Federal budget ups pension plan limits

Ottawa’s 2003 budget increases limits for tax-assisted retirement savings plans, as well as proposing changes to the employment insurance rate-setting process and announcing further funding for health care.

For HR professionals, there are a number of implications arising from these proposals. From a pension perspective, HR managers will need to consider the impact on plan costs, supplemental plan funding or security arrangements, DC RPP payout options, employee communication and plan administration. EI premium costs for 2004 will be reduced, and employers will need to consider how to handle the new compassionate family care provisions. And some help may be on the way in managing the costs of employer-sponsored health-care plans.

Tax-assisted retirement savings limits

The budget increases annual contribution limits for defined contribution registered pension plans (DC RPPs), registered retirement savings plans (RRSPs) and deferred profit sharing plans (DPSPs). There are also corresponding increases in the annual benefit limit for defined benefit (DB) RPPs from $1,722 per year of service to $1,833 for 2004 and $2,000 for 2005.

Until now, DB plan limits have been the most troublesome and effectively capped pension benefits for anyone making more than $86,100 a year. The budget proposals represent the first substantive increase since 1976. Arguably, the changes will make DB plans slightly more attractive for plan members since the changes allow members to increase benefits for past years of service while changes to DC plans will only apply on service after the changes take effect.

While the changes are good news for plan members they could represent new administration and contribution costs for plan sponsors, as well as new communication challenges. The specific impact of the change to these limits on an employer's retirement plans will depend on each plan’s design, funded status and demographics.

DB pensions

Since increases in the DB limit will be retroactive, employees will see an unexpected increase in benefits. Typically, such an increase was met with a reduction in RRSP contribution room via a past service pension adjustment (PSPA). However, the budget proposes to modify the PSPA rules to provide an exclusion for benefit increases arising directly as a result of increases to the DB limit. Employees getting an increase in benefits will not erode their RRSP room.

It is also expected that the higher DB limit will only apply to employees who retire on or after budget day. If so, pensions payable to existing retirees whose pensions have been capped at the current DB limit could not be adjusted to take advantage of the higher limit.

Depending on how an employer’s DB plan document is worded, the increase in the DB limit may or may not apply automatically. Many plan documents refer to the current $1,722 limit “or such other amount as may be adopted” by the tax legislation. If left unchanged, such wording would automatically incorporate the higher DB limit. Depending on each plan’s circumstances, this could lead to higher contributions to cover increased benefits.

Supplemental plans

For plan sponsors that provide benefit coverage in excess of the DB limit through a supplemental plan, the higher limit will shift liabilities from the supplemental plan back to the registered plan since more employees, or at least a greater portion of employee pensions, will fall under the registered plan. In those cases employers may wish to review funding or security arrangements (if any) for the supplemental plan. If, for example, a sponsor was funding a supplemental plan to cover $5 million in liabilities, budget changes may drop the liabilities in the supplemental plan to $3 million. In some cases the changes may take the pressure off companies to provide supplemental plans.

DC RPPs

In situations where employers capped contributions to a DC arrangement at the tax sheltered limits, the proposals will increase the cost for sponsors since greater contributions will now be going into the registered DC vehicle.

Similarly, if the plan was being topped up, but through an unfunded account, the benefit increases will represent a new cash cost (as opposed to an accounting cost). However, if the top-up arrangement is funded, the cost increase for the registered plan will be offset by a cost reduction for the top-up plan.

For employers considering a conversion of a retirement plan from a DC to a DB design (an increasingly popular idea as aging boomers look for more pension stability and security), the retroactive nature of the increase to the DB limits means members will be entitled to the increased benefits for all past years of service.

Plan administration, communication

The higher limits raise communication issues. Employers should consider how best to communicate the impact of the new limits to members. Payroll and pension administration systems will need to be updated to reflect the new limits.

Further changes may be coming

The government acknowledged that Canada’s tax system should be more conducive to saving for retirement and said it will consider improvements. In particular, it will examine whether U.S.-style tax pre-paid savings plans (TPSPs) could be an appropriate savings vehicle to introduce.

In a TPSP, contributions are not deductible but investment returns and plan withdrawals are not taxable. This would represent a welcome enhancement to the Canadian retirement savings regime. In addition to supplementing retirement income, it may also be a useful vehicle for pre-funding post-retirement benefits.

