requirements of the PBA, which does not permit the surrender of any part of a CV.
Until the new portability rules come into place at the end of June, the solution enacted by Bill 135 is for the administrator to ensure the annuity does not provide a larger amount of pension, with the excess between the annuity purchase price and the CV refunded to the former member in cash, subject to taxation. An administrator can again, optionally, provide the alternative to allow for the transfer of excess to a personal RRSP, provided there is available RRSP room.
Fortunately, this complication will be short-lived. The member’s right to request an annuity purchase directly from the plan will be eliminated at the end of June.
While these changes may not necessarily affect the CV transfer process for many plans, all plan administrators with Ontario members will need to review their plan documents, employee booklets, employee statements and option forms to determine what changes are necessary to reflect the requirements of Bill 135.