Why RRSP room lags a year behind money purchase pension limits: Reconciling retirement savings using the pension adjustment
To many, the tax system may seem to work in mysterious ways, sometimes to the point of appearing unfair. In truth though, fairness is a key principle informing our system, tempered with the real-world practicality of putting that principle into operation.
A visual way to show the contrast in terms of retirement savings would be to look at two savers, one who is a member of a money purchase registered pension plan (MP RPP), and the other making use of registered retirement savings plan (RRSP) room. On the face of it, this gives the impression of a systemic one-year lag in available contribution room that favours pensions over individual savings. (See table.)
But is this reality or illusion? An explanation of the pension adjustment (PA) will shed some light on the matter.
The pension adjustment
Our retirement savings system is designed to provide the opportunity for savers to set aside as much as 18% of annually earned income into one or more tax-sheltered plans: RRSPs, RPPs (whether MP or defined benefit(DB)), and deferred profit sharing plans (DPSPs).
To gather together the components of the comprehensive 18% limit, a pension credit system operates:
- Straight dollar-for-dollar pension credit for contributions to MP RPPs and DPSPs,
- A dollar-equivalent credit for benefits accrued under a DB RPP, based on the particular plan’s provisions
When accumulated, the total pension credits for a year form the PA, which is applied to reduce the maximum RRSP contribution room for the following year. Of course RRSP room for a current year is based on earned income in the prior year. Thus the PA dovetails the available information from the prior year into the current year’s RRSP room calculation.
Note that there is no pension credit calculation for contributions to group RRSPs, as this latter plan type simply shares the maximum RRSP room after the PA calculation.
… and PSPA, and PAR
The story doesn’t end with the PA alone. There are two other components to the system that account for changes in RPP and/or DPSP plan benefits, and may affect RRSP room.
There may be changes to a DB RPP that improve the pension the member would be entitled to receive. For example, there could be a negotiated increase to the per-year credit rate in calculating the eventual pension, say from 1% to 1.5%. In light of the improved benefit, the pension member had been entitled to place more in RRSPs than should have been the case. A past service pension adjustment (PSPA) sums up the pension credits that would have applied based on the upgraded benefits, and this then reduces RRSP room.
Just as the PSPA may reduce RRSP room, when someone terminates membership in a DB RPP or DPSP, there may be a loss of expected benefits. A pension adjustment reversal (PAR) restores RRSP room that had been previously reduced based on that expected but now un-received benefit.
The full RRSP room calculation
Gathered together, the RRSP contribution limit for a year is:
+ Unused room at the end of the immediately preceding year
+ 18% of previous year’s earned income (subject to RRSP dollar limit
– Any PA
– Any PSPA
+ Any PAR
TABLE: Contribution limits since 2003
RRSP MP RPP DB RPP DPSP
2003 $14,500 $15,500 $1,722.22 $7,750
2004 $15,500 $16,500 $1,833.33 $8,250
2005 $16,500 $18,000 $2,000.00 $9,000
2006 $18,000 $19,000 $2,111.11 $9,500
2007 $19,000 $20,000 $2,222.22 $10,000
2008 $20,000 $21,000 $2,333.33 $10,500
2009 $21,000 $22,000 $2,444.44 $11,000
2010 $22,000 $22,450 $2,494.44 $11,225
2011 $22,450 $22,970 $2,552.22 $11,485
2012 $22,970 $23,820 $2,646.67 $11,910
2013 $23,820 $24,270 $2,696.67 $12,135
2014 $24,270 $24,930 $2,770.00 $12,465
2015 $24,930 1/9 MP 1/2 MP
MP RPP = Money purchase registered pension plan (also know as a defined contribution registered pension plan),
DB RPP = defined benefit registered pension plan,
DPSP = deferred profit sharing plan