Remove or raise contribution limit on pensions: C.D. Howe

Institute says decline of DB plans caused largely by laws that foster underfunding by sponsors
By Sarah Dobson
||Last Updated: 07/14/2008

Limits on income-tax contributions should be removed or raised to help with the underfunding challenges of defined benefit (DB) pension plans in Canada. That’s according to the C.D. Howe Institute paper Lifting the Lid on Pension Funding, which says the decline of DB plans is largely caused by laws and regulations that foster underfunding by sponsors.

The Income Tax Act’s 10-per-cent limit is meant to prevent companies from making pensions contributions, that are tax deductible, to reduce taxable profits. But this benefit is marginal because: businesses prefer to reinvest earnings or pay them out as dividends; pension funds attract tax when distributed or withdrawn; and regulations prevent deliberate over-funding of designated plans, say authors Robin Banerjee, policy analyst, and William Robson, president and chief executive officer, both at C.D. Howe in Toronto.

In addition, “limiting contributions in good times stops plan sponsors saving in fat years to cushion against lean ones,” they say. “Having the flexibility to time investments can also help firms buy assets when they are cheaper and enjoy longer compounding periods.”

And most DB pension plans do not match assets to liabilities because pension plans have long horizons so they can tolerate short-term volatility.

As for limiting contributions when plans are in surplus, the authors suggest this “induces sponsors to inflate the size of reported liabilities so the cap does not constrain funding — a practice that perverts the cause of meaningful reporting — or stops companies from pursuing consistent contribution strategies as interest rates and asset markets fluctuate.”

The more sponsor contributions are constrained and sponsors are unable or unwilling to back promises, the more likely participants will have pensions smaller than bargained for.

A straightforward response would be to eliminate limits, says the paper, or raise the limit to 25 per cent, which already applies to multi-employer plans, with provisions for sharing of risk between sponsors and participants. Deficits in this case are as infrequent and small as with no limit at all.

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