On Feb. 23, Ralph Goodale, federal Minister of Finance, tabled his second budget. The budget contains a number of positive announcements relating to employers’ HR interests — in particular, the elimination of the foreign content limit and an increase in the contribution and maximum benefit limits for registered retirement savings and pension plans. (The following is an abridged version of the 2005 budget review. For the full analysis go to www.hrreporter.com click on “Advanced Search” and enter article # 3706 or click on the related articles link below.)
Elimination of the foreign content limit
The budget eliminates the 30-per-cent foreign content limit for registered retirement savings and pension plans, effective for 2005 and subsequent years. Registered plan assets may now be invested in foreign investments without limit.
This allows pension funds to create internationally diversified investment portfolios and is welcome news to sponsors that wish to increase foreign content. The Canadian equity market represents less than three per cent of the world’s market capitalization. To invest in a well-diversified portfolio of leading global corporations, Canadian investors must look outside Canada. As plan sponsors increase the proportion of their funds invested outside Canada, they will need to focus more on managing the currency risk inherent in such investments.
Eliminating the foreign content limit will permit plan sponsors to do away with complex and expensive devices previously used to get around these limits. Synthetic foreign equity funds, stacked pooled fund trusts, clone funds and total return swaps all had a cost associated with them. Eliminating the cost of these devices (more than one per cent per year in the case of some funds) will improve returns from these investments. Eliminating the foreign content limit will also do away with the cost of monitoring for Income Tax Act compliance.
Increases to contribution and maximum benefit limits
The budget announced modest, but nonetheless welcome, increases in the registered plan limits beyond the limits already announced in the 2003 budget. For defined benefit registered pension plans (DB RPPs), defined contribution registered pension plans (DC RPPs), and registered retirement savings plans (RRSPs), see table online.
The budget proposals represent a nine- to 13-per-cent increase in retirement savings room, assuming annual average wage growth in the range of two to three per cent for the next several years.
For HR managers, the implications of the increased registered plan limits will depend on each plan’s design.
DB registered pension plans: For many DB RPPs, plan documentation automatically reflects any future changes to legislated limits. The new limits increase costs for employers that sponsor plans structured this way. (The same is true for employers with plans that do not automatically incorporate the higher limits and have to amend plans to reflect new limits.)
DC registered pension plans, RRSPs and deferred profit sharing plans: In situations where employers cap contributions to a DC arrangement at the tax sheltering limits — or top-up DC amounts in excess of the tax sheltering limits through an unfunded (or notional) DC account — the proposals will increase the cash cost, since more will now be funded through the registered DC vehicle. 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.
Supplemental employee retirement plans (SERPs): The increased limits allow employers to shift pension liabilities and costs from SERPs to registered plans. Employers that have set up SERP funding or security arrangements may wish to review those arrangements, in light of the increased limits, as SERP assets may now be more than required. For employers that do not fund or otherwise secure the SERP, the increased limits may, in some cases, reduce the pressure to do so.
The higher limits also raise communication issues. Employers should consider how best to communicate the impact of the new limits to plan members. Payroll and pension systems will also need to be updated to reflect the new limits.
Possible changes to the Canada Pension Plan (CPP)
The 21st Actuarial Report on the Canada Pension Plan, tabled in Parliament in December 2004, states that the CPP is financially sustainable for at least the next 75 years.
As part of the next triennial review of the CPP, the budget indicates that the federal government, in consultation with the provinces, will consider a number of possible changes to the CPP, including adjustments for postponed retirement and the requirement to stop working as a condition for early pension commencement, similar to discussions recently initiated by the Quebec government regarding the Quebec Pension Plan.
The budget documents note that there have been significant changes in the work and retirement patterns of Canadians since inception of the CPP in 1966, including “taking varied paths to retirement.” The next triennial review will consider changes to reflect these developments. This review may include measures such as phased retirement. HR managers should watch for further developments following the next review.
A new approach for EI rate-setting
The government proposes to introduce a new permanent rate-setting mechanism for Employment Insurance based on principles originally described in the 2003 budget:
•The expected premium revenue should correspond to the expected program costs (the premium rate should be set at a break-even level).
•Premium rates should be set transparently, on the basis of independent expert advice.
•The premium rate-setting methodology should mitigate the impact of the business cycle.
•Premium rates should be relatively stable over time.
The new rate-setting mechanism is now expected to be in place in time to set the rate for 2006. To provide rate stability in the transition period, the government has said the EI rate for 2006 and 2007 will not exceed the current rates of $1.95 for employees and $2.73 for employers, per $100 of insurable earnings. Future premium increases will be limited to 15 cents per year for employees and 21 cents per year for employers.
Special pension provisions for public safety occupations
The budget proposes to extend the special maximum pension and early retirement rules to a broader range of public safety occupations, effective Jan. 1, 2005.
Paramedics will be added to the list of occupations (which includes commercial airline pilots, air traffic controllers, firefighters, police officers and corrections officers) for which employers can provide unreduced early retirement benefits at an earlier age than the tax rules normally allow.
And, to conclude …
The government confirmed $41.3 billion of new federal health-care funding over 10 years, as previously announced at the September 2004 first ministers’ meeting. This increased funding may indirectly benefit employers that sponsor health-care plans.
From a pension perspective, a continuing low interest rate environment will mean that funding and accounting costs for defined benefit pension plan sponsors will remain relatively high, investment returns for those members of defined contribution plans who choose to invest in term deposits and GICs will remain modest, and pension payments for those members of defined contribution plans who choose to buy annuities upon retirement will remain relatively low. The attractiveness of both DB and DC plans suffers — albeit in different ways — in a low interest rate environment.
C. Ian Genno is a consulting actuary and principal in the Toronto office of Towers Perrin. This article was prepared with the assistance of colleagues in the Toronto office.