But most still believe securing plans is not worth it
When Confederation Life collapsed in 1994, more than 30 retired executives lost out on supplementary pension benefits, and failed to win them back in the courts in 1997. Suddenly, security of supplemental executive retirement plans (SERPs) became an issue for a large and growing number of those who qualify for them.
Nevertheless, most Canadian companies’ SERPs still aren’t secured, though some research indicates that might be changing. William M. Mercer Ltd. research shows that 40 per cent of its clients that provide SERPs now secure them. This is up from a third in 1997 and just one quarter in 1994. And it is proof of what experts say is a trend toward securing supplemental plans, which is due, at least in part, to the continued hot labour market.
Every time we meet with top business people, security of SERPs is the big issue they want to talk about, said Grant Inglis, senior consultant and actuary at Watson Wyatt. Most companies agree that SERPs are vital, not only to paying executives — and a large portion of high-earning middle management — their rightful pension earnings, but because it’s a competitive recruitment and retention incentive.
Debbie Lomow, corporate pension and benefits actuary at Bank of Nova Scotia, says, “While I don’t think this (SERPs) is the most important thing when it comes to the role of compensation packages in recruitment and retention, I think it is definitely important. All our staff at the top of the house have supplemental plans, whether it is a SERP or through their own route. Executive plans are fundamental to the whole program.
“I think potential employees we look at are going to ask the question about retirement top-ups, and we have to make sure we have a competitive answer. They have to have the option of a supplemental plan.”
David Vincent, pension specialist at Fasken Campell Godfrey, a law firm in Toronto, said “If it is a choice between somebody who is going to fund a promise and someone who is not going to fund a promise, who are you going to work for?”
Yet, the majority of plans offered out there are still of the pay-as-you-go variety. Less complicated than funded plans — and sometimes as simple as a handshake and a promise to top-up the basic pension plan after retirement — pay-as-you-go plans are not secured.
“We’re still seeing a lot of companies saying, ‘We’ll have a SERP but we can’t get the same kind of tax shelter as we would with a registered pension plan (RPP) so we’re not going to fund it,’” said Inglis.
The current limit for pensionable earnings, set by Revenue Canada in 1976, is $85,000. This severely caps high-income earners’ tax sheltered contributions. A 1998 study from Watson Wyatt Canada found that one in eight employees earn more than the limit, and predicted that number could rise to one in four by 2005 when limits are scheduled to be reviewed.
But Jayne Casanova, senior consultant at Watson Wyatt, said in the long run, there is little if any difference between paying now or paying later. With complex accounting techniques, in fact, pre-funding may even be cheaper, she said.
Vincent too has heard convincing arguments that the cost of funding a SERP compared to the cost associated with a pay-as-you-go plan isn’t that much different.
In favour of securing SERPs
A number of issues are making securing SERPs more appealing, said Kevin Moriarty of William M. Mercer. Aside from pressures from employees and low interest rates, sponsors are beginning to have a clearer understanding of the tax and funding implications of SERPs.
You have to put the costs of SERPs in the right context, said Moriarty; there is no point in comparing them to a RPP, and more people are beginning to realize that.
Casanova agreed. When the SERP rules first came out, people were focused on the fact that it appeared twice as expensive to fund than a RPP because of the 50-per-cent refundable tax on any contributions to a fully funded plan — which does not earn interest. People were turned off by that, she said, and opted instead for a pay-as-you-go plan.
So, instead of putting money directly into a fund, some trustees choose to purchase a letter of credit. Rather than having to pay the refundable tax on the entire amount, sponsors only have to pay the tax on the annual premium, typically only .5 to 1.5 per cent of the face value of the liability. It is security but at a much lower cost. “It is not a perfect solution, but it is more tax efficient,” said Vincent.
Ian McSweeney pension specialist and partner with Osler, Hoskin & Harcourt, a law firm in Toronto, said, “The letter of credit provides the same level of security,” but the choice between the two approaches comes down to a cash-flow issue since the letter of credit “can eat into an employer’s credit facilities.”
Changes to accounting practices could also factor into decisions of whether or not to fund SERPs. Changes to the guidelines used by chartered accountants, effective Jan. 1, 2000, will oblige employers to account for all benefit costs, including SERPs, in a much more accurate manner, said Vincent, adding that once you recognize a cost, the tendency is to want to try to fund it.
Also worth keeping an eye on are efforts to fund SERPs from regular pension surpluses. This is just in the very early stages and still waiting for regulatory approval, said Vincent. It will probably involve some form of similar tax arrangement but would still be better than funding it from general revenue.
What the majority says
Often, in financially stable, “blue chip” companies, employees don’t demand secured pension funds — they feel confident the company will be around to fulfill its pension promises decades from now. Those companies not under severe pressure to pay-up now or find someone else, prefer to avoid the onerous tax burden and tricky accounting needed to secure funds.
Here’s what experts are saying.
