If you are lucky enough to belong to a workplace pension plan, there is one thing you will need before contributing to your Registered Retirement Savings Plan (RRSP) — your pension adjustment.
What is a pension adjustment?
A pension adjustment (PA) is the deemed value of pension benefits you have earned during the year. This is important to know because it reduces how much you can contribute in the coming year to your RRSP. So, for instance, your 2019 PA affects your 2020 RRSP contribution room.
The limit for tax-assisted retirement savings is 18% of earned income each year, including RRSP and any company pension plans. The RRSP contribution limit for 2020 is $27,230.
If you participate in a company pension plan, a company-sponsored registered retirement savings plan (RRSP), or a deferred profit-sharing plan (DPSP), you will have a pension adjustment calculated for you.
Your PA can be found on your T4 form.
Why is there a PA?
The idea behind the PA is to give equal tax advantages to those who do and who do not receive company retirement savings help, such as a pension plan. Without a PA, those who contribute to a pension with pre-tax dollars and contribute to an RRSP (which isn’t taxed until retirement or past age 71) would be able to save more money tax-deferred than someone who does not get a company pension and contributes the same amount to their RRSP.
When do you need to know your PA?
For anyone who contributes to an RRSP, it is important to know your PA. It determines the amount you can contribute to your RRSP without penalty, no matter what you hold in the registered account: equities such as stock funds, or fixed income such as GICs.
When you report your PA on your tax return, your RRSP contribution limit for the coming year is adjusted and is reported on your notice of assessment.
Calculating your PA
While your company will calculate your PA for you and report it on your T4 form, if you need to run the numbers, here’s how to calculate your PA.
This is important because the PA number may change year to year, so especially if you have set up automatic contributions to an RRSP, that amount may need to be recalculated annually.
Defined contribution plan
Participants in a defined contribution pension plan put in a set amount, often with an employer match, and its value depends on how well the investments in the account performed by the time the participant retires.
For a defined contribution plan, the PA is the sum of the employer and employee plan contributions.
Defined contribution plan PA = employer + employee plan contributions
Example: If you make $50,000 a year and contribute 2% of your earnings to the plan and your employer matches that, your PA for that year will be: $50,000 X 4% = $2,000.
Defined benefit plan
Participants in a defined benefit pension plan are promised a certain income or lump sum after retirement, based on salary, years worked and age at retirement, no matter how the investments in the plan performed.
The calculations can differ between:
- Final or best average: Benefits are based on the participant’s earnings averaged over a specific period, such as the last few years of service, or the three years of highest earnings (for example, 2% of the average of the final three years of pensionable earnings × years of pensionable service).
- Career average: Benefits are based on the participant’s earnings in each year they worked under the plan (for example, 2% of pensionable earnings for each year of service).
- Flat benefit: Generally, benefits are expressed as a dollar amount for each month or year of service (for example, $55 a month per year of service).
Once you know which number to use in your calculation, the PA is nine times the annual accrued benefit amount, less $600.
Defined benefit plan PA = (9 x annual accrued benefit) – $600
Example: If your average yearly earnings are $50,000 and you and your employer’s contribution is 2% of your earnings, your PA would be 9 X ($50,000 X 2%) – 600 = $8,400.
Deferred profit sharing plan
Employees who receive a share of the profits paid out by the employer do not have to pay federal taxes on the contribution or growth in a DPSP until it is withdrawn. The PA calculation for a DPSP depends on the company’s net profits, up to a limit of $13,915 for 2020.
Tax benefits without penalties
Taking your PA into account helps you avoid overcontributing to your RRSP. That way, you get the benefit of deferring taxes on the money saved until retirement, when most people are in a lower tax bracket. Plus, you can avoid the penalties of overcontributing to your RRSP and keep all the money to which you are entitled.