Sometime ago, I received an email that read: “Peter, I am the chief financial officer with a midsize software company in New York state. My company has just purchased a Canadian firm with more than 200 employees. We are seeking your assistance to help us with the set-up of an equivalent to the 401k plan for our new Canadian workforce. Can you refer us to a competent resource?”
The Canadian equivalent to the 401k is known as the Group RRSP. Unfortunately, very little has been written to act as a primer comparing a 401k plan to similar employee registered retirement plans for American companies that are in the process of locating in Canada or who have acquired a Canadian company.
This should be very surprising to the reader since Canada is the United States' largest trading partner of goods and services with more than $518 billion of cross border trade in 2007, according to the U.S. Census Bureau. This partnership has been accelerating since 1984 when then-Prime Minister Brian Mulroney declared Canada “open for business” with the dismantling of the Foreign Investment Review Agency, a Canadian protectionist agency, coupled with the passing of the Investment Canada Act (ICA).
A December 2005 report by the Canadian Centre for Policy Alternatives showed Canadian owned companies valued at more than $620.7 billion had been taken over by non-resident-controlled corporations since Investment Canada started keeping records of these transactions in 1985. Just in the last two years, $156 billion worth of domestic companies have been sold into foreign hands. Of those, the majority of these takeovers were by U.S. interests. This has all occurred within a country which Statistics Canada says has a population of 33 million people, a 2007 GDP of $1.274 trillion, and a national debt of only $467.3 billion. In the later part of this decade, Canada has successfully avoided an economic recession while maintaining the healthiest financial statements of all the Group of Eight Nations (G8).
All things being equal, if we were to remove the Canadian publicly funded healthcare system from the equation the difference between the Canadian and U.S. economies are marginal at best. The Fraser Institute’s Economic Freedom of the World 2007 Annual Report says the United States and Canada ranked together with Britain in fifth spot as the most economically free, open, and competitive economies in the world today.
It is this continuous trend towards integration of the economies of the United States and its partner to the north that has prompted me to create this primer to decipher the secret code between the U.S. 401k and the Canadian Group RRSP and help demystify these two great retirement plans for employers on both sides of the 49th Parallel.
401k Versus Group RRSP
The story of the 401k begins in 1978 when the U.S. Congress amended the Internal Revenue Code to add section 401(k). The birth of the RRSP occurred more than 20 years prior in 1957 when the Canadian federal parliament passed legislation amending the Canadian Income Tax Act to include these retirement plans. Both retirement plans are similar in that they allow workers to save for retirement while deferring income tax on the saved money and earnings until withdrawal.
Found within the plan text of both the 401k and the Group RRSP is the voluntary nature of membership for all employees. For an employee to be eligible to participate in a 401k, they have the choice to become a member of this plan the first day of each calendar quarter, following the participant’s date of employment. Eligibility and membership in a Group RRSP is similar to the 401k. However, in a Group RRSP there is no legislative requirement to limit or grant eligibility. Employers may set eligibility rule for their Group RRSP to suit their needs.
The normal retirement age for a 401k participant is after their 65th birthday. The earliest that a 401k participant can withdraw income is at age 59½ and the lastest is age 70½.
The normal retirement date for a Group RRSP member is very flexible and may be set by the employer as age 65 or earlier. Group RRSP participants can enjoy the benefits of a registered plan until December 31 of the year after they turn age 71. At that time, members must convert all their RRSPs into a Registered Retirement Income Fund (RRIF) or an annuity and start withdrawing money from their retirement plan.
Other main differences between the 401k and the Group RRSP revolve around the maximum allowable employer matching contributions rules and eligibility rules.
401k employer contributions can be up to 100% of an employee’s pre-tax compensation. 401k employee maximum contribution limits for 2008 for individuals under age 50 are $15,500 and for 401k participants age 50 and older limits are $20,500 annually. As of 2009, 401k maximum contribution limits will be indexed to inflation.
While the maximum contribution into a Group RRSP (both employer and employee) allowed by the Canada Revenue Agency is the lesser of 18 per cent of last year’s earned income of the employee – up to a maximum of $20,000 in 2008, $21,000 in 2009, $22,000 in 2010, and indexed thereafter. If the 401k maximum contribution amounts are not used in the year that they are awarded the member of the plan is not allowed to carry that unused room forward to future years to make contributions into these plans. RRSP unused room can be carried forward indefinitely. In addition and individual can accumulate unused RRSP room going back to 1991.
The rules for vesting the employer’s contributions into the 401k for the member differ greatly from the Group RRSP. The vesting rule of an employer’s contributions for the 401k by law is six years. The Group RRSP vests an employer’s contributions in the employee’s hands as soon as the employer contributions are remitted to the employee’s RRSP account.
