When a pension isn’t a pension
Canada taxes pension income—that much is clear. But what if what appears to be a pension is not a pension but, rather, a retirement savings plan?
That was the question before the Tax Court of Canada recently in a case (Jacques v The Queen, 2016 TCC 245) involving Canadian resident Julie Jacques, whose sister, Carrie Mechsner (a U.S. resident), died in 2008.
At the time of her death, Mechsner held funds in a U.S. plan known as the Mohawk Carpet Corporation Retirement Savings Plan II, which had been established through her employment. Jacques was Mechsner’s named beneficiary, and when Mechsner died, Jacques received the plan proceeds.
CRA reassessed Jacques to include the proceeds received from the plan in her 2009 income. Jacques appealed that reassessment to tax court, saying that the amount wasn’t a taxable pension, but rather the accumulation of her sister’s retirement savings, and should be received tax-free.
Under the Income Tax Act, a taxpayer must include in income “any amount received by the taxpayer in a year as, on account or in lieu of payment of, or in satisfaction of a superannuation or pension benefit.” While the act specifically lists a number of taxable pension benefits (e.g., OAS, CPP, and a variety of other benefits), the amount that Jacques received out of the plan wasn’t classified under any of those listed benefits.
The act defines a “superannuation or pension benefit” as “including any amount received out of or under a superannuation or pension fund or plan.” Thus, the real issue was whether the U.S. plan was a superannuation or pension fund or plan.
Under U.S. tax law, the Mohawk plan was a 401(k), but since neither party introduced expert evidence on the provisions of the U.S. tax code, the judge was “unwilling to draw any conclusions as to the nature of the plan from the fact that it is governed by those particular provisions of the [U.S. Internal Revenue] Code.” While acknowledging that 401(k) plans are “a common form of retirement planning in the U.S.,” the judge wrote that, “in the absence of evidence in respect of the relevant provisions, I am not prepared to conclude that such plans are, by their nature, either savings plans or superannuation or pension funds or plans.”
The Mohawk plan’s purpose is described in its governing document as follows:
The purpose of this Plan is to encourage thrift on the part of Participants by allowing them to accumulate tax-deferred savings while providing an incentive through matching contributions made by the Employer.
On this point, the judge acknowledged that, while accumulating savings is “an important part of retirement planning, the mere fact that money is being saved towards retirement does not indicate that the vehicle through which it is being saved is a pension.”
Qualifying employees were automatically enrolled in the plan, but employees had to elect to contribute to it. As a result, employees could effectively opt out by never making contributions. This factor doesn’t mean the plan wasn’t a pension plan.
Employees seemed to have full flexibility in determining the amount they contributed annually if they decided to contribute. Their contribution could be as low as 1% of their compensation or as high as 50%, and they could stop and restart their contributions at any time. The judge felt that the ability of an employee to significantly vary the amount contributed annually makes the Mohawk plan seem much more like a savings plan than a pension plan.
While there was the ability for the employer to match employee contributions, which is a characteristic consistent with pension plans, the employer was not actually required to do so.
The judge called this feature “unusual,” saying that employer contributions would normally be “an automatic part of a standard workplace pension plan.”
As well, all of an employee’s contributions to the plan vested immediately. Once an employee had been employed for one year, all of the employer’s contributions (if any) vested as well. This is consistent with a pension plan.
Each employee’s plan had its own account wherein the employee could select from a list of possible investment funds how his or her contributions would be invested. This is a common feature of both workplace pension plans and savings plans.
Perhaps the most determinative factor considered by the judge was the method by which funds are ultimately distributed out of the plan.
The default rule was that distributions were to be made in a single lump sum payment. Furthermore, the plan did not provide for the payment of anything that could be described as a fixed or determinable allowance or a regular post-retirement income.
Quoting a prior case, a “superannuation or pension fund or plan is an arrangement which provides for payment of regular post-retirement income to employees and determines the entitlement, the amount and frequency of such payments.”
The judge concluded that the ability for employees to receive only a single lump sum payment was “far more consistent with a savings plan than a superannuation or pension fund or plan.” The judge ruled that the amount was therefore not taxable to Jacques.