2017 tax change gives extra incentive to look at annuitizing certain pension obligations

With the taxation of certain annuity payments affected by impending changes to Canadian tax rules, employers that offer supplementary pension benefit plans may wish to annuitize current and deferred pensioners before the end of the year.

Effective Jan. 1, 2017, the Income Tax Act will incorporate updated mortality tables, established in 2000, for the purpose of calculating the extent to which annuities of that kind will be subject to tax.

“Because life expectancy has improved substantially, the new tables will reduce the amount of the annuity that is treated as deductible capital,” says Terra Klinck of Hicks Morley Hamilton Stewart Storie LLP in Toronto. “Employers may wish to annuitize so as to preserve more favourable tax treatment for pensioners and possibly reduce settlement costs for themselves.”

Tables produced by Sun Life Assurance Co. of Canada show that a 65-year-old pensioner receiving $5,906 annually from an annuitized supplementary pension benefit plan will see the taxable portion of the annuity rise to $980 from $412 under the old tables.

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The new tables will apply to supplementary pension benefit annuities purchased after Jan. 1, 2017. “If the terms of the annuity are fixed and determined before 2017, the old regime applies, even if the payments do not commence until a future date,” says Klinck.

The rules treat a portion of each payment as return of capital to reflect the premium, spread over the life expectancy of the pensioner, to purchase the annuity. The rest of the payment is taxable income.

“The idea is that pensioners get their capital back during their lifetime and that portion of the annuity payment is not taxable,” says Elizabeth Boyd of Blake Cassels & Graydon LLP in Toronto. “The new mortality tables, however, spread the capital over a longer lifetime, meaning that capital will constitute less of the payment and more of the payment will be taxable as income.”

Employers, therefore, may wish to expedite planned settlement of supplement benefits to allow pensioners to take advantage of the current regime. But doing that may also benefit employers by reducing their settlement costs.

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For example, where the terms of their plans require employers to provide payments to compensate pensioners for reduced net income, annuity purchases after January could involve added costs. The same considerations apply where the supplemental pension plan provides that payments made by employers to individuals who buy annuities themselves must take into account the tax consequences to the person who makes the purchase.

For many, time is running short. “For a host of reasons, annuity purchases can take several months to implement,” says Klinck. “This is especially true where the prospective annuitants include former employees who must be located and contacted.”

Employers must first determine whether their supplementary pension plan allows annuity purchases, a step that may require obtaining legal advice.

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Assuming the plan allows for annuitization, employers will also have to obtain the necessary consent from those authorized to approve them. Where the consent of plan members is necessary, employers will have to decide whether they must make other options available.

And because conditions in annuity markets can change quickly, it can be advantageous to do the groundwork as soon as possible in order to take advantage of favourable market developments.

“The clock is ticking,” says Klinck. “But there is still certainly an incentive to look into this before year’s end.”