Phased retirement bridging a gap

Can I get an advance from my future pension benefit? HR professionals might hear this question frequently from staff in the coming years as the boomers retire.

The advent of phased retirement plans allows older employees to keep working while semi-retired. Pension legislation first in Quebec and now in Alberta allows employees to tap into their pension benefits and receive a yearly lump sum payment. This compensates for the reduction in earning while they only work part-time.

When the employee retires, his accrued pension benefit is reduced to take into account the “advance” lump sum payments that he received from the company pension plan. This practice is commonly referred to as a “phased retirement” program or “transitional” retirement. Many provinces are studying the Quebec initiative but have not yet amended pension standards laws to permit similar phased retirement options.

How it works
Under a phased retirement scheme, a plan member who is within 10 years of the normal retirement date can make a request each year to receive a payment from the pension plan. This payment can not exceed the lesser of 70 per cent of the reduction in earnings or 40 per cent of the maximum pensionable earnings for the year ($15,320 in year 2001) or the value of pension benefits that remain to the member’s credit. The member has the option to request such a payment (or not) for each year until the termination of the reduced hours agreement or the employee’s retirement.

As an added bonus, the Canada Customs and Revenue Agency (CCRA) has ruled that the Quebec-style phased retirement programs are exempt from the traditional tax rule that prohibits accruals of pensionable service after an employee has begun to receive pension payments. The CCRA considers the annual lump sum payments under a phased retirement program to be partial commutations of accrued pension benefits and not to be pension payments.

Let’s consider an example of a 60-year-old employee who has an annual salary of $50,000 and 30 years of service in a pension plan that provides an annual pension at retirement equal to 1.5 per cent of salary times years of service, minus a five-per-cent reduction for each year that retirement precedes age 65. If he retired immediately, he could receive an annual pension of $16,875 (1.5 per cent x 30 years x $50,000 minus 25 per cent for retiring five years early). If he elected to start Canada Pension Plan (CPP) payments at age 60, the maximum annual CPP amount of $9,300 would be reduced (by 30 per cent) to $6,500.

After having earned $50,000 per year, this employee might decide that he cannot afford to retire at age 60 with an annual retirement income (including CPP) of approximately $23,400. But maybe he can afford to “retire partially” by working fewer days per week (or months per year) for the final years of his career. His employer could have many reasons why it would prefer to retain this employee (tight labour market, the employee’s experience and knowledge), even if it means he works on a part-time or part-year basis, rather than retire early.

Suppose they agree that the employee will reduce his work time by 40 per cent from age 60 to 65, receive a salary of $30,000 (60 per cent of his regular salary) and receive a $10,000 lump sum payment from the company pension plan for each of those five years. He will continue to accrue additional pension service credits until his full retirement at age 65. When he retires at age 65, the employee’s pension will be reduced to compensate for the lump sum withdrawals.

If he receives an additional three years (60 per cent of five years) of pension service from age 60 to 65, the employee could retire at age 65 with an annual company pension of $19,750. He would now be entitled to full CPP benefits of $9,300, for a total annual retirement income (before Old Age Security) of approximately $29,000. If the employer is generous enough to grant five full years of pension service from age 60 to 65, the retirement income would increase by another $1,500 to $30,500 per year.

Instead of retiring on $23,400 per year at age 60, this employee worked from age 60 to 65 at 60 per cent capacity and $40,000 per year compensation ($30,000 from employer and $10,000 from the pension plan) and he increased his annual pension from $23,400 to an amount between $29,000 to $30,500. The company pension was reduced to compensate for the five $10,000 lump sum payments, but the employee benefits from extra pension service and has no early retirement penalties on both his company pension and CPP by waiting to age 65 for his full retirement.

Phased retirement legislation is progressive and offers flexibility for an employer and its employees who are close to normal retirement age. Will other provinces soon follow Quebec’s lead?

Andrew Donelle is a pension consultant with Buck Consultants. He can be reached at (416) 865-0060 ext. 269 or [email protected]

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