Canada: Pensions: The Penny Dropped

The federal government tabled its budget yesterday afternoon. The government will be eliminating the penny.  But that is not the only penny that has been dropped. Mr. Harper announced on January 26, 2012, at the World Economic Forum in Davos, Switzerland that the government was looking at increasing the retirement age for the Old Age Security ("OAS") system. Now it is official: eligibility for Old Age Security benefits is being increased to age 67. Other notable changes in the budget are:  public sector pensions are being made more fiscally responsible and long-term disability plans in the federal sector will have to be provided on an insured basis.

Re-Engineering the Three Pillars

The government has subtly re-engineered the Canadian retirement income system. For the past 45 years, the Canadian system has been described as having three pillars:

  1. Government-sponsored plans.  The first pillar has been comprised of the broad-based government-run, supposedly universal pension schemes, including Old Age Security, the Guaranteed Income Supplement ("GIS") and other provincial supplements, and the Canada/Quebec Pension Plans ("Q/CPP").
  2. Employer-sponsored plans.  The second pillar has been comprised of the employer-provided pension plans, whether defined benefit or defined contribution.
  3. Individual savings.  The third pillar has been comprised of individual tax-assisted retirement savings, primarily through registered retirement savings plans. 

This is the way the system was described to me when I entered this industry 30 years ago.

More recently, including in its budget papers yesterday, the federal government has conveniently shifted the pillars, because of a glaring weakness in the second pillar. I pointed this out in our March 25, 2010, edition of the Pension Pulse ("Three Pillars: Ten Questions").  

This is significant and should not go unnoticed. Just like the Olympic stadium in Montreal, cracks have begun to appear in our retirement income system and pieces are crashing down. By changing the pillars, somehow our system is made to look stronger and more sustainable. 

The three pillars, as described by our federal government, now are:

  1. the OAS, GIS and other provincial supplements;
  2. the Q/CPP; and
  3. all other forms of accumulating retirement savings, including employer pension plans, savings plans, RRSPs and tax-free savings accounts. 

I believe part of the reason for the re-jigging is because the old pillar number two, traditionally employer-sponsored defined benefit pension plans, are largely defunct, at least in the private sector. By lumping all employer-sponsored plans and private savings into the third pillar, this pillar does not look as weak, relative to the other two.  Plus, the new first pillar, being comprised only of the OAS and other non-contributory programs funded exclusively from government revenues, can be treated separately. 

It used to be that the traditional first pillar, comprised of OAS and Q/CPP were universal schemes which, when combined would provide retirement income equal to about 40% of the year's maximum pensionable earnings (currently about $50,000).  Then, in 1989 the OAS claw-back was introduced, thereby eliminating universality.

Moving the Normal Retirement Age

In its budget, the federal government announced a further chipping away at the OAS, with the increasing of the normal retirement age at which full benefits will become available. Currently age 65, the age will be gradually increased to 67, starting with those born in 1958.  (Interestingly, when the OAS was introduced in 1952, the normal retirement age was 70.)  Starting in 2023, the normal retirement age will be increased by one month every two months, such that those born in 1962 or later will not be entitled to full OAS benefits until they reach age 67 (in 2029).  The reasons are increased cost because of the baby boom generation moving through the system, increased life expectancy and, according to the government, many people wanting to work longer!  The first two factors have not been a secret to demographers; the third factor is incongruous.

The increase to the normal retirement age for the OAS brings imbalance to the system. The Q/CPP is based upon age 65 retirement. Public and private sector pension plans are based upon age 65 retirement. Although mandatory retirement has been eliminated across Canada, the vast majority of workplaces use age 65 as a normal retirement age. Insured benefits are often reduced at age 65 and some, such as disability benefits, are eliminated at age 65.  Further, the design of many employer pension plans implicitly or explicitly account for OAS benefits and Q/CPP benefits starting at age 65.  With this change, many employers will be forced to rethink the design of their retirement plans.

One salutary change to the OAS will be to permit the deferral of the start date, for those who wish to start their pension later and perhaps coordinate the OAS start date with that of the Q/CPP which currently provide for late start dates. The proposal is to permit individuals to defer their start date by up to five years, in which case the OAS benefits would be actuarially increased.  It is interesting that under the fully mature OAS with a normal retirement age of 67, the latest start date will be age 72, which is beyond the date by which pension and RRSP income has to start being received (the end of the year in which one attains age 71).

The government has confirmed that no changes are being made to the CPP. The combined employer/employee contribution rates will remain constant at 9.9%.

Scaling Back Public Sector Pensions

The government will be making changes to pensions in the public sector. It is committed to making these plans "fair relative to those offered in the private sector". However, the only changes announced are to increase the normal retirement age from 60 to 65 (not 67) for those who join the public service after 2012, and to gradually increase employee contributions to 50% of overall cost. 

Very, very few pension plans in the private sector provide for full retirement at age 60. Maintaining the age 60 retirement age for everyone currently employed in the public sector means that this extremely lucrative benefit, unique to the public sector, will be around for decades.  Public sector employees currently age 25 can still look forward to full pensions at age 60, some 35 years from now.  The disparity between public sector and private sector plans will continue to grow as a result.  The increase in employee contributions to a reasonable level has long been needed. The government is to be commended for taking this step, although we will wait to see how long the phase-in period is.

Insuring Long-Term Disability Plans

One other change announced in the budget is to require employers in the federal sector that provide long-term disability plans, to do so on a fully insured basis. Currently, some large employers provide LTD benefits on a pay-go basis, rather than insuring the benefits through an insurance company. The logic is that these employers save in the long run by not paying premiums to insurance companies. The difficulties arise in the event of bankruptcy, in which case disabled employees are left without protection. The requirement to insure the benefits would provide a much needed level of security. The last people who should suffer in the case of corporate bankruptcy are those most vulnerable, namely, the disabled.

For details on tax-related changes announced in the federal budget, please refer to our Tax Communiqué.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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