Douglas R. Lovat
Director, pensions,
employer benefits
Air Canada
“The biggest problem with executive pensions is that you cannot fund them properly and companies have to come up with inventive ways to secure the benefit. With Revenue Canada’s limit, pension professionals and senior HR people are severely limited.
For Air Canada, we are unique in that our pilots also require top-up pensions.
We are not dealing with just a half a dozen executives, but also a couple thousand pilots. And Revenue Canada has made it almost impossible. There is no practical solution. Nothing is very cost-effective.
I am not aware of any companies that have come up with long-term solutions to the problem. The top-up is paid straight out of (Air Canada’s) corporate revenue. It’s just the way it is and we don’t have a solution.
As long as a company has long-term viability, (non-funded supplemental plans) are fine. But a lot can happen too. Look at the Confederation case.
One can be philosophical about someone else’s pension, but it’s
quite another to be philosophical with your own.
We can only hope Revenue Canada increases the limit. It’s been more than 20 years now and its not relevant to today’s salaries.
But they said they were going to change it in 1994, 1995, 1999, and now they have postponed it to 2005.”
Debbie Lomow
Corporate pension and benefits actuary
Bank of Nova Scotia
“At Scotiabank, our objective has been to provide an executive pension program, like all our programs, that is competitive and flexible. When you get right down to executive pensions, with the limit on defined benefit plans, there really isn’t a tax effective way around it.
Here at Scotia, about 10 to 15 years ago, we had only a handful of people (all executives) with SERPs. Now we have 200 or 300 covered.
We don’t call it supplemental executive retirement plans anymore, but supplemental employee retirement plans. And ours are unfunded. We have not found a tax effective way to fund these benefits.
I would think some of our employees are concerned about security. But we are unique in that we are a bank.
I mean there is the option to buy insurance, but a lot of employees would probably prefer to put their faith in a bank than in an insurance company given the recent history of a couple of life insurance companies.
We do offer employees (who require SERPs) a choice to opt out. If they prefer, they can take advantage of RRSP savings. But there are tax limitations, or rather stalling on RRSPs also.
I would not be surprised that employees find it frustrating. No matter whether they go with the supplemental plan or RRSP, tax limits are whacking them.”
Warren Baldwin
Regional vice-president
T.E. Financial Consultants
“Companies have to offer supplemental plans because it’s more awkward not to when the competition is. And what usually happens is companies pay it out of their pocket. Funding supplemental pensions is difficult to do effectively because it’s not tax effective for companies.
In theory, companies should be allocating funds to supplemental plans. While they are not putting money aside, they should at least show it as an increasing liability on the records.
There’s this philosophy too, not one I agree with, but that if an executive has set up and run a company, and they have a non-funded SERP, they have a vested interest in ensuring the company stays strong up to and even after retirement.”
Nevertheless, most Canadian companies’ SERPs still aren’t secured, though some research indicates that might be changing. William M. Mercer Ltd. research shows that 40 per cent of its clients that provide SERPs now secure them. This is up from a third in 1997 and just one quarter in 1994. And it is proof of what experts say is a trend toward securing supplemental plans, which is due, at least in part, to the continued hot labour market.
Every time we meet with top business people, security of SERPs is the big issue they want to talk about, said Grant Inglis, senior consultant and actuary at Watson Wyatt. Most companies agree that SERPs are vital, not only to paying executives — and a large portion of high-earning middle management — their rightful pension earnings, but because it’s a competitive recruitment and retention incentive.
Debbie Lomow, corporate pension and benefits actuary at Bank of Nova Scotia, says, “While I don’t think this (SERPs) is the most important thing when it comes to the role of compensation packages in recruitment and retention, I think it is definitely important. All our staff at the top of the house have supplemental plans, whether it is a SERP or through their own route. Executive plans are fundamental to the whole program.
“I think potential employees we look at are going to ask the question about retirement top-ups, and we have to make sure we have a competitive answer. They have to have the option of a supplemental plan.”
David Vincent, pension specialist at Fasken Campell Godfrey, a law firm in Toronto, said “If it is a choice between somebody who is going to fund a promise and someone who is not going to fund a promise, who are you going to work for?”
Yet, the majority of plans offered out there are still of the pay-as-you-go variety. Less complicated than funded plans — and sometimes as simple as a handshake and a promise to top-up the basic pension plan after retirement — pay-as-you-go plans are not secured.
“We’re still seeing a lot of companies saying, ‘We’ll have a SERP but we can’t get the same kind of tax shelter as we would with a registered pension plan (RPP) so we’re not going to fund it,’” said Inglis.
The current limit for pensionable earnings, set by Revenue Canada in 1976, is $85,000. This severely caps high-income earners’ tax sheltered contributions. A 1998 study from Watson Wyatt Canada found that one in eight employees earn more than the limit, and predicted that number could rise to one in four by 2005 when limits are scheduled to be reviewed.
But Jayne Casanova, senior consultant at Watson Wyatt, said in the long run, there is little if any difference between paying now or paying later. With complex accounting techniques, in fact, pre-funding may even be cheaper, she said.
