Canada Pension Plan – Benefit or Tax?
April 2nd, 2009
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by admin · Filed Under: Radio Show · Uncategorized · seminars
Canada Pension Plan is a touchy subject with many business owners. Most feel they could do better investing their contributions independently of this program. With a rate of return estimated at about 1%, CPP is not appealing as an investment and many regard it as just another tax.
In the last fiscal year Canada Pension Plan reported a loss of 1.5% in its investments. The assets in the plan dropped $1.1 Billion. Contribution limits have increased from 5.8% in 1998 to the current rate of 9.9%. In 1995, projections by the chief actuary predicted a need for increases to 14.2% by the year 2030. The rate is now expected to stay at 9.9%, referred to as the ‘steady-state rate’, which in 2001 was projected to be enough to sustain the fund.
In 1966 Canadians’ CPP maximum contributions were $79 per year. By the year 2000 maximum contributions had gradually increased to $2,659. In 2002 this increased further to $3,365 and then to $3,603 in 2003. Even though the percentage is now set at a steady 9.9%, as the Yearly Maximum Pensionable Earnings amount is adjusted each year, the dollar amount of maximum contributions is increasing. The contribution ceiling in 2003 is set at $39,900, up from $39,100 in 2002 and $38,300 in 2001.
In 1998 CPP underwent major changes. Benefits were tightened up and investment policies were amended. The method for calculating combined benefits was changed resulting in lower combined survivor/retirement and survivor/disability benefit amounts. Disability benefit requirements were made tougher. The death benefit was reduced from a maximum of $3,580 to a maximum of $2,500.
|
2003 CPP Maximum Monthly Benefit |
|
|
Disability benefit |
$971.26 |
|
Retirement pension at age 65 |
$801.25 |
|
Survivors benefit under age 65 |
$444.96 |
|
Survivors benefit over age 65 |
$480.75 |
|
Combined survivors and Retirement benefit at age 65 |
$801.25 |
There is no way to predict what additional changes to the plan will be made in the future and whether or not high income earners will eventually be faced with adjustments or clawbacks. Certainly many successful business owners feel strongly that they would be better off retaining control of the funds currently being directed to CPP, regardless of their projected CPP benefit at retirement. Participation in CPP is mandatory on T4 employment income received directly from the employer. Both the employer and employee portion must be paid on the plan. Business owners have a unique opportunity to direct profits so as to avoid CPP expense. This is accomplished by setting up an Employee Profit Sharing Plan Trust. The income received by the individual from the trust and reported by way of a T4PS is not subject to employment taxes such as CPP and EI.
Employee Profit Sharing Plan Trust
The EPSP trust is an effective income splitting, tax saving strategy for business owners. Entirely discretionary, this trust allows an employer to share profits with some or all of its employees. There is no requirement that all employees be included or that they be treated equally. For this reason it is an excellent tool for shareholders wishing to eliminate CPP expense and other taxes while income splitting with family members. While these plans have existed for quite some time, their popularity has recently been growing. Due largely to the new legislation of sec 120.4 affecting split income from family trusts, commonly referred to as the ‘kiddie tax’
Setting up the EPSP trust is simple and inexpensive. The setup cost is just a fraction of the first year savings and the ongoing maintenance and cost is minimal. The trust is not subject to tax and therefore does not require filing of an annual tax return, unlike the family trust where annual filing is mandatory. Like RRSPs and registered pension plans, the income of the trust accumulates on an untaxed basis. Each year the trust must allocate income amongst all of the EPSP members. The allocation would include employer contributions, profits of the trust and capital gains or losses of the trust. These allocations qualify as ‘earned income’ for he purpose of the RRSP contribution limits. The members of the trust pay tax annually on the allocation by the trust. Funds can be held within the trust and are not required to vest in employees immediately. The vesting period can vary in order to ensure that the employer’s objectives in setting up the trust are met. The business owner retains complete control of the trust and the funds directed to it. It can be effective as an education savings plan for the children of the business owner of a means by which total family income can be split amongst several lives to take advantage of the lowest initial tax rate several times. If a member of the trust leaves the plan before vesting they are entitled to a tax deduction equivalent to the in-received amount allocated to them.
The requirements for the EPSP trust include naming a trustee. This person can be the employer with an alternate trustee named to assist if the primary trustee in unable or unavailable to act in that capacity. A separate bank account is required for the trust. Registration is not required but is recommended to ensure qualification as an EPSP in the future. Employer contributions to the trust are to the trust are tax deductible to the corporation within 120 days of the year end. They must be calculated using a predetermined formula that relates to profits. A business owner might choose for example, to contribute to the trust, annual profits in excess of $300,000 with a required minimum contribution of $100,000 per year. This would provide for a minimum annual family income of $100,000 and the ability to direct everything over the small business limit to the trust and ultimately to the business owner for taxation at the lower personal rate. There is no withholdings by the employer for Canada Pension Plan or Employment Insurance premiums on contributions to the EPSP, nor on the allocations or distributions to the members from the EPSP. This effectively eliminates those expenses for the business owner and his or her family.
The EPSP trust is an excellent planning tool that is suitable for many business owners. It provides an opportunity to redirect funds that are currently being paid out as employment expenses, to more beneficial programs such an Individual Pension Plans or other tax deferral and growth sheltering options. As with any major financial planning decision, participation by the business owner’s accountant and lawyer is essential. Their professional guidance is critical in determining the suitability of the EPSP Trust for a particular client.
Benefits of an EPSP Trust
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|
Business Owner |
Spouse |
Total |
|
Cost of Paying Income to Corporation (Income + Employer share of CPP and EI) |
$151,801 |
$32,616 |
$184,417 |
|
Gross Income to Employee |
$150,000 |
$30,000 |
$150,000 |
|
Taxes Payable (will vary by province) |
$59,000 |
$6,200 |
$85,200 |
|
$1,801 |
$2,384 |
$4,185 |
|
|
Total taxes and employment expense |
$62,602 |
$11,200 |
$73,802 |
|
Net Family Income |
$87,389 |
$18,800 |
$110,499 |
Example: A business owner who is currently taking $180,000 family income from the business and split $150,000/$30,000 with spouse.
The same business owner established an EPSP trust and includes members of the trust, two teenage children who perform some minor tasks for the business.
|
|
Business Owner |
Spouse |
Child |
Child |
Total |
|
Cost of Income to Corporation |
$90,000 |
$30,000 |
$30,000 |
|
$184,417 |
|
Taxes Payable CPP and EI) |
$31,745 |
$6,200 |
$6,200 |
$6,200 |
$50,345 |
|
$0 |
$0 |
$0 |
$0 |
$0 |
|
|
Total taxes and employment expense |
$31,745 |
$6,200 |
$6,200 |
$6,200 |
$50,345 |
|
Net Family Income |
$58,255 |
$23,800 |
$23,800 |
$23,800 |
$129,655 |
Before the EPSP Trust this business owner was paying out $73,802 in taxes, CPP and EI for family members. With the EPSP Trust that amount dropped to $50,345. The savings in this example would be $23,457 per year.
This memo was originally written by Annie Marie Dryden, CLU, CFP of Great West Life.
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