Changes to pension legislation makes it easier for Canadians to work longer
The Honourable Jim Flaherty, Minister of Finance, tabled his second federal budget on March 18, 2007. Among other announcements, the budget includes proposals that begin to address potential workforce shortages and aging population issues faced by employers.
Phased retirement opportunities
The budget includes a proposal to encourage retirement-eligible workers to stay on the job by allowing phased retirement. This proposal — if complementary amendments are enacted to provincial pension legislation — could be a meaningful step in helping address an impending labour and skills shortage faced by employers in many sectors of the economy.
The early retirement benefits of many pension plans were designed decades ago to help employers encourage mature and expensive workers to retire, and be replaced by younger and cheaper employees who were readily available.
But employers in many sectors of the economy are projecting shortages in the workforce. This, combined with reduced physical demands in many jobs due to improved technology and continuing improvements in life expectancies, is prompting many employers to re-examine early retirement policies. Much of the current or impending labour and skills shortage could be eased by encouraging older, productive employees to extend their careers.
But the early retirement benefits of many pension plans are so generous they act as a disincentive to continued employment. An employee who opts to keep working may not earn enough after-tax income to make the effort worthwhile. Employees may also feel they’re “leaving money on the table” if they don’t take advantage of the early retirement opportunities their pension plans provide.
The Income Tax Act also acts as a barrier to continued employment. Under current tax rules, members of a defined benefit (DB) registered pension plan (RPP) who are eligible to retire must choose between staying on the job in order to earn further pensionable service or retiring in order to start to collect the pension benefits they’ve already earned. In many cases, individuals with significant pensionable service simply conclude they’re better off retiring, particularly if the DB plan offers an unreduced early retirement benefit. Upon retirement, some individuals then take another job elsewhere — often with a competitor.
Under current legislation, there are very few ways to get around this. The employee can retire and then be rehired at a later date with defined contribution (DC) pension coverage for future service. Or the employer can use the existing phased-retirement provisions available in Quebec, Manitoba and Alberta (which are complicated, involve transferring a partial commuted value from the pension plan and offer limited opportunity for higher-paid employees). Or, as noted above, individuals can simply retire, and then take a position with a competing employer — in which case the Income Tax Act places no restrictions on the ability to collect and earn DB pension benefits simultaneously.
DC plans are not subject to the same restrictions. The Income Tax Act does not prevent an individual from starting to draw funds from a DC plan while still employed and earning further contributions.
Phased retirement proposals
Under the budget proposals, starting in 2008, employers that sponsor DB plans (other than “designated plans” that cover a small group of highly-paid employees or employees who are connected with the employer) will be allowed to give plan members the option to receive partial pension payments while continuing to work and earn further pension benefits.
Members of a DB plan who are at least 55 and entitled to an unreduced pension will be allowed to receive up to 60 per cent of their accrued pension while continuing to earn current service benefits. No reduction in work time or salary would be required. Pre-65 “bridge” benefits could be paid even if lifetime retirement benefits have not yet commenced.
These proposed rules offer more flexibility to employers than the rules already introduced or proposed in Quebec, Manitoba and Alberta. However, the federal government will need to work through a consultation process on the technical aspects of these proposals in 2007 before enacting the necessary amendments to the Income Tax Act. Other provincial pension legislation may also have to be amended before these phased retirement proposals can be implemented by employers. The government has indicated that the federal Pension Benefits Standards Act — governing pension benefits of employees working in federally regulated industries such as banking and interprovincial transportation — will be amended to operate in concert with the budget’s phased retirement proposals.
The budget proposals favour public-sector plans and other DB plans that offer generous unreduced early retirement benefits. While the employers that sponsor such plans are the ones that are currently at greatest risk of losing talented mature workers — and therefore are most in need of the opportunity created by the budget proposals — this will be of no benefit to the many employers that sponsor DB plans that do not offer unreduced early retirement subsidies. A better approach might be a broader application of phased retirement rules to assist sponsors of DB plans regardless of the type of early retirement benefits offered by the plan.
It is also likely that any phased retirement opportunity will need to be offered to eligible employees in a manner that does not give rise to discrimination complaints. Provincial pension rules generally require an even-handed approach to benefit enhancements and retirement opportunities. Offering phased retirement to one employee, but not to another in the same position, may give rise to complaints. In any situation involving phased retirement opportunities, appropriate performance management processes must be in place to ensure qualified retirement-eligible workers are encouraged to stay while others are afforded an opportunity to retire with dignity.
