Retirement planning is one of the most important components of your household’s financial landscape. To accommodate that, many employers have instituted pension plans. Both the employee and the business pay into the fund, accelerating its growth. If your office has a company pension plan, it is particularly important to understand what a pension adjustment (PA) is. Not only does it apply directly to your long-term retirement plan, but it also plays a part in your annual tax filing. By learning how pension adjustments work, and how they apply to you specifically, you can make the best plan for your future.
What Is A Pension Adjustment?
A pension adjustment refers to the amount which can be contributed to a Registered Retirement Savings Plan within a set year. Though the term adjustment can be misunderstood as a permanent change, it is actually a monetary amount that is recalculated every time you file your taxes. It is the combined value of both individual and employer pension credits. When planning for your annual RRSP contributions, the pension adjustment is one of the most important factors. There are monetary penalties associated with over-contributing to pensions. To avoid these, it is essential to understand the implications of pension adjustments and how they work.
How Does A Pension Adjustment Work?
Pension adjustments are calculated by Revenue Canada on an annual basis, with individual adjustment values for each pension. It refers to the estimated value of a specific pension, with each pension being assessed separately. Meant as an equalizing calculation, the purpose behind a pension adjustment is to level the playing field for those both with and without employer-matching pension plans.
A member participating in any kind of Registered Pension Plan can locate the annual pension adjustment in Box 52 of their T4. The same is true if you are a member of a Deferred Profit Sharing Plan. It accounts for the fact that those with employer-based pensions can save by contributing funds through gross earnings, not getting taxed on that amount. Those governing their own pensions don’t have that benefit. An adjustment is meant to correct that differential.
How To Calculate Your Pension Adjustment?
Relatively straightforward in most cases, the formula is used to determine the pension adjustment on any given account. Revenue Canada calculates the value of nine times your annual accrued benefits. It then takes this figure and subtracts $600 to reach the value of your adjustment. The purpose is to ensure that everyone has equal access to tax assistance.
Though it is usually a simple process, depending on your approach to contributions, there are different ways the adjustment is calculated. There are three main types, each with slightly different calculations going into determining the adjustment. While your PA will show up on your T4, if you want to double check the math, there are some simple steps you can take.
Also called a defined contribution plan, this is when pension participants invest a pre-set amount. Typically, this comes with an employer-matching program. The value of your pension depends on the quality of the investments in the account, determined at the time of the participant’s retirement. In terms of pension adjustment, it is the cumulative value of both the employer’s and the participant’s contributions.
Employee Contribution: 2%
Employer Matching: 2%
Total Contributions: 4%
Pension Adjustment: $100,000 x 4% = $4,000
Referred to as a defined benefit plan, in these situations, you are guaranteed either a predetermined income or large, one-time payment. The amount is determined by the duration of employment, salary, and age of worker at the time of retirement. The approach to calculating the pension adjustment differs between three main methods:
- Set benefit: Also called a flat benefit, this is when the benefits are stated as a financial figure; a dollar amount representing each period (year or month) that the employee worked. An example is the pensioner receiving $50 a month per year of employment at the company.
- Average over career: In this case, the pension benefit is determined based on what the participant earned each year they worked. For instance, if you contribute 2% and your employer matches it, the benefit is calculated at 4% for each year you worked.
- Best average: Also called the final average, this is determined based on the yearly earnings as averaged over a set period. This is usually calculated based on the best three years of service or the most recent set of years. A good example is determining the PA based on the amount determined by taking the percentage of pensionable salary for the last three years of service. This figure is then multiplied by the years of service.
Once you know the amount, your pension adjustment is calculated by determining nine times the annual benefit, less six hundred dollars.
Defined plan pension adjustment = (9 x annual benefit) – $600
PA = 9 x ($100,000 x 4%) – $600 = $35,400
Deferred Profit Sharing Plan
In this situation, workers gain access to a portion of the profits which the employer pays out. Until it’s withdrawn, employees are not required to pay taxes on either the contribution or the value of it’s growth. It will still be displayed in Box 52 of your T4, but the calculation depends wholly on the company’s post-tax profits. The PA can go to a limit of up to $13,915, according to 2020 data.
Learn more about the difference between an RRSP and an RSP.
How Do You Report A Pension Adjustment?
The number you report for your pension adjustment is meant to detail the value of your earnings under your pension plan. Whether it is a Deferred Profit Sharing Plan or a Registered Pension Plan, with each passing year and added contribution, it gains value. The adjustment refers to the difference with each passing tax year. Meant as an equalizer, it ensures that an accurate figure is represented each year, factoring things like interest and employer matching.
Employer Reporting: Box 52
Though your employer will report the amount in Box 52, you are still required to take action. The amount the employer reports accounts for contributions The employer takes into account his contributions to your retirement accounts from both you and the company, considering your current income and any forfeited amounts.
Tax-Payer Reporting: Line 20600
Despite your employer noting the amount, you still must declare it separately on your return. While it will not impact your income as either a deduction or earnings, it can impact your contribution eligibility for the following year. Accurate reporting ensures that your pension is above board, reducing the chance of issues down the road.
If in doubt about how much you are eligible to contribute, you can consult Revenue Canada’s online service and access the My Account section of your online portal. It will specifically indicate your contribution limits so that you don’t risk running an overage when planning for retirement.
What is a pension adjustment for?
When do you need a pension adjustment?
What is the formula to calculate the PA on a defined benefit plan?
Financial planning, especially when it comes to retirement, relies on your keeping track of all aspects of your pension. The annual PA may not seem like a massive figure, but it does play a large role in avoiding penalties. The goal is to grow your investments, defer taxes on the funds you save until retirement, and avoid penalties resulting from overpayments. It’s worth taking the extra time to check your adjustment figure, and to use the RRSP contribution section of the Revenue Canada tax portal. Provided you keep track of your pension, using all available metrics, you can plan for a strong, fulfilling retirement.
Rating of 5/5 based on 2 votes.
Largest Lender Network In Canada
Save time and money with Loans Canada. Research and compare lenders before you apply. Share your experiences with Canada's top lenders.
50 Free Trades Offer
Almost $500 in commission-free trades. Code “50TRADESFREE”. Conditions apply.
Earn 5% Cash Back With Neo
Earn an average 5%¹ cash back at thousands of partners and at least 1%² cashback guaranteed.
Build Credit With Refresh
Build credit while spending money with the Refresh Financial VISA card.
Check out our interview with addy; a platform that allows Canadians to invest in different properties across Canada with as little as $1.