TAX ON PENSION

 

There are two categories of pension:

  • State pension, and
  • Private pension.

A resident individual can have a state pension, private pension, or both. 

 

Pensions can also be divided into two types: -

  • A defined benefit plan - a DB plan specifies exactly how much retirement income employees will get once they retire;
  • A defined contribution plan - a DC plan only specifies what each party – the employer and employee – contributes to an employee's retirement account. 

The basic difference is what each plan promises its participants

 

Country rules - Canada, the United Kingdom

 

Tax relating to pension in the U.K. normally include the following: -

1. Contribution to the pension,

2. Income earned from the assets in the pension,

3. Distribution received from the pension.

Broadly speaking:

  • income that is paid into a private pension is exempt from income tax;

  • income earned from investments within the pension fund is also exempt (and capital gains are exempt from capital gains tax);

  • money received from the pension is taxed.

This is often referred to as "exempt-exempt-taxed" or "EET" treatment. 

 

Comparison - UK and Canada

 

Private pensions

In the United Kingdom

In Canada

In the USA

Self-invested Personal Pension (SIPP) for employees

 

401k plan

Small Self-Administered Scheme (SSAS) for self-employed or owner-directors

Registered Retirement Savings Plan (RRSP)

401k plan

 

Comparison – <Exempt-Exempt-Taxed, the E-E-T route>

 

Contribution

Earning

Withdrawal

Withdrawal age

Canada

(RRSP)

Tax-exempted, subject to the limit of 18% of reported income or CAD $27,830 (2020) 

Tax-exempted

Taxed

at age 71

The U.K.

(SSAS)

Tax-exempted, subject to limit GBP 40,000 per year

Tax-exempted

Taxed

at age 75

The U.S.

401k plan

Tax-exempted, subject to the limit of $20,500 under age 50 and over, $27,000 [*]  

Tax-exempted

Taxed

at age 72

[*] 2023 adjustment

401(k) plan limits

2022

2023

Change

Maximum salary deferral for workers

$20,500

$22,500

+$2,000

Catch-up contributions for workers 50 and older

$6,500

$7,500

+$1,000

Total contribution limit

$61,000

$66,000

+$5,000

Total contribution limit, plus catch-up contribution

$67,500

$73,500

+$6,000

 

 

Savings Account Comparison - <Taxed-Exempt-Exempt, the T-E-E route>

 

Contribution

Income earned and gains after contribution

Distribution/withdrawal

Canada

(TFSA)

Taxed, contribution

limited to CAD $6,000 per year

Tax-exempted

Tax-exempted

The U. K.

(ISA)

Taxed, limited to GBP20,000 per year

Tax-exempted

Tax-exempted

The U.S.

(Roth IRA)

Taxed, limited to US$6,000 (or 7,000 for those aged 50 or above)

Tax-exempted

Tax-exempted

TFSA = Tax-free savings account; ISA = Individual savings account; Roth IRA = Roth individual retirement arrangement

 

Recommended articles:

  • Taxation of private pensions explained [read]
  • 401(k) vs. RRSP: What’s the Difference? [read]