What steps should HR managers take? While it’s still early to begin serious work to act on these proposals, now may be a good time to:
•review the early retirement incentives already built into pension plans;
•assess the degree of exposure to an aging employee population and projected shortages in the workforce;
•consider whether rewards programs support — or compete with — business strategies;
•consider what strategies are already available to help address this; and
•as the government’s consultation process moves forward during 2007, assess how the phased retirement proposals could help employers retain the necessary talent and experience.
Retirement savings age limit
Effective 2007, the budget proposes to raise, from 69 to 71, the age at which taxpayers must begin to receive payments from retirement savings held in RPPs, registered retirement savings plans (RRSPs), registered retirement income funds (RRIFs) and deferred profit sharing plans (DPSPs). Special provisions are made for members who turn 70 or 71 in 2007.
This is a positive announcement, which restores the retirement savings maturation age to pre-1997 limits and provides older Canadians with additional flexibility in managing their retirement income.
This will require plan sponsors and financial institutions to update their plan texts and contracts. Existing registered plan annuities can be amended to reflect the new age limit. As was the case when the age limit was reduced from 71 to 69 in the 1996 federal budget, it is possible that the Canada Revenue Agency will issue a standard form to enable employers to adopt the necessary changes to pension plan texts quickly and easily. (Of course, allowing continued accrual in a pension plan between ages 69 and 71 is optional for the plan sponsor.)
Employers should also consider communication initiatives for retirees who may benefit from the increased flexibility offered by this proposal, as well as any employees working beyond age 69 who may be able to accrue pension coverage for a longer period.
Pension income splitting
The budget restates an announcement made by the Minister of Finance in October 2006 that, beginning in 2007, couples will be permitted to split certain kinds of pension income for tax purposes. This measure will reduce the total tax payable by couples where one individual receives significantly higher income than the other.
It is not yet known exactly how it will be administered and reported on personal tax returns, or how the withholding tax requirements for payers of pension benefits will be affected.
Qualified investments for registered plans
The tax rules for qualified investments for RPPs, RRSPs and other registered plans are being updated. Debt instruments with an investment-grade rating, that are part of a minimum $25 million issuance, will now qualify.
The list of qualified investments will also be streamlined and updated through a new system of recognizing stock exchanges, which will allow the tax rules to respond to evolving market needs.
These proposals will enable investments in “maple bonds” (Canadian-dollar denominated bonds issued by foreign entities), as well as foreign-listed trusts and partnership units, providing opportunities for additional diversification.
These proposals, if enacted, will be effective retroactively to March 19, 2007. Employers that sponsor DB and DC plans should discuss this further with their investment advisors.
Canada-U.S. tax treaty
Canada and the United States have agreed in principle on the major elements of an updated tax treaty, with formal negotiations expected to conclude soon. The changes are intended to support cross-border labour mobility, with further harmonization of the tax treatment of pension contributions in the two countries and new rules to clarify the treatment of stock options.
No further details were provided in the budget documents. Employers that transfer employees between Canada and the U.S. will need to monitor this as further details are announced.
Health care initiatives
The federal government proposes to rebalance the Canada Health Transfer to an equal per capita basis when the current arrangement expires in 2014. The budget speech affirms the government’s commitment to a universal health care system and notes the need for electronic health records to improve the efficiency and quality of care.
The government is spending $300 million for cervical cancer immunization programs. The latter initiative in particular would be welcome news for employers who may have been considering whether to cover this expensive preventative therapy.
Ian Genno is a Principal of Towers Perrin, located in the firm’s Toronto office. This article was prepared with the assistance of colleagues in his office.
What to do
Five steps to take in wake of budget
On the immediate horizon, employers will need to:
• assess the potential benefits of the government’s phased retirement proposals, if an existing DB pension plan offers unreduced early retirement opportunities, and consider what other strategies could be adopted to address impending labour and skills shortages;
• amend pension and retirement savings plan provisions to reflect the change to the retirement savings age limit, once the necessary legislation is adopted, and undertake the associated communication to plan members;
• monitor proposals for how withholding tax requirements for pension benefit payments will be affected;
• discuss the expanded range of qualified pension and retirement plan investments with their investment advisors; and
• watch for further developments on the Canada-U.S. tax treaty.
