Professional Referrals

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Comparing RRSP with its American cousin

Some time ago I received an e-mail from the chief financial officer of a New York-based software company that had just bought a Canadian firm with 200 employees. They were asking for a resource to set up an equivalent to the 401k plan for their new Canadian workforce. 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.

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 over 20 years prior in 1957 when Parliament passed legislation amending the Canadian Income Tax Act to include these retirement plans. The plans are similar in that they allow workers to save for retirement while deferring income tax on the saved money and earn-
ings until withdrawal. 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 59-and-a-half and the latest is age 70-and-a-half. The normal retirement date for a group RRSP member is highly flexible and may be set by the employer to be age 65 or earlier. Group RRSP participants can enjoy the benefits of a registered plan until Dec. 31 of the year they turn 71. At that time the members must convert all their RRSPs into a Registered Retirement Income Fund (RRIF) and start withdrawing money.

One of the main differences between the 401k and the group RRSP revolves around the maximum allowable employer matching contributions rules and eligibility rules. The 401k employer contributions can be a maximum of 100 per cent of an employee’s pre-tax compensation. The 401k employee maximum contribution limit for 2008 for individuals under age 50 is $15,500 and for people age 50 and older

$20,500. As of 2009, 401k maximum contribution limits will be indexed to inflation. Even if the 401k member contributes the maximum amount each year, their employer’s matching contributions are in addition to these employee limits. The maximum contribution into a group RRSP (both employer and employee) allowed by the Canada Revenue Agency (CRA) is 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. 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 bylaw is six years. The group RRSP vests an employer’s contributions in the employee’s hands as soon as employee contributions are remitted to the employee’s RRSP account. However, employee salary deferrals into a 401k are immedi-
ately 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 or she is entitled to those deferrals,
plus any investment gains (or minus losses) on their deferrals.

Many American companies can rest easy knowing that an RRSP can accommodate the 401k contributions formula. Employee and employer contributions are remitted monthly for both the group RRSP and 401k. The employer will match the employee contributions. Employer matching contributions are also remitted monthly.

Within both the 401k and the group RRSP, transfers from other similar registered plans are
allowed. 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 CRA for their members. 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 withdraws may occur for the purchase of a primary residence or to avoid foreclosure on a primary residence. The 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 a Home Buyers Plan 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 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 Life-long 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 taken into 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 as the right to future employer contributions for a  period of time, if a withdrawal is made, while in the service of the employer.

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. All 401k plans must follow the Employee Retirement Income Security Act (ERISA). This 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.

Nora Cole

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