A Group Pension Fix?

. It could require a slight revision in CPP, EI and worker compensation payroll taxes or benefits to ensure full funding of these plans.

While eliminating the existing discrimination against group RRSPs would help many businesses to provide retirement income benefits for their employees, other policy changes would still be useful to consider.

Several experts have recommended changes to pension regulations to enable insurance companies or pension administrators to set up multi-employer plans that would enable the comingling of assets and allow a sponsor who is not the employer or employee. This would be another change giving employers and employees greater choices while achieving cost efficiencies and more risk pooling in handling their retirement accounts. Even with this form of regulatory change, it would still be quite appropriate to amend tax law to create a level-playing field among different plans.

Also, many employees worry that they could see their accumulated wealth decline when the market turns south, thereby reducing their retirement income. Defined benefit arrangements whereby employees contribute to a fund that provides a more secure retirement income, essentially by deferring their salary to retirement years, may be a preferable arrangement since employees avoid risk as much as possible.

The shift away from defined benefit pension arrangements addressed the risk faced by employers with funding shortfalls when credit becomes scarce, as witnessed with the 2008 downturn. However, as the labour force ages and employees become in short supply, many employees may wish to return to defined benefit plans to retain workers. Policies are needed to ensure that defined benefit arrangements are as viable as alternatives.

Group RRSPs may not be the best vehicle to provide defined benefit arrangements, although it is possible to develop more annuitized income arrangements for employees under these plans. As a supplement to help especially low-income workers, increases in CPP limits on a fully funded basis for existing workers might be needed if markets are unable to achieve alternative defined benefit arrangements.

Whatever reforms are being considered, it is a no-brainer to eliminate the tax discrimination against group RRSPs. It would help many businesses provide reasonable efficient retirement saving plans to their workers, especially small businesses. Other proposals are coming in to fix the Canadian pension system. Jonathan Chevreau of the National Post reports, Pension Reform for Dummies: 5 simple “no-brainer” proposals:

This morning BMO Financial Group’s BMO Retirement Institute released a paper by director of retirement strategies Tina Di Vito [pictured above] outlining five such simple changes. Those who read Tina’s paper in the March issue of Policy Options may already be familiar with them. While I’ve borrowed the ideas from the paper, the exact wording here below is mine. You can find Di Vito’s original here.

1.) Remove age restrictions for RRSPs

Currently, RRSPs have to be converted to annuities or RRIFs at age 71, or cashed out with a big tax penalty. This makes little sense in a world where mandatory retirement is a thing of the past. If Ottawa wants us to live longer and save more, it’s sending us the wrong message in legislating unnecessary and unwanted RRIF payments that are fully taxable and may trigger OAS clawbacks. I agree with BMO that Canadians should decide when they need to withdraw the money from their RRIFs to live on — it’s inevitable that they will one day need to do so and when they do, the government will get its coveted tax bonanza.

2.) Reduce taxes on RRIF withdrawals

RRIF withdrawals are taxed as if they were interest/salary income even if the growth was derived from some combination of dividends and capital gains. We looked at this topic and Andrew Dunn’s suggestion for fixing it in this blog last week. Di Vito is singing from the same song sheet and notes that had such growth been achieved outside registered plans, the income would have received preferred tax treatment and resulted in a lower tax rate. The current tax treatment “skews” investment behaviour in favor of sheltering the highest-taxed but lowest-yielding fixed income investments. At today’s low interest rates, such retirees may not even keep up with inflation. The fix is to consider only the original RRSP contributions as “deferred employment income” while the growth in the plan should be taxed at a rate that mimics non-registered investments.

3.) Broaden opportunities for tax-free RRSP/RRIF rollover on death

Ottawa gets a big tax bonanza when a RRIF holder who is the second spouse to die passes away: the plan balance is included as taxable income in the year of the death. BMO suggests a tax-free rollover to the next generation’s RRSP or RRIF. This would have huge implications for the much ballyhooed “trillion-dollar ” intergenerational transfer of wealth. Of the five proposals this is the one Ottawa may balk at most and I’d think the industry would be content if 1,2, 4 and 5 were adopted at the expense of conceding number 3.

4.) Lower the rate of mandatory RRIF withdrawals

Seniors get understandably upset by the requirement to withdraw — and be taxed on — at least 7.38% of a RRIF’s balance every year, a percentage that rises to 20% in one’s 90s. These requirements were designed during an era of high interest rates but at current rates means retirees are in danger of outliving their money in old age. As medical science advances and longevity rises further, current policy puts those in their 90s at peril. As BMO says, “it is highly unlikely in today’s investment world that investment returns will keep pace with the withdrawals” — especially if invested in fixed income. To point number 2, seniors would have a better shot at it if invested in stocks but current policy motivates them to stay in low-yielding interest-bearing vehicles. BMO suggests Ottawa can extend the lives of RRIFs by lowering the withdrawal rate but doesn’t specify what the new lower rate might be. I’d suggest it should be no higher than what 3- or 5-year GICs currently pay.

5.) Increase maximum contribution amounts for RRSPs

This recommendation parallels a similar one by the CD Howe Institute, as mentioned in this blog entry. BMO thinks RRSP contribution limits need to be hiked from the current 18% of earned income and $22,000 maximum to higher (but unspecified) levels. It suggests there be parity with current Defined Benefit pensions, which are able to make plan members whole in the event of investment losses. BMO notes an interesting fact I’d not seen before: that current RRSP rules favor households: a couple each earning $75,000 get combined RRSP room of $27,000 while a single taxpayer earning $150,000 can only contribute $22,000.

This particular paper focuses on just RRSPs and RRIFs but of course further tweaking is possible with the new TFSAs, of which Di Vito is a fervent advocate. We’ve looked before at Malcolm Hamilton’s proposal to make TFSA contribution room retroactive to age 18, or to introduce a lifetime TFSA contribution room that might be some hundreds of thousands of dollars. There are also suggestions that it be made easier to make lump-sum contributions to RRSPs or TFSAs from special lifetime events like inheritance, severance and the sale of certain assets.

In short, the tools to fix a pretty-good system and make it into a world-beating system are all there now: all we need to do is get Ottawa to bring them into the 21st century. BMO’s suggestions are a good place to start.

This morning, I appeared before the Senate Standing Committee on Banking, trade and Commerce. James Pierlot, pension lawyer and consultant also presented his views. After us, the Committee heard from Kevin Milligan and Richard Shillington. The minutes of the proceedings will soon be available here.

James and I agreed on many fronts, except he wants to push for large multi-employer pension plans, whereas I was arguing for a universal pension plan (UPP) managed by several defined-benefit plans spread throughout the country, and incorporating world leading governance standards.

I enjoyed this meeting but it was too short. The Senators asked great questions and I feel like we only scratched the surface here. Hopefully they will invite us back so we can discuss pensions, the financial system and the economy. I thank them for giving me the opportunity to discuss my thoughts on this important issue.