Phased retirement opportunities
The budget includes a proposal to encourage retirement-eligible workers to stay on the job by allowing phased retirement. This proposal — if complementary amendments are enacted to provincial pension legislation — could be a meaningful step in helping address an impending labour and skills shortage faced by employers in many sectors of the economy.
The early retirement benefits of many pension plans were designed decades ago to help employers encourage mature and expensive workers to retire, and be replaced by younger and cheaper employees who were readily available.
But employers in many sectors of the economy are projecting shortages in the workforce. This, combined with reduced physical demands in many jobs due to improved technology and continuing improvements in life expectancies, is prompting many employers to re-examine early retirement policies. Much of the current or impending labour and skills shortage could be eased by encouraging older, productive employees to extend their careers.
But the early retirement benefits of many pension plans are so generous they act as a disincentive to continued employment. An employee who opts to keep working may not earn enough after-tax income to make the effort worthwhile. Employees may also feel they’re “leaving money on the table” if they don’t take advantage of the early retirement opportunities their pension plans provide.
The Income Tax Act also acts as a barrier to continued employment. Under current tax rules, members of a defined benefit (DB) registered pension plan (RPP) who are eligible to retire must choose between staying on the job in order to earn further pensionable service or retiring in order to start to collect the pension benefits they’ve already earned. In many cases, individuals with significant pensionable service simply conclude they’re better off retiring, particularly if the DB plan offers an unreduced early retirement benefit. Upon retirement, some individuals then take another job elsewhere — often with a competitor.
Under current legislation, there are very few ways to get around this. The employee can retire and then be rehired at a later date with defined contribution (DC) pension coverage for future service. Or the employer can use the existing phased-retirement provisions available in Quebec, Manitoba and Alberta (which are complicated, involve transferring a partial commuted value from the pension plan and offer limited opportunity for higher-paid employees). Or, as noted above, individuals can simply retire, and then take a position with a competing employer — in which case the Income Tax Act places no restrictions on the ability to collect and earn DB pension benefits simultaneously.
DC plans are not subject to the same restrictions. The Income Tax Act does not prevent an individual from starting to draw funds from a DC plan while still employed and earning further contributions.
Phased retirement proposals
Under the budget proposals, starting in 2008, employers that sponsor DB plans (other than “designated plans” that cover a small group of highly-paid employees or employees who are connected with the employer) will be allowed to give plan members the option to receive partial pension payments while continuing to work and earn further pension benefits.
Members of a DB plan who are at least 55 and entitled to an unreduced pension will be allowed to receive up to 60 per cent of their accrued pension while continuing to earn current service benefits. No reduction in work time or salary would be required. Pre-65 “bridge” benefits could be paid even if lifetime retirement benefits have not yet commenced.
These proposed rules offer more flexibility to employers than the rules already introduced or proposed in Quebec, Manitoba and Alberta. However, the federal government will need to work through a consultation process on the technical aspects of these proposals in 2007 before enacting the necessary amendments to the Income Tax Act. Other provincial pension legislation may also have to be amended before these phased retirement proposals can be implemented by employers. The government has indicated that the federal Pension Benefits Standards Act — governing pension benefits of employees working in federally regulated industries such as banking and interprovincial transportation — will be amended to operate in concert with the budget’s phased retirement proposals.
The budget proposals favour public-sector plans and other DB plans that offer generous unreduced early retirement benefits. While the employers that sponsor such plans are the ones that are currently at greatest risk of losing talented mature workers — and therefore are most in need of the opportunity created by the budget proposals — this will be of no benefit to the many employers that sponsor DB plans that do not offer unreduced early retirement subsidies. A better approach might be a broader application of phased retirement rules to assist sponsors of DB plans regardless of the type of early retirement benefits offered by the plan.
It is also likely that any phased retirement opportunity will need to be offered to eligible employees in a manner that does not give rise to discrimination complaints. Provincial pension rules generally require an even-handed approach to benefit enhancements and retirement opportunities. Offering phased retirement to one employee, but not to another in the same position, may give rise to complaints. In any situation involving phased retirement opportunities, appropriate performance management processes must be in place to ensure qualified retirement-eligible workers are encouraged to stay while others are afforded an opportunity to retire with dignity.
