How to set up a 401(k) in Canada

Despite its global popularity, the 401(k) is a strictly American retirement account. If you’re looking to expand your business north of the Canadian border, you may need to set up a Canadian equivalent to the 401(k). Here’s a lowdown on how to go about it.

What is 401(k)?

A 401(k) is a retirement savings plan that’s offered by an employer to help employees plan for their future. Employer and employee contributions are tax-deductible up to annual contribution limits set by the Internal Revenue Service¹. A 401(k) can help you attract and retain top talent. 86% of job seekers say that a 401(k) is an important consideration when deciding whether or not to work for a company. Another 73% are willing to stay at a company because of its retirement plan². In Canada, the numbers are similar so it’s good compensation practice to offer a group retirement plan here as well.

To make life easier for employers, Congress passed the SECURE Act in December 2022. Among other things, the Act created the Pooled Employer Plan (PEP), which is essentially a multiple employer 401(k) plan. Unrelated employers can participate by opening individual 401(k) plans to create a single large plan, hence the “pooled plan”. Unlike a traditional 401(k), which is typically sponsored and managed by the employer or an administrator picked by the employer, a PEP is usually sponsored and managed by a third party³.

Third-party management of your pension plan offers several advantages. First, it takes administrative tasks and burdens off employers’ hands, leaving them to focus on actual business-related activities. Secondly, pooling assets into one large plan creates economies of scale, reducing costs. Thirdly, it reduces employers’ liability.⁴

If you’re a US employer who is planning to hire Canadian employees either remotely or by expanding into Canada, you and your workers will benefit from offering similar retirement savings plans in each country – especially if the plan is a PEP (in the US) or works like a PEP (in Canada).

How do pensions work in Canada?

There are no cross-border pension plans that serve both the US and Canada so if you’re expanding into Canada, you will need to find a 401(k) equivalent offered by a local provider. Group retirement plans in Canada are similar to the US, with some different names. The main group-plan options in Canada are defined benefit (DB) pension plans, defined contribution (DC) pension plans, Registered Retirement Savings Plans (RRSPs), “Group” RRSPs, and Deferred Profit Sharing Plans.

As in the US, all the Canadian plan types noted above are “tax-deferred” – contributions are tax-deductible, investment earnings are not taxed, and withdrawals/benefits are taxed as income.

DB pension plan

A defined benefit (DB) pension plan provides pension benefits based on a formula that takes several factors into account, such as employees’ years of service and salary. Benefits are paid in the form of a lifetime annuity. If the contributing employee dies, their spouse continues to receive lifetime benefits if they haven’t waived the survivor rights. As in the US, few Canadian employers offer defined benefit pension plans because they are complex to administer and financially risky.

DC pension plan

Single-employer DC plans in Canada are like a 401(k) in the US. Retirement benefits are based on accumulated employer/employee contributions and investment returns. Members select investments from funds made available by the employer, who must provide investment information and decision-making tools to the employees. This creates workload and risk for the employer and the employees. Because most employees are not financial experts, they have difficulty choosing investments and often do not engage with the selection process.

With a DC plan, expenses be can deducted and employer contributions do not increase payroll taxes like Employment Insurance (EI) premiums, Workplace Safety and Insurance Board (WSIB) premiums, Employer Health Tax (EHT), and Canada/Quebec Pension Plan (C/QPP) contributions.

Most DC plans don’t pay pensions. Members must transfer their funds to a personal plan when they retire.

Deferred Profit-Sharing Plan (DPSP)

A DPSP is a group-retirement plan to which an employer makes contributions “out of profit”. No employee contributions are permitted. Employees are limited to half the dollar limit for DC contributions and there are restrictions on membership. Employees who cannot join include some types of shareholders of the employer and related individuals. DPSPs don’t pay pensions and members must transfer their money out when they terminate employment or retire.

Registered Retirement Savings Plans (RRSP)

An RRSP is like a US Individual Retirement Account (IRA). Individuals can set up an RRSP with an “issuer” – a financial institution – and make tax-deductible contributions to fund their own retirement. On or before December 31 of the year in which they attain age 71, employees must transfer their RRSP to a Registered Retirement Income Fund or apply their RRSP Funds to purchase an annuity from an insurance company.

Group Registered Retirement Savings Plan (Group RRSP)

A Group RRSP is a collection of individual RRSP accounts administered by an employer under an agency agreement with a “recordkeeper” – a financial institution that provides access to mutual fund investments. The employer must offer a selection of investments and provide investment information and decision-making tools to members. As with single-employer DC plans, member engagement with the investment process is poor, which often leads to mediocre or poor investment outcomes.

Employers are not required to contribute to a Group RRSP. When employers do contribute, the contributions increase employees’ taxable income. While there is an offsetting deduction for income tax, the increase in reportable income arising from employer contributions to a Group RRSP often results in increased payroll taxes for some or all of EI, WSIB, EHT, and C/QPP.

Expenses for Group RRSP administration are not deductible. Group RRSPs do not pay pensions and the options for retirement are the same as for any other RRSP – transfer funds to a RRIF or buy an annuity.

With most DC plans, the employer is the administrator and must ensure compliance with tax rules and pension legislation. Regulators may apply monetary penalties for non-compliance.

Is there a 401(k) equivalent in Canada?

The closest 401(k) equivalent in Canada is a DC pension plan. Like a 401(k), employers can make matching contributions, and investments are selected by the members from funds provided by the employer through a third-party recordkeeper. Just like a 401(k), a DC plan accommodates employer and employee contributions and member-selected investments. As with a regular 401(k), the administrator of a single-employer DC pension plan is the employer.

DC plan vs. 401(k)

Although a DC plan is not a perfect 401(k) equivalent, the two plans have several features in common.

