The driving force behind phased-retirement programs is a desire to defer the date of full retirement, not to encourage early retirement
As a large number of baby boomers approach retirement, employee retention is the primary motivator behind a renewed interest in phased retirement.
In the mid-1990s, a number of Canadian employers, primarily in the public sector, used phased retirement programs to encourage workers to retire early. Phased retirement programs are any arrangements that enable employees approaching retirement age to reduce their work hours or job responsibilities in order to gradually ease into full retirement. Since the primary goal in the ’90s was payroll and workforce reduction, when an employee opted-in to a phased retirement plan, there was generally no turning back.
But things have changed. Today, the major reason for implementing a phased retirement program is to defer the date of full retirement, rather than to accelerate the date of partial retirement. This is a key challenge in the design of a phased retirement program.
A logical model would allow an employee to work part time, accruing benefits based on hours actually worked, while collecting a partial pension in respect of the part of the work week that the employee is no longer working.
However, in Canada, Income Tax Regulation 8503(3)(b) does not allow a member of a defined benefit plan to simultaneously collect and accrue a pension from the same organization.
This rule exists despite the fact that an individual can fully retire from one employer and work for another, and thereby collect and accrue a pension at the same time. It’s also possible to draw a defined benefit pension and accrue a different type of pension such as under a defined contribution provision or a registered retirement savings plan from the same employer.
In addition, the Income Tax Act requires that lifetime pensions must be paid in equal and periodic amounts. This hinders one of the objectives of a phased retirement model, which is to pay increasing pension amounts as an individual gradually reduces working hours.
Another obstacle is that to receive early Canada Pension Plan (CPP) benefits from age 60, the employee must have “substantially withdrawn from the workforce.” In 2002, this meant earning less than $9,465.
The net result, again, is that some employees may be more inclined to fully retire from a career position, collect CPP and then accept a full- or part-time position with another organization.
Quebec has solved these legislative hurdles in two ways.
First, it has changed the Quebec Pension Plan (QPP) so that an employee aged 55 to 70 can continue to accrue — and contribute towards — QPP benefits based on full salary rather than the reduced salary during a phased retirement period.
In addition, an employee aged 60 to 65 who reduces work hours so that wages are reduced by at least 20 per cent can receive an early QPP pension while continuing to work part-time.
Second, the Quebec Supplemental Pension Plans Act has been amended to effectively get around the barrier in the income tax act — no accruals of pensions while receiving a pension.
It allows a phased retiree to accrue a pension based on actual earnings while receiving a series of lump sum payments from the pension plan rather than a monthly pension.
There are certain restrictions in terms of the amount that may be received early from a pension plan in this manner. Alberta has made similar changes to its Employment Pension Plans Act so that employees can take partial retirement and continue to contribute to their pension plan while receiving annual lump sum payments from the plan.
Yet Quebec’s innovative lump sum approach has had a very low take-up rate. There are three major reasons for this:
•First, the employee foregoes any early retirement subsidies offered by the employer. The individual selects lump sums that are received annually during the phased retirement period and a pension of equivalent actuarial value is later offset against the normal retirement pension accrued to the date of final retirement. In a plan with a generous early retirement provision, this represents a huge potential loss.
•Second, the Canada Customs and Revenue Agency (CCRA) will not permit income to be drawn from the pension fund more frequently than annually, while pension accruals are continuing. CCRA believes that paying out more frequently would break the “no accruals while receiving a pension” rule. Yet many individuals would prefer to draw income monthly, rather than once a year. This issue may be less of a problem in future, since CCRA has recently approved a phased retirement program for New Brunswick Nurses in which the plan sponsor will hold the lump sum in trust and pay it out on a monthly basis to phased retirees.
•Third, there is a cap equal to 40 per cent of the yearly maximum pensionable earnings ($15,960 in 2003) on the lump sum that may be drawn annually during the phased retirement period. For an individual whose pay drops under, say, $25,000 during the phased retirement period, an annual lump sum of up to $15,960 is probably an acceptable replacement for the loss of income. But for many individuals who only want to work one or two days of work each week, or for those whose annual salary is more than about $60,000, the cap creates a potentially large drop in cash flow.
The Department of Finance, which develops federal tax policy, has been reluctant to tackle the “collect and accrue” problem due to concerns about excessive tax sheltering and the added complexity that amendments might create for an already complicated pension tax system.
This is in spite of the fact that a retiree receiving a pension can accept a job with another organization and accumulate pension credits in the new job without any restriction. Federal policy-makers have also been slow to recommend CPP amendments similar to those in the QPP which were designed to facilitate phased retirement.
However, legislative change alone will not be the catalyst that results in the growth of phased retirement programs across the country. From a practical standpoint, many employers are concerned about making phased retirement too attractive. The result could be that employees who might have continued to work will instead opt for phased retirement, at greater expense to the employer.
The challenge is to design a program that can be offered selectively to employees the employer wants to stay on, after they have indicated a desire to retire early. This could include a supplement payable outside the pension plan to partially compensate for reduced earnings during the period of phased retirement.
The additional compensation will have to be great enough to attract the potential early retiree, but not so lucrative as to lure people who would have continued working without the additional sweetener.
Furthermore, the phased retirement program will also have to address the job content and working conditions of phased retirees so they truly see this as a stepping stone to full retirement.
