CRA draft newsletter on annuity purchases from pension plans
The Registered Plans Directorate of the Canada Revenue Agency (CRA) has released a draft newsletter for public consultation (the Draft Newsletter). The Draft Newsletter provides guidance on the tax effects of the purchase of annuities by both plan administrators and individuals from registered pension plans, with a focus on purchases of annuities from defined benefit (DB) pension plans.
CRA’s interpretation of “materially different”
Section 147.4 of the Income Tax Act provides safe harbour for the purchase of an annuity from a pension plan, provided that the annuity terms are not “materially different” from the pension plan terms. If the annuity terms are materially different, then section 147.4 does not apply and the individual is deemed to have received the full purchase price as a taxable payment from the pension plan.
Until the release of the Draft Newsletter, the CRA’s practice has been to take a conservative view of the term “materially different”, effectively requiring annuity terms to be substantively identical to the pension plan terms. This has proven problematic where the pension plan provides for adjustment based on the Consumer Price Index (CPI), as it can be difficult to find insurers willing to issue annuities to replicate that feature.
The Draft Newsletter states that the CRA will now accept fixed-rate indexation in lieu of CPI indexation. The fixed rate can either be the mid-range of the Bank of Canada’s inflation control range at the date of purchase (currently, 2%) or the spread between Canada long bond and real return bonds in the month of purchase or the month preceding (currently, 1.57%). Where the pension plan provides a lesser rate of indexing based on CPI (such as CPI minus 1% or 40% of CPI), that rate must be adjusted accordingly.
This revised position applies to both buy-out annuities purchased by the pension plan administrators and annuities purchased by individuals using their commuted value upon termination of employment.
The Draft Newsletter states that, if a different method is elected, it is recommended that a written request be made to the Registered Plans Directorate with the rationale outlined. Such requests will reviewed on a case by case basis.
Annuity purchases by individuals using the commuted value
Where the commuted value of pension plan benefits is not enough to purchase an annuity to provide the promised benefits, the purchase of the annuity with the commuted value is acceptable, provided that the purchase price is the only payment from the pension plan. The annuity can provide lesser benefits than the pension plan in such a situation.
Where the commuted value of pension plan benefits is more than enough to provide the promised benefits under an annuity, the CRA has always maintained that the excess must be paid in cash to the member. This position is maintained in the Draft Newsletter.
The main change in the Draft Newsletter is the new guidance respecting the forms of inflation indexing that will not be considered materially different by the CRA from CPI-based indexing. These will be welcome to plan administrators of pension plans who wish to purchase annuities with respect to benefits with CPI-based indexing.
Written comments on the Draft Newsletter can be made on or before March 1, 2019.