Long awaited amendments to ease the process of correcting contribution errors in Defined Contribution ("DC") pension plans are now law. Federal Bill C-47 passed and received Royal Assent on June 22, 2023. It includes certain eagerly awaited pension-related amendments to various statutes.
This article considers the new rules for correcting contribution errors in DC pension plans under the Income Tax Act (Canada) and its regulations (the "Tax Act"), and identifies some unresolved issues.
Correcting Under-contribution Errors
The problem
Under-contribution errors in DC plans arise, for example, when an eligible employee ought to have been enrolled in a pension plan or contributions ought to have been made on their behalf during a leave of absence. Under the prior Tax Act rule, it was not possible to go back to prior years when correcting missed employer and employee contributions. Contributions to correct previous years (plus any investment returns) were added to contributions for service in the current year. All such contributions could not exceed the annual pension contribution limit under the Tax Act. In many cases, employers and members had to spread their missed contributions over several years, which was at times impractical.
The fix
The new Tax Act rules allow employers and members to correct under-contributions through a tax deductible "permitted corrective contribution" ("PCC"), a new concept. A key feature of the PCC is that, unlike the prior rule, it is not subject to the annual Tax Act contribution limits. A PCC is subject to a newly created separate limit. The prior rules will continue to operate alongside the PCC.
The key rules
The upper PCC limit is 150% of the money purchase limit in the year the PCC is contributed (i.e. 150% x $31,560 in 2023 = $47,340), less any prior PCCs for the individual. This limit contemplates that an employer may add reasonable investment returns on missed contributions.
A PCC reduces the member's RRSP deduction limit in future years and may result in negative value for an individual's RRSP deduction limit. The member recovers the negative room through earned income in future years but cannot contribute to their RRSP in the meantime without attracting penalty tax.
A PCC can be made only for an error that relates to a failure to:
(1) enroll the individual as a member of the plan; or
(2) make a member or employer required contribution (i.e., not voluntary contribution),
with respect to the pension plan of the employer or a predecessoremployer. The error must also have occurred in one of the 10 years before the year the PCC is contributed.
An individual can commit in writing to make a PCC in installments. However, the full amount of the PCC is reported at the time of the written commitment. The plan administrator must report a PCC to the Canada Revenue Agency ("CRA") by prescribed deadlines using Form T215.
What's missing
The rules do not address whether PCCs will be allowed for inactive members or members who cannot recover negative RRSP contribution room (for instance, deferred members, members on disability income, or individuals who have reached the maximum age for accumulating retirement income under the Tax Act). For certain contribution errors, the PCC limit may be too low (e.g., for enrolment errors) or the ten-year look back may not be long enough.
Correcting Over-contribution Errors
The problem
Over-contribution errors arise, for example, when certain compensation is erroneously treated as pensionable earnings. Until now the Tax Act allowed a plan administrator to return employer and employee contributions only in limited circumstances. Plan administrators have found these rules to be cumbersome in practice. The tax implications of the refund are also complex (income inclusions, amended T4s, and reversing prior deductions). Moreover, refunding investment earnings is not specifically permitted by the Tax Act, meaning that investment returns presented additional challenges
The fix
The proposed Tax Act changes will allow for "pension adjustment correction" ("PAC"), a new concept. The PAC applies to refunds of over-contributions from the plan where the refund is required to avoid revocation of the plan's registration. The new rule therefore expands on the prior rules. The refund will generally restore (or increase) the employee's RRSP deduction limit to the extent it was previously reduced by the over-contributions. The refund rules also specifically allow for a distribution of reasonable investment returns on over-contributions.
The key rules
The refund must relate to one or more of the 10 years immediately preceding the calendar year in which the plan provides the refund. The PAC rules include simplified reporting requirements. The plan administrator must report the PAC to the CRA by prescribed deadlines using form T10.
What's missing
Depending on the nature of the error, a 10-year look-back period may still be insufficient. Additionally, the governing pension standards legislation continues to apply. This means a plan administrator applying the new Tax Act provisions must also consider any additional steps to comply with pension standards provisions.
Going Forward
The changes are deemed to have come into force on January 1, 2021, such that a plan administrator is permitted to have made a PPC or PAC prior to June 22, 2023. We expect that more nuances of PPC and PAC rules will become apparent as plan administrators apply them.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.