TFSAs provide opportunity to refine design of benefits
When federal Finance Minister Jim Flaherty tabled his third federal budget late last month, he unveiled two initiatives that will be welcome news for individuals and employers — the establishment of a new board to administer the employment insurance (EI) program and the creation of a tax-free savings account (TFSA).
EI reform
Ottawa is creating a new Crown corporation — the Canada Employment Insurance Financing Board (CEIFB). Reporting to the Minister of Human Resources and Social Development, the CEIFB will operate independently of the government and have responsibility to set EI premium rates and administer EI premiums collected from employers and employees.
Starting in 2009, the CEIFB will administer a new EI premium-setting mechanism designed to ensure the EI system operates on a “break-even” basis over time. To ensure rate stability, CEIFB will maintain and manage an EI cash reserve to which the federal government will contribute an initial amount of $2 billion. Differences between EI benefit payments and EI premiums will be paid from or into the cash reserve account, with the maximum year-over-year increase or decrease in the EI premium rate to be set at 15 cents per $100 of insured earnings.
To date, the cumulative surplus of EI premiums (contributions less benefit payments) has reached more than $50 billion. The CEIFB will therefore be welcome news to the many employers and economists who have advocated for reform of the EI system to align premiums with benefit payments.
The fact the budget does not announce any changes to EI benefit payments suggests if unemployment rates remain stable, both employers and employees may be able to look forward to reductions in EI premium rates.
As the CEIFB is created and works to set EI premium rates, employers should monitor developments closely to assess whether budgets for 2009 EI premiums need to be adjusted.
Tax-free savings accounts
Beginning in 2009, individuals will be able to contribute up to $5,000 per year to a TFSA, with no impact on registered retirement savings plan (RRSP) contribution room. Investment earnings on funds contributed to a TFSA will not be subject to tax. Other key features of the TFSA include:
• contributions will not be deductible from taxable income and withdrawals will not be taxed;
• the $5,000 contribution limit will be indexed to inflation with annual increases rounded to the nearest $500;
• unused TFSA contribution room will be carried forward to future years, and amounts withdrawn from a TFSA will be applied to increase future contribution room;
• TFSAs will be permitted to hold the same investments as an RRSP, subject to a prohibition against investments in entities with which a TFSA owner does not deal at arm’s length;
• an individual who provides funds to a spouse to invest in a TFSA will be exempt from attribution rules that would normally require the spouse’s TFSA investment earnings to be taxed in the individual’s hands;
• on death, the TFSA assets can be transferred to the TFSA of a surviving spouse or common-law partner;
• on the breakdown of a spousal relationship, amounts can be transferred between the TFSAs of separating spouses on a tax-free basis;
• TFSAs will not be protected from creditors in the event of bankruptcy and TFSA assets can be pledged as security for loans;
• interest will not be deductible on funds borrowed to invest in a TFSA;
• TFSA investment earnings and withdrawals will not affect eligibility for income-tested benefits and credits, including the Canada Child Tax Benefit, the Goods and Services Tax Credit, the Age Credit, the Old Age Security Benefit, the Guaranteed Income Supplement and EI benefits; and
• unlike RRSPs, there is no age limit by which the TFSA assets must be withdrawn.
Implications of TFSAs for employers
TFSAs may present opportunities for employers to refine the design, funding or delivery of certain benefit programs.
Sponsors of capital accumulation plans (such as RRSPs, defined contribution registered pension plans, deferred profit sharing plans and employee profit sharing plans) may wish to review the structure of these savings arrangements to assess whether the mix of vehicles is optimal. Once they are available in 2009, TFSAs may be a useful vehicle for holding short- to medium-term savings, as well as retirement savings.
Although annual contributions are limited, in certain circumstances a TFSA might provide a useful vehicle for pre-funding a supplemental employee retirement plan (SERP) or post-retirement health-care benefits.
Employers that contemplate using TFSAs to fund employment benefit programs should consider whether employees may perceive this as an encroachment on their own ability to contribute to TFSAs.
Other highlights for employers
Medical expense tax credit (METC): METC rules will be clarified to confirm eligible drugs include only those that:
• can lawfully be acquired only if prescribed by a medical practitioner; or
• are on the restricted list of METC eligible drugs that can be acquired without a prescription, such as insulin.
Because the METC rules are used to define drugs and other medical expenses that can be covered under tax-preferred private health services plans (PHSPs), this clarification may be significant for plans that currently cover over-the-counter drugs, homeopathic substances and other health products that, while prescribed by a physician or other provider, can be obtained without a prescription. Employer-sponsored benefit programs may need to be reviewed and restructured either to exclude ineligible expenses or to provide coverage for them under a separate, taxable arrangement.