However, employee salary deferrals into a 401k are immediately 100 per cent vested – that is, the money that an employee has put aside through salary deferrals cannot be forfeited. When an employee leaves employment, he/she is entitled to those deferrals, plus any investment gains (or minus losses) on their deferrals.
Many American companies can rest at ease knowing that an RRSP can accommodate the 401(k) contributions formula. Employee and employer contributions are remitted monthly for both the Group RRSP and 401k. If the employer matches the employee contribution, these matching contributions are also remitted monthly.
Within both the 401k and the Group RRSP, transfers from other similar registered plans are allowed into these plans. In addition, monies within these plans may be transferred out to similar registered plans as well. Both transfers into the 401k and the Group RRSP and transfers out to other registered retirement plans will not trigger taxes by either the Internal Revenue Service (IRS) or Canada Revenue Agency (CRA) for their members choosing to do so.
Participants in a 401k may be permitted to access funds from these plans subject to the rules set within the individual 401k plan text for reasons other than retirement. These allowable 401k withdrawals may occur for the purchase of a primary residence or to avoid foreclosure on a primary residence. 401k funds can also be used to pay for post-secondary schooling within a 12-month period, medical expenses, and funeral expenses.
In regards to the Group RRSP, registered assets are not assignable and cannot be used as collateral for a loan, except for an interest-free, tax-free withdrawal for Home Buyers Plans or other eligible Canadian government program such as the Lifelong Learning Program.
Under the RRSP Home Buyers Plan, the maximum that can be withdrawn is $20,000 and the withdrawal amount must be repaid into any RRSP within 15 years, in no more than 15 equal yearly installments. Although $20,000 can be withdrawn from an RRSP over four years to pay for a post-secondary education using the Lifelong Learning Program, the most that can be taken out of an RRSP in one calendar year is $10,000. The participant has 10 years to repay the money borrowed from their RRSP. Required monies not repaid back into the Group RRSP for either the Home Buyers Plan or the Lifelong Learning Program are counted as income by the RRSP member for that year and taxed.
Both the 401k and the Group RRSP have taxes withheld on funds withdrawn out of these plans for retirement. With a Group RRSP, the plan must allow for withdrawals at the employee’s discretion. However, deterrents from withdrawing funds can be imposed such eliminating the right to future employer contributions for a period of time.
In both Canada and the U.S., there are rules revolving around what employers and plan sponsors are required to communicate to their plan participants about their plans to help their members make informed decisions. All 401k plans must follow the Employee Retirement Income Security Act (ERISA). ERISA is a federal law that sets minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in these plans.
ERISA requires plans to provide participants with plan information including important information about plan features and funding; provides fiduciary duties for those who manage and control plan assets; requires plans to establish a grievance and appeals process for participants to get benefits from their plans; and gives participants the right to sue for benefits and breaches of fiduciary duty.
Most providers offering Group RRSPs have procedures that are consistent with ERISA and comply with the Canadian Capital Accumulation Plan (CAP) Guidelines. CAPs include all Group RRSPs, Defined Contribution pension plans, deferred profit sharing plans, employee profit sharing plans, and all other types of employee non-registered savings plans in which employees make their own investment decisions. One of the guidelines is employers are responsible for providing access to investment decision-making tools and for cautioning employees that they ought to obtain independent investment advice.
Obviously, setting up Canadian retirement benefits such as Group RRSPs, DC pension plan, Retirement Compensation Arrangement, Employee Profit Sharing Plan, Defined Benefit pension plan, or group medical and dental plan for American companies locating in Canada requires specialties in areas as diverse as the Canada/U.S. Tax Treaty, the Employee Retirement Income Security Act (U.S.), and Canadian Capital Accumulation Plan Guidelines, accounting, actuary evaluation, investment management, pension legislation, employment law, and employee benefit plan construction.
Many employers and their trusted advisors will need to seek educational services to aid them in the set-up, maintenance, and wind-up stages of these employee group benefits. Therefore, it is well worth the time and money to hire a skilled certified financial planner who possesses this expertise to assist in the design, implementation, maintenance, and wind-up of these solutions.
About the Author:
Peter J. Merrick, BA, FMA, CFP, FCSI, is President of MerrickWealth.com, a fee-for-services Certified Financial Planner and executive benefit advisory firm in Toronto, Canada. His consulting work involves creating executive and employee benefits that meet the requirements set in the Canadian/US Tax Treaty, ERISA standards and CAP guidelines. Peter is a professor of financial planning and group benefits, author of “The Essential Individual Pension Plan Handbook” (Lexisnexis Canada, 2007) and was a presenter at the prestigious Canadian Institute of Chartered Accountants 2007 National Conference on Income Taxes.
©Peter Merrick, 2008. Reproduced with permission.