Vincent too has heard convincing arguments that the cost of funding a SERP compared to the cost associated with a pay-as-you-go plan isn’t that much different.
In favour of securing SERPs
A number of issues are making securing SERPs more appealing, said Kevin Moriarty of William M. Mercer. Aside from pressures from employees and low interest rates, sponsors are beginning to have a clearer understanding of the tax and funding implications of SERPs.
You have to put the costs of SERPs in the right context, said Moriarty; there is no point in comparing them to a RPP, and more people are beginning to realize that.
Casanova agreed. When the SERP rules first came out, people were focused on the fact that it appeared twice as expensive to fund than a RPP because of the 50-per-cent refundable tax on any contributions to a fully funded plan — which does not earn interest. People were turned off by that, she said, and opted instead for a pay-as-you-go plan.
So, instead of putting money directly into a fund, some trustees choose to purchase a letter of credit. Rather than having to pay the refundable tax on the entire amount, sponsors only have to pay the tax on the annual premium, typically only .5 to 1.5 per cent of the face value of the liability. It is security but at a much lower cost. “It is not a perfect solution, but it is more tax efficient,” said Vincent.
Ian McSweeney pension specialist and partner with Osler, Hoskin & Harcourt, a law firm in Toronto, said, “The letter of credit provides the same level of security,” but the choice between the two approaches comes down to a cash-flow issue since the letter of credit “can eat into an employer’s credit facilities.”
Changes to accounting practices could also factor into decisions of whether or not to fund SERPs. Changes to the guidelines used by chartered accountants, effective Jan. 1, 2000, will oblige employers to account for all benefit costs, including SERPs, in a much more accurate manner, said Vincent, adding that once you recognize a cost, the tendency is to want to try to fund it.
Also worth keeping an eye on are efforts to fund SERPs from regular pension surpluses. This is just in the very early stages and still waiting for regulatory approval, said Vincent. It will probably involve some form of similar tax arrangement but would still be better than funding it from general revenue.
What the majority says
Often, in financially stable, “blue chip” companies, employees don’t demand secured pension funds — they feel confident the company will be around to fulfill its pension promises decades from now. Those companies not under severe pressure to pay-up now or find someone else, prefer to avoid the onerous tax burden and tricky accounting needed to secure funds.
Here’s what experts are saying.
Douglas R. Lovat
Director, pensions,
employer benefits
Air Canada
“The biggest problem with executive pensions is that you cannot fund them properly and companies have to come up with inventive ways to secure the benefit. With Revenue Canada’s limit, pension professionals and senior HR people are severely limited.
For Air Canada, we are unique in that our pilots also require top-up pensions.
We are not dealing with just a half a dozen executives, but also a couple thousand pilots. And Revenue Canada has made it almost impossible. There is no practical solution. Nothing is very cost-effective.
I am not aware of any companies that have come up with long-term solutions to the problem. The top-up is paid straight out of (Air Canada’s) corporate revenue. It’s just the way it is and we don’t have a solution.
As long as a company has long-term viability, (non-funded supplemental plans) are fine. But a lot can happen too. Look at the Confederation case.
One can be philosophical about someone else’s pension, but it’s
quite another to be philosophical with your own.
We can only hope Revenue Canada increases the limit. It’s been more than 20 years now and its not relevant to today’s salaries.
But they said they were going to change it in 1994, 1995, 1999, and now they have postponed it to 2005.”
Debbie Lomow
Corporate pension and benefits actuary
Bank of Nova Scotia
“At Scotiabank, our objective has been to provide an executive pension program, like all our programs, that is competitive and flexible. When you get right down to executive pensions, with the limit on defined benefit plans, there really isn’t a tax effective way around it.
Here at Scotia, about 10 to 15 years ago, we had only a handful of people (all executives) with SERPs. Now we have 200 or 300 covered.
We don’t call it supplemental executive retirement plans anymore, but supplemental employee retirement plans. And ours are unfunded. We have not found a tax effective way to fund these benefits.
I would think some of our employees are concerned about security. But we are unique in that we are a bank.
I mean there is the option to buy insurance, but a lot of employees would probably prefer to put their faith in a bank than in an insurance company given the recent history of a couple of life insurance companies.
We do offer employees (who require SERPs) a choice to opt out. If they prefer, they can take advantage of RRSP savings. But there are tax limitations, or rather stalling on RRSPs also.
I would not be surprised that employees find it frustrating. No matter whether they go with the supplemental plan or RRSP, tax limits are whacking them.”
Warren Baldwin
Regional vice-president
T.E. Financial Consultants
“Companies have to offer supplemental plans because it’s more awkward not to when the competition is. And what usually happens is companies pay it out of their pocket. Funding supplemental pensions is difficult to do effectively because it’s not tax effective for companies.
In theory, companies should be allocating funds to supplemental plans. While they are not putting money aside, they should at least show it as an increasing liability on the records.
There’s this philosophy too, not one I agree with, but that if an executive has set up and run a company, and they have a non-funded SERP, they have a vested interest in ensuring the company stays strong up to and even after retirement.”