The budget also proposes to extend the list of items eligible for the METC (and consequently PHSPs). Employers should review the updated list of eligible expenses to confirm what should be included for coverage under benefit programs.
Unlocking of life income funds (LIFs) subject to the federal Pension Benefits Standards Act: Individuals who hold LIFs arising from funds transferred from a federally registered pension plan will have increased flexibility to unlock their funds:
• individuals 55 or older with LIF holdings of up to $22,450 will be able to collapse their LIF and receive the proceeds in cash or transfer the proceeds to a non-locked-in RRSP or registered retirement income fund (RRIF);
• individuals 55 or older will also have a one-time opportunity to transfer up to 50 per cent of LIF holdings to a non-locked-in vehicle, such as an RRSP or RRIF;
• a LIF holder in financial hardship will also be entitled to withdraw up to $22,450 as a taxable lump sum; and
• the maximum withdrawal amount of $22,450 will increase annually in step with increases in the average wage.
No effective date is specified. This measure is similar to changes announced in other jurisdictions in recent months.
Once this proposal is implemented, employers with federally registered pension plans may want to update employees on the new, less restrictive locking-in provisions.
Late penalties for income tax: The budget proposes a graduated penalty regime for late remittances of income tax, Canada Pension Plan contributions and EI contributions withheld from employees’ pay. Currently, late remittances are generally subject to a flat penalty of 10 per cent of the amount required to be remitted. As of Feb. 26, 2008, the government proposes to replace the current penalty regime with graduated late-remittance penalties that cap at 10 per cent after seven days.
Other HR-related measures: The budget also includes proposals to:
• expand registered education savings plan (RESP) participation opportunities;
• increase the earned income threshold at which guaranteed income supplement (GIS) claw-back comes into effect;
• increase the tax deduction available to eligible residents of Northern Canada communities; and
• provide an additional $90 million in funding (over three years) under the Targeted Initiative for Older Workers, a federal-provincial program introduced in 2006 to assist unemployed older workers in vulnerable communities to stay in the workforce.
For certain organizations, such as retailers that employ retirees on a casual basis, natural resource companies operating in Northern Canada and companies contemplating workforce reductions in smaller communities, these budget proposals may have a beneficial effect for employers and employees.
Ian Genno is an actuary and James Pierlot is a lawyer in the Toronto office of Towers Perrin. You can reach them at [email protected] and [email protected] This article was prepared with the assistance of several colleagues in their office.
EI reform
Ottawa is creating a new Crown corporation — the Canada Employment Insurance Financing Board (CEIFB). Reporting to the Minister of Human Resources and Social Development, the CEIFB will operate independently of the government and have responsibility to set EI premium rates and administer EI premiums collected from employers and employees.
Starting in 2009, the CEIFB will administer a new EI premium-setting mechanism designed to ensure the EI system operates on a “break-even” basis over time. To ensure rate stability, CEIFB will maintain and manage an EI cash reserve to which the federal government will contribute an initial amount of $2 billion. Differences between EI benefit payments and EI premiums will be paid from or into the cash reserve account, with the maximum year-over-year increase or decrease in the EI premium rate to be set at 15 cents per $100 of insured earnings.
To date, the cumulative surplus of EI premiums (contributions less benefit payments) has reached more than $50 billion. The CEIFB will therefore be welcome news to the many employers and economists who have advocated for reform of the EI system to align premiums with benefit payments.
The fact the budget does not announce any changes to EI benefit payments suggests if unemployment rates remain stable, both employers and employees may be able to look forward to reductions in EI premium rates.
As the CEIFB is created and works to set EI premium rates, employers should monitor developments closely to assess whether budgets for 2009 EI premiums need to be adjusted.
Tax-free savings accounts
Beginning in 2009, individuals will be able to contribute up to $5,000 per year to a TFSA, with no impact on registered retirement savings plan (RRSP) contribution room. Investment earnings on funds contributed to a TFSA will not be subject to tax. Other key features of the TFSA include:
• contributions will not be deductible from taxable income and withdrawals will not be taxed;
• the $5,000 contribution limit will be indexed to inflation with annual increases rounded to the nearest $500;
• unused TFSA contribution room will be carried forward to future years, and amounts withdrawn from a TFSA will be applied to increase future contribution room;
• TFSAs will be permitted to hold the same investments as an RRSP, subject to a prohibition against investments in entities with which a TFSA owner does not deal at arm’s length;
• an individual who provides funds to a spouse to invest in a TFSA will be exempt from attribution rules that would normally require the spouse’s TFSA investment earnings to be taxed in the individual’s hands;
• on death, the TFSA assets can be transferred to the TFSA of a surviving spouse or common-law partner;
• on the breakdown of a spousal relationship, amounts can be transferred between the TFSAs of separating spouses on a tax-free basis;
• TFSAs will not be protected from creditors in the event of bankruptcy and TFSA assets can be pledged as security for loans;
• interest will not be deductible on funds borrowed to invest in a TFSA;
• TFSA investment earnings and withdrawals will not affect eligibility for income-tested benefits and credits, including the Canada Child Tax Benefit, the Goods and Services Tax Credit, the Age Credit, the Old Age Security Benefit, the Guaranteed Income Supplement and EI benefits; and
• unlike RRSPs, there is no age limit by which the TFSA assets must be withdrawn.
