Defined benefit plans are far more predictable because the employee knows how much his/her pension will be upon retirement. The benefit that the employee eventually receives is based on one of, or a combination of, the following factors:
- a pre-determined percentage of the employee’s salary over a specified number of years (for example, 2% of the average salary of the last three years of service, multiplied by the number of years in which the person was a member of the RPP) and in which the required contributions are based on the amount of the benefit;
- the number of years of service; and/or
- the amount contributed to the plan.
With a defined benefit plan, the employer is basically promising the employee a predetermined level of pension income. Because of this assurance, this type pf plan is more popular with employees than money purchase plans. The employer, however, is faced with the responsibility of ensuring that the plan is adequately funded and that pension obligations are met. Actuarial valuations are necessary to ensure that the plan is sufficient to future pension obligations. The CICA Handbook includes extensive accounting requirements as to the reporting of under-funded pension liabilities, additional reporting, and administrative costs.
Any corporation with an under-funded benefit plan may deduct the requisite contributions when bringing that plan to obligatory standards.
RPP-Defined Benefit Plans-Employer Contributions (Post-1990)
Since employer contributions to defined benefit plans largely depend on fund requirements, strict rules ensure that contributions are eligible. Contributions by an employer are eligible if:
- an actuary recommends them; and
- the CRA has approved the recommendation in writing.
The employer must fund at least 50% of the cost of the plan. The calculations are extremely complex and beyond the scope of this text.
RPP-Money Purchase Plans-Employer Contributions (Post-1990)
Money purchase plans payout contributions in addition to any compounded earnings that have accumulated in the fund. The payout depends on how well the fund was managed and how well it performed over the years. Paragraph 20(1)(q) permits an employer to deduct contributions to an RPP in computing income from business. However, subsection 147.2(1) limits the contribution amounts, per employee, to the lesser of:
- the “money purchase limit” for the year; or
- 18% of the employee’s compensation.
The “money purchase limit” is the contribution’s limits for both the employer and the employee. This limit is pertinent to all registered plans and provides the basis for the dollar limit on deductible contributions to RRSPs, RPP, and DPSPs. The money purchase limit for 1996 (as originally proposed) was reduced from $15,500 to $13,500 and had been frozen at that level until 2003