Sheryl Smolkin is a lawyer and director of Watson Wyatt Worldwide’s Canadian Research and Information Centre in Toronto. She can be contacted at [email protected].
In the mid-1990s, a number of Canadian employers, primarily in the public sector, used phased retirement programs to encourage workers to retire early. Phased retirement programs are any arrangements that enable employees approaching retirement age to reduce their work hours or job responsibilities in order to gradually ease into full retirement. Since the primary goal in the ’90s was payroll and workforce reduction, when an employee opted-in to a phased retirement plan, there was generally no turning back.
But things have changed. Today, the major reason for implementing a phased retirement program is to defer the date of full retirement, rather than to accelerate the date of partial retirement. This is a key challenge in the design of a phased retirement program.
A logical model would allow an employee to work part time, accruing benefits based on hours actually worked, while collecting a partial pension in respect of the part of the work week that the employee is no longer working.
However, in Canada, Income Tax Regulation 8503(3)(b) does not allow a member of a defined benefit plan to simultaneously collect and accrue a pension from the same organization.
This rule exists despite the fact that an individual can fully retire from one employer and work for another, and thereby collect and accrue a pension at the same time. It’s also possible to draw a defined benefit pension and accrue a different type of pension such as under a defined contribution provision or a registered retirement savings plan from the same employer.
In addition, the Income Tax Act requires that lifetime pensions must be paid in equal and periodic amounts. This hinders one of the objectives of a phased retirement model, which is to pay increasing pension amounts as an individual gradually reduces working hours.
Another obstacle is that to receive early Canada Pension Plan (CPP) benefits from age 60, the employee must have “substantially withdrawn from the workforce.” In 2002, this meant earning less than $9,465.
The net result, again, is that some employees may be more inclined to fully retire from a career position, collect CPP and then accept a full- or part-time position with another organization.
Quebec has solved these legislative hurdles in two ways.
First, it has changed the Quebec Pension Plan (QPP) so that an employee aged 55 to 70 can continue to accrue — and contribute towards — QPP benefits based on full salary rather than the reduced salary during a phased retirement period.
In addition, an employee aged 60 to 65 who reduces work hours so that wages are reduced by at least 20 per cent can receive an early QPP pension while continuing to work part-time.
Second, the Quebec Supplemental Pension Plans Act has been amended to effectively get around the barrier in the income tax act — no accruals of pensions while receiving a pension.
It allows a phased retiree to accrue a pension based on actual earnings while receiving a series of lump sum payments from the pension plan rather than a monthly pension.
There are certain restrictions in terms of the amount that may be received early from a pension plan in this manner. Alberta has made similar changes to its Employment Pension Plans Act so that employees can take partial retirement and continue to contribute to their pension plan while receiving annual lump sum payments from the plan.
Yet Quebec’s innovative lump sum approach has had a very low take-up rate. There are three major reasons for this:
•First, the employee foregoes any early retirement subsidies offered by the employer. The individual selects lump sums that are received annually during the phased retirement period and a pension of equivalent actuarial value is later offset against the normal retirement pension accrued to the date of final retirement. In a plan with a generous early retirement provision, this represents a huge potential loss.
•Second, the Canada Customs and Revenue Agency (CCRA) will not permit income to be drawn from the pension fund more frequently than annually, while pension accruals are continuing. CCRA believes that paying out more frequently would break the “no accruals while receiving a pension” rule. Yet many individuals would prefer to draw income monthly, rather than once a year. This issue may be less of a problem in future, since CCRA has recently approved a phased retirement program for New Brunswick Nurses in which the plan sponsor will hold the lump sum in trust and pay it out on a monthly basis to phased retirees.
•Third, there is a cap equal to 40 per cent of the yearly maximum pensionable earnings ($15,960 in 2003) on the lump sum that may be drawn annually during the phased retirement period. For an individual whose pay drops under, say, $25,000 during the phased retirement period, an annual lump sum of up to $15,960 is probably an acceptable replacement for the loss of income. But for many individuals who only want to work one or two days of work each week, or for those whose annual salary is more than about $60,000, the cap creates a potentially large drop in cash flow.
The Department of Finance, which develops federal tax policy, has been reluctant to tackle the “collect and accrue” problem due to concerns about excessive tax sheltering and the added complexity that amendments might create for an already complicated pension tax system.
This is in spite of the fact that a retiree receiving a pension can accept a job with another organization and accumulate pension credits in the new job without any restriction. Federal policy-makers have also been slow to recommend CPP amendments similar to those in the QPP which were designed to facilitate phased retirement.
However, legislative change alone will not be the catalyst that results in the growth of phased retirement programs across the country. From a practical standpoint, many employers are concerned about making phased retirement too attractive. The result could be that employees who might have continued to work will instead opt for phased retirement, at greater expense to the employer.
The challenge is to design a program that can be offered selectively to employees the employer wants to stay on, after they have indicated a desire to retire early. This could include a supplement payable outside the pension plan to partially compensate for reduced earnings during the period of phased retirement.
The additional compensation will have to be great enough to attract the potential early retiree, but not so lucrative as to lure people who would have continued working without the additional sweetener.
Furthermore, the phased retirement program will also have to address the job content and working conditions of phased retirees so they truly see this as a stepping stone to full retirement.
Sheryl Smolkin is a lawyer and director of Watson Wyatt Worldwide’s Canadian Research and Information Centre in Toronto. She can be contacted at [email protected].
