Pension Reform Needs Consideration With ORPP
While the Ontario government is to be lauded for finally taking concrete steps to address significant issues concerning retirement income adequacy in this province, this latest initiative cannot be looked at in isolation, says Mark Newton, of Newton HR Law, in a submission with his personal views to the Ontario ministry of finance. In particular, the arduous, drawn-out multi-year reform process in respect of amendments to the Pension Benefits Act which has not helped to reverse, and may have exacerbated the continuing flight away from defined benefit pension plans needs to be examined.
His submission follows:
I agree with the basic thrust of the government’s report, that there is a growing gap in retirement income adequacy not only in Ontario, but across Canada. Many reasons have been put forward over the past several years for this phenomenon. For example, while we used to be known as a country of savers, this is no longer the case. The average amount of household debt has been rising and the proportionate amount of savings has been declining.
Canada can be quite proud of its retirement system. The Canada/Quebec Pension Plan, in particular, stands out when compared with other countries’ contributory social security systems. Indeed, the C/QPP has been referred to as a ‘Maple Revolutionary’ by the Economist magazine. I have spoken about the C/QPP at both the ‘World Pension Summit’ in Amsterdam and the ‘China Pension Forum’ in Beijing. Our home-grown plan has garnered a lot of attention in global pension circles.
In addition, Canada has a sophisticated tax-assisted retirement savings system. We are one of few jurisdictions in the world that has an income tax system that integrates all forms of defined benefit and defined contribution pension plans and retirement savings vehicles. Yet, while the retirement savings vehicles are available, the tax-deferred room is, for the most part, not being used. Statistics show that only about five per cent of available RRSP contribution room is used.
The proposed definition of comparable workplace pension plan is not fair and underestimates the value of defined contribution retirement savings plans. As stated above, the Canadian tax-assisted retirement savings system is one single integrated system under which defined benefit plans are equated with defined contribution plans. The 18 per cent contribution limit under the Income Tax Act (Canada) is equated with a two per cent final average earnings defined benefit pension plan, using the factor of 9.
Given the integrated design of the Canadian system and given that there can be rich defined contribution plans and poor defined benefit plans, to simply exclude all forms of defined contribution plans from the definition of comparable workplace pension plans and conversely to include all forms of defined benefit and target benefit MEPPs is illogical and simplistic. It grossly understates the work that many employers have undertaken to design and implement very viable defined contribution plans.
Furthermore, within the sphere of defined contribution plans, it should not make any difference whether an employer sponsors a defined contribution pension plan, a group RRSP, or DPSP; they are all tax-deferred retirement savings plans. Some employers choose to sponsor stand-alone pension plans with matching contributions from the employer and employees. Others pair up a group RRSP for employee contributions, with the pension plan for employer contributions, while others use a group RRSP and a DPSP for employer contributions.
The proposed reforms by the Ontario government should recognize and embrace the diversity of retirement pension and savings arrangements within the universe of tax-assisted retirement savings plans in the Income Tax Act (Canada). Granted, only pension plans, whether they are defined benefit or defined contribution, lock-in the benefits to the age of early retirement. However, our regulatory framework, even for registered pension plans, permits unlocking in certain circumstances including hardship, shortened life expectancy, and residence outside of the country.
The current proposals should likewise recognize non-pension plans, such as RRSPs and DPSPs, as valid and viable retirement plans. The proposals should also allow for some latitude in how employers design their retirement plans and how individuals choose to manage their retirement assets. The current proposals set up a two-tier system under which defined contribution arrangements, whether they are pension plans, RRSPs or DPSPs, are treated as less vital or less integral to the retirement system. This is neither fair nor does it accord with reality.
The integration of the Canadian system is also reflected in Ontario’s pension legislation which, since 1988, has permitted portability of members’ pension benefits. Essentially, upon termination of employment prior to retirement, a member’s accrued defined benefit is converted to a defined contribution lump sum and may be transferred to the member’s locked-in RRSP or other similar vehicle. Over a career, an individual may accumulate retirement assets from defined benefit and defined contribution plans, all of which may have been converted to locked-in lump sums.
The portability feature in Ontario’s pension legislation creates a level playing field, to a considerable degree, between defined benefit and defined contribution plans, particularly for the majority of employees who change employers during a working career and who will typically transfer lump sum commuted values to locked-in RRSPs. Page 11 of the government’s report discusses the mobile workforce, yet page 8 of the report fails to account for portability of pension benefits.
