A Group Pension Fix?

Jack Mintz’s writes in the National Post, A group pension fix:

Governments are searching for new measures to help Canadians save for their retirement. One proposal among current federal consultations: Amend regulations to allow insurance companies or other providers, including government-sponsored pension plans, an opportunity to effectively provide multi-employer pensions.

Here is an alternative proposal that could have a big impact in helping business provide multi-employer plans at a relatively low cost: Eliminate the current discrimination against group RRSP plans by enabling companies to deduct their employer contributions from the tax base used to determine CPP, EI and other payroll taxes. At present, employer contributions to pension funds are deductible but not in the case of group RRSPs.

Why would this be important? Many companies are abandoning defined benefit plans — pensions with benefits based on years of service and salary levels — in favour of defined contribution plans or group RRSPs, both of whose retirement benefits ultimately depend on the investment experience of the funds held on behalf of the employee. From an employee’s perspective, the defined contribution plan and group RRSPs are similar in that the employee bears investment risk that determines how much wealth is accumulated at retirement.

However, from an employer’s perspective, group RRSPs and defined contribution pension plans are not the same. Since contributions to group RRSPs are not deducted from the payroll tax base, they are less favourable to provide than defined contribution plans. Larger companies will choose to set up defined contribution plans even though they are more costly to administer than group RRSPs. Small businesses have little choice since defined contribution plans are harder to set up for their employees.

Group RRSPs have grown very quickly in the past decade and are now as important as defined contribution pension plans. As an inducement to save for retirement, employers can contribute to a plan, often on a matching basis, thereby strongly encouraging participation. Employees can choose the type of investment on advice given by the provider. If the employee quits the firm, the amounts are transferred to individual-managed RRSPs.

Groups RRSPs can be reasonably inexpensive, especially if the funds are invested in indexed funds, although employees have often chosen to invest in actively managed funds that can be more costly. Current administrative, distribution and advisory costs are about 90 basis points on average, about 30 basis points more than defined contribution plans largely because group RRSPs are typically smaller accounts.

For employees who move from job to job, group RRSPs are much more flexible saving plans compared to defined contribution pension plans. If leaving an employer, defined contribution pension assets are kept in the plan or transferred to other pension assets or locked-in retirement accounts. Locked-in accounts require individuals to hold assets in plans until a certain age when they can be withdrawn but only up to a regulated amount (e.g. 8% of assets). While lock-in arrangements encourage plan holders to use assets only for retirement purposes, the arrangements make estate planning more difficult (for example when someone has a terminal disease) or for contingencies that come up before the age of retirement.

If contributions to group RRSPs became deductible from payroll tax bases, larger firms would likely be more willing to provide them, enabling them to be offered at a low cost. Employees might prefer them since group RRSPs are far more flexible than defined contribution plans in saving money and meeting future needs and contingencies.

Governments would see some decline in payroll tax revenues to the extent that new group RRSP plans are created, as opposed to substituting for current defined contribution pension plans whose contributions are already deducted from the payroll tax base