If you’re lucky enough to have a workplace pension plan, chances are you’ve come across your Pension Adjustment (PA). You’ll find out your PA for the prior year at the end of February when you receive your T4 slip. If you have a Defined Contribution (DC) plan, figuring out your PA is pretty straightforward. For those with Defined Benefit (DB) plans, calculating your PA requires a bit more work. Let’s take a look at what exactly a PA is, why it matters, and how to calculate it.
Understanding Your PA
The PA, in a nutshell, is the deemed value of pension benefits you’ve earned during the year. As you know, all pension plans aren’t created equal. The value of your pension has a lot to do with the pension formula. All things equal, an employee enrolled in a generous two per cent Best Average Earnings pension plan will end up with a higher pension at retirement than if the formula was only 1.3 per cent Career Average Earnings. Rather than have a different PA formula for each pension plan, a standard PA formula is used for DB pensions.
Why Should I Care About My PA?
You often hear employees with pension plans complain they barely have any room to contribute to their RRSP (though in my opinion, rather than complain they should count their lucky stars they have a pension!). This is due to the PA. Employees with pensions have a big advantage when it comes to retirement savings. If you have a pension, you can contribute with pre-tax dollars and often receive a matching contribution. To make it fair for those without the luxury of a pension, the PA was created. Here’s how it works: your previous year’s PA reduces how much you can contribute in the current year to your RRSP. For example, your 2012 PA affects your 2013 RRSP contribution room.
Calculating Your PA
Let’s start with the DC PA Formula. The formula is pretty simple:
DC PA = Employer Contributions + Employees Contributions
For example, if you contributed five per cent of your annual earnings (5% X $50,000 = $2,500) and your employer matches that amount ($2,500), your PA would be $5,000 ($2,500 + $2,500 = $5,000). Simple enough, right?
For DB plans it’s a bit more complicated. As mentioned, there’s a standard PA formula that applies to all plans:
DB PA = 9 X pension earned – $600
Although the formula is the same, the pension earned value varies. For example, if your plan is has a 1% benefit and your average earnings are $50,000, your DB PA will be:
DB PA = 9 X ($50,000 X 1%) – 600 = $3,900
However, if your pension had a more generous two per cent benefit, your PA will be:
DB PA = 9 X ($50,000 X 2%) – 600 = $8,400
As you can see, the more generous the pension plan, the greater the PA and the less room you’ll have to contribute to your RRSP.
How To Keep Track Of Your PA
Now that you have a better understanding of your PA, hopefully you pay closer attention next time you receive your T4 slip. Your RRSP is meant as a way to help defer tax until retirement when you’re (hopefully) in a lower tax bracket – the last thing you want to do is pay penalties for forgetting about your PA and over contributing. Your Notice of Assessment will show your RRSP room and your PA. Be sure to pay attention before you contribute to your RRSP.