There are two common pension plans: A defined-benefit (DB) plan and a defined-contribution (DC) plan. Under the DB plan, a pensioner receives a known fixed income for the rest of his life. Under the DC plan, the pensioner is given a lump sum of money for him to invest and manage. The amounts he can withdraw in the future are unknown and will depend on the markets and investment performances.
Under the DC plan, the employee and/or the employer will contribute to a locked-in RRSP (LRSP) which will be used to provide retirement income. The funds in a LRSP are managed and invested by the employee.
When in need of income, the pensioner converts the LRSP into a life income fund (LIF) and the pensioner is then entitled to withdraw funds. The amounts he/she can withdraw are restricted to a minimum and a maximum, which change every year depending on the market value of the LIF and the age of the pensioner.
Employees on DC plans can be those who entered the workforce of companies that offered only DC plans, or can be the product of those who were DB plan members but chose to commute their DB benefits, in other words, they chose to replace those earned DB benefits into a lump sum e.g. took the buyout.
These two pension plans are very much different in nature. Among the many differences between the two plans, the taxman also treats them differently. Income from both plans is taxable. Under the DB plan, the pensioner can split his pension income to a maximum of 50 per cent with his/her spouse.
This is important for lowering your taxes when the spouse is in a lower tax state. In addition, both the pensioner and his/her spouse can claim the pension income tax credits worth a total of about $700 in tax reductions.
But under the DC plan, the pensioner has to wait until he/she turns 65 before he can participate in the income splitting and claim the tax credit. As an example, we will compare the amount of taxes paid by the DB and DC pensioners. I will assume that each has a total income of $60,000, which includes a pension income of $40,000.
The other $20,000 could be withdrawals from an RRSP or other taxable incomes.
The spouses have no income. The combined taxes paid by the DB pensioner and his spouse is about $7,200 while it is a bout $9,900 for the DC pensioner. A difference of about $2,700 a year. This difference can be greater or lower, depending on the circumstances. A DC pensioner who retires at age 55 is subjected to this higher tax for a period of 10 years.
I urge everyone who belongs to the DC pension plans, immediately affected or not, to voice their concerns to a Member of Parliament as well as the Minister of Finance. Simply send a copy of the above document, adding your own comments if you wish.
You can write to: Hon. James Flaherty, Minister of Finance, L’Esplanade Laurier – East Tower, 140 O’Connor St, Ottawa, ON, K1A 0G5
You should also send a letter to: Alex Atamankeno, MP., 337 Columbia Ave, Castlegar, BC, V1N 1G6.