• Benefits: retirement benefits are based on accumulated contributions and investment income.
• Matching: the employer decides the contribution formula and may match employee contributions. A 401(k) has no minimum contribution. With a DC plan, a minimum employer contribution of 1% of pensionable salary is required.
• Portability: employees who change jobs can move their funds to a new plan.
• Investment: 401(k) investments are selected by members from employer-provided funds. Usually – but not always – DC plan members also select investments.

Is there a multi-employer, 401(k) Pooled Employer Plan equivalent in Canada?

Just like in the US, where the Pooled Employer Plan offers an outsourced 401(k) option, there is a pooled “collective DC” solution in Canada: Blue Pier’s Pension Plan as a Service.

Blue Pier’s Pension Plan as a Service

Blue Pier is Canada’s first Pension Plan as a Service and for US employers who know about 401(k) Pooled Employer Plans, Blue Pier will be familiar.

Like a Pooled Employer Plan, Blue Pier pools assets of employees from multiple employers to create economies of scale and gain access to higher-performing, institutional-grade asset management, recordkeeping and custodial services. Best of all, the administrative workload and fiduciary risk of plan administration are outsourced – you make contributions, Blue Pier does the rest.

There are two key features Blue Pier offers that Pooled Employer Plans don’t:  

• Blue Pier members don’t have to select investments, which are managed under an investment policy established by Blue Pier’s Board of Trustees by RBC Global Asset Management – Canada’s largest asset manager. Blue Pier’s institutional, administrator-directed investment-management approach mirrors that of the largest, most successful pension plans in Canada – e.g. HOOPP, OTTPP, OMERS – while reducing work, risk, and cost for Blue Pier’s participating employers and members.
• Single-employer 401(k) plans and Pooled Employer Plans don’t pay pensions. With Blue Pier, members receive their retirement income directly from the Blue Pier plan for as long as they want to, with no cost or risk to employers. This provides peace of mind for retiring employees and increases the value of Blue Pier as a total compensation offering.

Blue Pier’s Multi-Employer, Collective DC Plan

A multi-employer, collective DC pension plan, Blue Pier’s Pension Plan as a Service leverages a pension-delivery model that is fast becoming the global standard for pensions. The economic principle of “comparative advantage” dictates that businesses and other enterprises should focus on doing what they do best and outsource the rest.

Blue Pier makes that possible. Blue Pier takes care of investment management, regulatory compliance, record-keeping, member communications and benefit payments. You enrol employees, make contributions, and report them employees’ T4 slips (the Canadian version of Form W2) and we do the rest. You can be up and running with your own, customized workplace pension program in eight weeks.

Just like a Pooled Employer Plan (PEP) in the US, Blue Pier’s multi-employer, collective DC plan combines plans from multiple employers into a large, efficient asset pool. This delivers economies of scale and better results through lower costs and the potential for better investment returns.

Even small differences in investment returns and fees matter a lot. As a rule of thumb, a one percent difference in returns or fees over a career will mean a 20 percent difference in retirement income. With Blue Pier’s collective DC design, you can deliver better retirement outcomes to your employees, for less.

Which Canada pension plan is right for your business?

Offering a group retirement plan is a good idea for all employers in Canada and in the US. So which kind of plan should you choose?

Like most employers, you probably want to avoid the risk and complexity of sponsoring a DB pension plan, not to mention the lack of flexibility to change the design and contribution rates. Other than DB, your options will be single-employer plans (DC / Group RRSP / DPSP) or Blue Pier’s collective DC, multi-employer Pension Plan as a Service.

While some large employers may be comfortable with the compliance risks and workload that comes with single-employer plans, the vast majority of employers are small – 100 or fewer employees – and don’t have the expertise or the resources to take on plan management.

Regardless what group retirement plan type you choose, you’ll need to work with a Canadian provider to set it up. When choosing a provider, key questions to ask providers will be the following:

• How long does it take to set up and what are the costs?
• What are the ongoing costs and are they flexible to accommodate my budget?
• What will be my workload and risks?
• Who does plan administration?
• What’s my commitment? Can I change to a different plan type or design after I’ve started?

The Blue Pier advantage: more than a 401(k) and a Pooled Employer Plan Canadian equivalent

If you’re like most employers, a collective solution like Blue Pier will probably work best and offers a number of advantages over single-employer DC plans, Group RRSP and DPSPs, for you and your team:

• Low cost: All employers get low fees
• Low risk: Blue Pier takes care of the compliance work for you
• Tax-effective: Less payroll taxes for you, more saving room for your employees
• Tax-free portability: We want you to stay, but you don’t have to
• Customized, flexible design: You decide the contributions and who participates
• Strong creditor protection: Because your employees deserve that
• Institutional investment management: Because prudent, cost-effective asset management is what every good pension plan delivers

Blue Pier is for any employer in Canada, and it’s the best solution for US employers who need to set up a 401(k) equivalent or join the equivalent of a Pooled Employer Plan in Canada.

Contact Blue Pier today and discover how employers are leveraging our pension planning service to attract and retain top talent. Reach out to learn more about the Blue Pier™ Pension Plan as a Service and get a free consultation.

The Blue Pier Retirement Plan is a pension plan registered with the Financial Services Regulatory Authority of Ontario. Blue Pier™ is a registered trademark. © Blue Pier™ 2023. All rights reserved.

References 

1. Paychex – Employer Benefits of 401(k) Plans
2. Morgan Stanley – Leverage a 401(k) to Retain and Attract Top Talent
3. Ropes & Gray – Pooled Employer Plans (“PEPs”): Putting a little PEP in a 401k retirement plan could help to protect your Portfolio Companies
4. Employee Fiduciary – Pooled vs. Single-Employer 401(k) Plans – Are PEPs for You?
   https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/ic77-1/deferred-profit-sharing-plans.html