DC RPP settlement options

Currently, at retirement, members of DC plans must transfer their savings into a life annuity or another tax-sheltered vehicle such as an RRSP or Registered Retirement Income Fund (RRIF).

Now, members will no longer be forced to create their own retirement accounts. They will have the option of leaving savings in the employer’s plan — with benefits paid out in a RRIF-type arrangement — to take advantage of the lower investment management fees typically charged on employer-sponsored pension plans.

The budget proposes to permit the transfer of funds back into a DC plan by former members who had previously transferred their DC accounts to a RRIF.

These measures will apply starting in 2004. They raise a number of plan administration concerns, such as:

•How this will be interpreted by the pension standards regulators? Will it be optional or mandatory for DC plans to offer RRIF-type payments to retiring members?

•Plan sponsors will need to consider the administration implications of monitoring minimum and maximum withdrawal amounts.

•Employers should also consider the communication, education and governance implications of having retirees continue to participate in the DC plan.

Maximum pension accrual rate for firefighters

The budget proposes changes to help firefighters save for retirement at a faster rate than usual. In all DB plans integrated with the Canada or Quebec Pension Plan (the typical arrangement for firefighters) the maximum accrual rate will increase to 2.33 per cent per year of service from the current two per cent. This was approved in principle by the House of Commons in 2002, and it will now be up to the firefighters to negotiate the extra benefits with the municipalities. It remains to be seen whether other public safety occupations (or, indeed, unions representing employees in physically demanding jobs) will lobby for similar treatment. In the absence of similar changes for other employee groups, it is possible that some unions will still demand higher accrual rates, which would then have to be provided through a supplemental plan.

Employment Insurance

Employment Insurance (EI) premiums are currently 2.10 per cent for employees and 2.94 per cent for employers. The budget proposes to reduce the EI premium rate for 2004 to 1.98 per cent and 2.77 per cent of insurable earnings. EI premiums have exceeded EI payments for several years resulting in a surplus. It’s expected the reduced rate will generate premium revenues equal to projected program costs for 2004.

The government will also consult with stakeholders on a new permanent EI rate-setting regime for 2005 and future years that would offer greater accountability and transparency. Most importantly the possible changes would effectively ensure the EI premium revenues would correspond to expected program costs, thus preventing any future accumulation of program surplus.

Employers will welcome the greater accountability suggested by these proposals. Interested parties may provide submissions to the government until June 30, 2003.

The budget also proposes an EI compassionate family care leave benefit, effective Jan. 4, 2004. This will provide benefits for a six-week period to care for a gravely ill or dying child, parent or spouse. The Canada Labour Code will be amended so that permanent employees working in federally regulated businesses can take the leave. This will likely place pressure on the provinces to follow suit.

Health care

The budget confirms increased health-care funding of $34.8 billion over the next five years. This includes $16 billion for a Health Reform Fund covering primary health care, home care and catastrophic drug coverage. The Health Reform Fund may play some role in managing the costs of employer-provided health-care benefits. Although the details of the fund are not specified, depending on the terms of provincial programs, assistance for home care and drug coverage could reduce some of the costs of employer programs.

Automobile benefits and expenses

The budget proposes to improve the taxable automobile benefit provisions by reducing the standby charge for employees with company cars who drive primarily for business purposes, starting in 2003. Currently, the standby charge is 2 per cent of the cost of the vehicle (or two-thirds of the lease payment) per month.

The current standby charge is reduced if the employee’s personal use is less than 12,000 kilometres per year and if all, or almost all (generally 90 per cent) of the driving is for business purposes. The budget proposes to allow the reduced standby charge to apply to the extent the annual personal use is less than 20,000 kilometres and the automobile is used primarily (more than 50 per cent) for business purposes.

Medical expense tax credit

It is also proposed to expand the list of eligible expenses for purposes of the medical expense tax credit to include:

•real-time captioning for persons with a speech or hearing impediment;

•note-taking services for individuals with mental or physical impairments; and

•the incremental cost associated with the purchase of gluten-free food products for individuals with celiac disease who require a gluten-free diet.

These changes will take effect for the 2003 tax year. The administration of group benefit plans that have a health care spending account will need to be revised to reflect these changes. Employers may also wish to consider extending such coverage under their insured group benefit plans.

C. Ian Genno is a consulting actuary and principal in the Toronto office of Towers Perrin. He can be reached at (416) 960-2700. This article was prepared with the assistance of colleagues in the Toronto office.

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