What steps should HR managers take? While it’s still early to begin serious work to act on these proposals, now may be a good time to:
•review the early retirement incentives already built into pension plans;
•assess the degree of exposure to an aging employee population and projected shortages in the workforce;
•consider whether rewards programs support — or compete with — business strategies;
•consider what strategies are already available to help address this; and
•as the government’s consultation process moves forward during 2007, assess how the phased retirement proposals could help employers retain the necessary talent and experience.
Retirement savings age limit
Effective 2007, the budget proposes to raise, from 69 to 71, the age at which taxpayers must begin to receive payments from retirement savings held in RPPs, registered retirement savings plans (RRSPs), registered retirement income funds (RRIFs) and deferred profit sharing plans (DPSPs). Special provisions are made for members who turn 70 or 71 in 2007.
This is a positive announcement, which restores the retirement savings maturation age to pre-1997 limits and provides older Canadians with additional flexibility in managing their retirement income.
This will require plan sponsors and financial institutions to update their plan texts and contracts. Existing registered plan annuities can be amended to reflect the new age limit. As was the case when the age limit was reduced from 71 to 69 in the 1996 federal budget, it is possible that the Canada Revenue Agency will issue a standard form to enable employers to adopt the necessary changes to pension plan texts quickly and easily. (Of course, allowing continued accrual in a pension plan between ages 69 and 71 is optional for the plan sponsor.)
Employers should also consider communication initiatives for retirees who may benefit from the increased flexibility offered by this proposal, as well as any employees working beyond age 69 who may be able to accrue pension coverage for a longer period.
Pension income splitting
The budget restates an announcement made by the Minister of Finance in October 2006 that, beginning in 2007, couples will be permitted to split certain kinds of pension income for tax purposes. This measure will reduce the total tax payable by couples where one individual receives significantly higher income than the other.
It is not yet known exactly how it will be administered and reported on personal tax returns, or how the withholding tax requirements for payers of pension benefits will be affected.
Qualified investments for registered plans
The tax rules for qualified investments for RPPs, RRSPs and other registered plans are being updated. Debt instruments with an investment-grade rating, that are part of a minimum $25 million issuance, will now qualify.
The list of qualified investments will also be streamlined and updated through a new system of recognizing stock exchanges, which will allow the tax rules to respond to evolving market needs.
These proposals will enable investments in “maple bonds” (Canadian-dollar denominated bonds issued by foreign entities), as well as foreign-listed trusts and partnership units, providing opportunities for additional diversification.
These proposals, if enacted, will be effective retroactively to March 19, 2007. Employers that sponsor DB and DC plans should discuss this further with their investment advisors.
Canada-U.S. tax treaty
Canada and the United States have agreed in principle on the major elements of an updated tax treaty, with formal negotiations expected to conclude soon. The changes are intended to support cross-border labour mobility, with further harmonization of the tax treatment of pension contributions in the two countries and new rules to clarify the treatment of stock options.
No further details were provided in the budget documents. Employers that transfer employees between Canada and the U.S. will need to monitor this as further details are announced.
Health care initiatives
The federal government proposes to rebalance the Canada Health Transfer to an equal per capita basis when the current arrangement expires in 2014. The budget speech affirms the government’s commitment to a universal health care system and notes the need for electronic health records to improve the efficiency and quality of care.
The government is spending $300 million for cervical cancer immunization programs. The latter initiative in particular would be welcome news for employers who may have been considering whether to cover this expensive preventative therapy.
Ian Genno is a Principal of Towers Perrin, located in the firm’s Toronto office. This article was prepared with the assistance of colleagues in his office.
What to do
Five steps to take in wake of budget
On the immediate horizon, employers will need to:
• assess the potential benefits of the government’s phased retirement proposals, if an existing DB pension plan offers unreduced early retirement opportunities, and consider what other strategies could be adopted to address impending labour and skills shortages;
• amend pension and retirement savings plan provisions to reflect the change to the retirement savings age limit, once the necessary legislation is adopted, and undertake the associated communication to plan members;
• monitor proposals for how withholding tax requirements for pension benefit payments will be affected;
• discuss the expanded range of qualified pension and retirement plan investments with their investment advisors; and
• watch for further developments on the Canada-U.S. tax treaty.
