This week I want to discuss a creative idea called a notional defined contribution plan (NDCP).
An NDCP is really a supplemental pension plan for high-income employees that can be offered by any employer. If you're not currently participating in a pension or other retirement savings plan at work, or where you're not satisfied with the level of the pension you expect to receive one day, you may want to speak to your employer about an NDCP.
The benefits of an NDCP are impressive: A deferral of tax on a portion of your compensation, no limit on the benefits to be received in retirement as with a registered pension plan, no regulated contribution limit, and flexibility to tie the rate of return in the plan to any stock, stock market, interest rate or other benchmark negotiated with your employer.
By the way, an NDCP is not a bad deal for your employer either since there is no cash outlay by your employer until benefits are paid to you in retirement.
These plans are different than registered pension plans in that, generally, they are unfunded. The amounts set aside are notional -- that is, these are amounts on paper only. The Canada Revenue Agency has given its blessing on these plans in two advance tax rulings (ATR 9732103, April 17, 1998, and ATR 982643, Dec. 30, 1998).
Consider this example.
William's employer has set up an NDCP for key employees. When William began work for the company last year, he negotiated a $250,000 salary. William opted to join the NDCP because he liked the idea of deferring the tax on a portion of his salary to a future year. So, rather than taking a $250,000 salary, he accepted a $230,000 salary with an agreement that his employer would contribute 14.3 per cent of salary over $90,000 to the NDCP. The result? An additional $20,000 is "set aside" notionally in the NDCP.
In William's case, the NDCP grows annually based partly on his employer's stock price and partly on notional investments chosen by William.
William will not pay tax on the notional contributions to the plan, or the growth of the plan over time. Payments made to him by his employer later will be taxed as pension benefits, and his employer will deduct those payments in the years they're made.
To satisfy the CRA, participation in the plan should be optional, and begin upon negotiation of a new or renewed employment contract. Changing your existing contract during its term to reduce your pay and take contributions to an NDCP in lieu of that pay can be a problem.
There are other conditions that an NDCP should meet in order to pass muster. Visit a tax pro who understands these plans for more.
Tim Cestnick, FCA, CPA, CFP, TEP, is a tax specialist and author of Winning the Tax Game 2005 and The Tax Freedom Zone.
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