Re-engineering the three pillars
Moving the normal retirement age
Scaling back public sector pensions
Insuring long-term disability plans
In its recent budget, the federal government revealed that it will be eliminating the penny. However, that is not the only penny that has dropped. Prime Minister Stephen 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 system. Now it is official: eligibility for old-age security benefits will be increased to age 67. Other notable changes in the budget are that 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:
- government-sponsored plans – broad-based government-run, supposedly universal pension schemes, including old-age security, the guaranteed income supplement and other provincial supplements and the Canada/Quebec pension plans;
- employer-sponsored plans – employer-provided pension plans, whether defined benefit or defined contribution; and
- individual savings – individual tax-assisted retirement savings, primarily through registered retirement savings plans.
The government has conveniently shifted the pillars due to a weakness in the second pillar. This is not insignificant and should not go unnoticed. Cracks have begun to appear in the retirement income system; by changing the pillars, the system has been made to look stronger and more sustainable.
The adjusted three pillars, as described by the federal government, are:
- the old-age security system, guaranteed income supplement and other provincial supplements;
- the Canada/Quebec pension plans; and
- all other forms of accumulating retirement savings, including employer pension plans, savings plans, registered retirement savings plans and tax-free savings accounts.
Part of the reason for this reorganisation is because the former second pillar (traditionally employer-sponsored defined benefit pension plans) is 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. In addition, the new first pillar, comprised only of the old-age security system and other non-contributory programmes funded exclusively from government revenues, can be treated separately.
In the past, the old-age security system and the Canada/Quebec pension plans (the traditional first pillar) 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). In 1989 the old-age security system claw-back was introduced, thereby eliminating universality.
Moving the normal retirement age
In its budget, the government announced a further chipping away at the old-age security system, 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.(1) Commencing 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 old-age security benefits until they reach age 67 (in 2029). The given reasons are:
- increased cost due to the baby boom generation moving through the system;
- increased life expectancy; and
- according to the government, 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 old-age security system brings imbalance to the system. The Canada/Quebec pension plan is based on a retirement age of 65, as are public and private sector pension plans. Although mandatory retirement has been eliminated across Canada, the vast majority of workplaces use 65 as a normal retirement age. Insured benefits are often reduced at 65 and some, such as disability benefits, are eliminated at 65. Further, the design of many employer pension plans implicitly or explicitly accounts for old-age security benefits and the Canada/Quebec pension plan 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 old age security system will be to permit the deferral of the start date for those wishing to start their pension later and perhaps coordinate the old age security start date with that of the Canada/Quebec pension plans, 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 old age security benefits would be actuarially increased. It is interesting that under the fully mature old age security system with a normal retirement age of 67, the latest start date will be age 72, which is beyond the date by which pension and registered retirement savings plan income must start being received (the end of the year in which one reaches age 71).
The government has confirmed that no changes are being made to the Canada Pension Plan. 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 increase gradually employee contributions to 50% of overall cost.
Few pension plans in the private sector provide for full retirement at age 60. Maintaining 60 as the 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 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 it remains to be seen 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 long-term disability 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 benefits would provide a much needed level of security.
For further information on this topic please contact Mark Newton at Heenan Blaikie LLP by telephone (+1 416 360 6336), fax (+1 416 360 8425) or email ([email protected]).
Endnotes
(1) Interestingly, when the old-age security system was introduced in 1952, the normal retirement age was 70.