The report makes the simplistic statement that defined contribution plans are “limited to the value of accumulated contributions and investment returns” and the benefits “are not necessarily provided for life.” Plan members have to deal with longevity risk. The exact same scenario exists, however, for those who worked most of their careers while participating in defined benefit pension plans and who transferred their commuted values to locked-in RRSPs.
Given the integration of the Canadian system, and given the portability of pension benefits as described above, it would be counter-intuitive of the government to isolate two types of pension plans, namely, defined benefit plans and target benefit MEPPs, as exempt from the ORPP or, conversely, to impose the ORPP on employers that sponsor other types of retirement plans.
In addition, due to the regulatory, funding, and accounting complexity of defined benefit plans, many employers over the last 20 years made the difficult and costly decision to move away from defined benefit plans and to adopt defined contribution plans of one sort or another. Many such employers engaged actuaries, accountants, and lawyers in this process in order to design appropriate defined contribution plans. These decisions were never, in my experience, made hastily or without extensive consultation.
For the government to now declare that employers without defined benefit or target benefit MEPPs will be required to participate in the ORPP, without regard to the richness of an employer’s defined contribution plans, whether registered pension plans, group RRSPs or DPSPs, is not only unfair, it is outrageous. The likely reaction of a number of such employers will be to reduce the level of employer contributions to the defined contribution plan to account for the additional contributions under the ORPP.
If there must be distinctions between employers that are required to participate in the ORPP and those that are not, accounting for the retirement plan that they sponsor, the distinction should not be based upon the type of plan, namely, defined benefit, target benefit MEPP, defined contribution, RRSP, or DPSP. Rather, the distinction should align with the philosophical purpose of the ORPP.
The issue the ORPP is attempting to address is the anticipated gap in retirement savings in the next generation of people who will be retiring. The associate minister’s message makes this clear: “The undersaving problem is real. There is a gap between what people will need and what they will have. Our current system, while strong, simply is not filling the gap.” This gap will not be effectively addressed by targeting employers who do not sponsor defined benefit pension plans or target benefit MEPPs.
If the overarching concern of the Ontario government is the “undersaving problem,” the solution should be targeted specifically at that concern. The proposed ORPP is not targeted with the appropriate degree of precision. It takes a buckshot approach, aimed at all employers with defined contribution plans of one type or another. A far better approach, and one which would be consistent with the government’s thesis, would be to mandate participation based purely on the value of an employer’s retirement plan.
As stated above, in Canada we already have an integrated system that provides for a common value ascribed to defined benefit and defined contribution plans. The total retirement value earned by an individual in a calendar year, expressed as a pension adjustment, cannot exceed 18 per cent of earned income. The methodology already exists for comparing defined benefit accruals with defined contribution benefits.
It would be preferable, therefore, to mandate participation in the ORPP based upon the value of the employer’s retirement plan, rather than the type of plan. The value could be easily derived for defined benefit pension plans, target benefit MEPPs (which are valued the same as defined contribution pension plans if they are ‘specified MEPPs’ under the Income Tax Act (Canada)), defined contribution pension plans, RRSPs, or DPSPs. That value could then be targeted at, for example, five per cent of an employee’s earnings.
I have a couple of final comments. Firstly, distinctions between employers, based upon whether they sponsor defined benefit or defined contribution plans, will also cause significant complexity for the entity that will administer the ORPP. Canada’s workforce is fairly mobile. Employees on average work for five to eight employers during a working career. Using any one employee as an example, he or she might work for employers at different times with defined benefit or defined contribution plans. The administration of the ORPP will have to account for this sort of fragmented retirement plan participation.
Lastly, the government’s proposed ORPP is described as a ‘CPP enhancement.’ The CPP is a universal workplace social security scheme. The ORPP, on the other hand, would only apply to those employers without a defined benefit or target benefit MEPP. It would be far from universal. Notably, the ORPP would not apply to the Ontario public service. While the CPP is a single-tier system, the ORPP would create a bifurcated two-tier system. As such, it is inaccurate to describe the ORPP as a CPP enhancement.
Mark Newton, the founder of Newton HR Law, has been a pension and benefits lawyer in Ontario for 32 years. He is a former chair of the pensions and benefits law section of the Ontario Bar Association and the founding chair of the national pensions and benefits law section of the Canadian Bar Association and the Osgoode six-day pension certificate course.