Implications of TFSAs for employers
TFSAs may present opportunities for employers to refine the design, funding or delivery of certain benefit programs.
Sponsors of capital accumulation plans (such as RRSPs, defined contribution registered pension plans, deferred profit sharing plans and employee profit sharing plans) may wish to review the structure of these savings arrangements to assess whether the mix of vehicles is optimal. Once they are available in 2009, TFSAs may be a useful vehicle for holding short- to medium-term savings, as well as retirement savings.
Although annual contributions are limited, in certain circumstances a TFSA might provide a useful vehicle for pre-funding a supplemental employee retirement plan (SERP) or post-retirement health-care benefits.
Employers that contemplate using TFSAs to fund employment benefit programs should consider whether employees may perceive this as an encroachment on their own ability to contribute to TFSAs.
Other highlights for employers
Medical expense tax credit (METC): METC rules will be clarified to confirm eligible drugs include only those that:
• can lawfully be acquired only if prescribed by a medical practitioner; or
• are on the restricted list of METC eligible drugs that can be acquired without a prescription, such as insulin.
Because the METC rules are used to define drugs and other medical expenses that can be covered under tax-preferred private health services plans (PHSPs), this clarification may be significant for plans that currently cover over-the-counter drugs, homeopathic substances and other health products that, while prescribed by a physician or other provider, can be obtained without a prescription. Employer-sponsored benefit programs may need to be reviewed and restructured either to exclude ineligible expenses or to provide coverage for them under a separate, taxable arrangement.
The budget also proposes to extend the list of items eligible for the METC (and consequently PHSPs). Employers should review the updated list of eligible expenses to confirm what should be included for coverage under benefit programs.
Unlocking of life income funds (LIFs) subject to the federal Pension Benefits Standards Act: Individuals who hold LIFs arising from funds transferred from a federally registered pension plan will have increased flexibility to unlock their funds:
• individuals 55 or older with LIF holdings of up to $22,450 will be able to collapse their LIF and receive the proceeds in cash or transfer the proceeds to a non-locked-in RRSP or registered retirement income fund (RRIF);
• individuals 55 or older will also have a one-time opportunity to transfer up to 50 per cent of LIF holdings to a non-locked-in vehicle, such as an RRSP or RRIF;
• a LIF holder in financial hardship will also be entitled to withdraw up to $22,450 as a taxable lump sum; and
• the maximum withdrawal amount of $22,450 will increase annually in step with increases in the average wage.
No effective date is specified. This measure is similar to changes announced in other jurisdictions in recent months.
Once this proposal is implemented, employers with federally registered pension plans may want to update employees on the new, less restrictive locking-in provisions.
Late penalties for income tax: The budget proposes a graduated penalty regime for late remittances of income tax, Canada Pension Plan contributions and EI contributions withheld from employees’ pay. Currently, late remittances are generally subject to a flat penalty of 10 per cent of the amount required to be remitted. As of Feb. 26, 2008, the government proposes to replace the current penalty regime with graduated late-remittance penalties that cap at 10 per cent after seven days.
Other HR-related measures: The budget also includes proposals to:
• expand registered education savings plan (RESP) participation opportunities;
• increase the earned income threshold at which guaranteed income supplement (GIS) claw-back comes into effect;
• increase the tax deduction available to eligible residents of Northern Canada communities; and
• provide an additional $90 million in funding (over three years) under the Targeted Initiative for Older Workers, a federal-provincial program introduced in 2006 to assist unemployed older workers in vulnerable communities to stay in the workforce.
For certain organizations, such as retailers that employ retirees on a casual basis, natural resource companies operating in Northern Canada and companies contemplating workforce reductions in smaller communities, these budget proposals may have a beneficial effect for employers and employees.
Ian Genno is an actuary and James Pierlot is a lawyer in the Toronto office of Towers Perrin. You can reach them at [email protected] and [email protected] This article was prepared with the assistance of several colleagues in their office.
