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On December 14, 2007, the Federal Government gave Royal Assent to legislation implementing the phased retirement rule changes announced in the 2007 Federal Budget and Economic Statement. The legislation is a significant step towards the introduction of phased retirement across all Canadian jurisdictions, although provincial action is still required to allow non-federally-regulated employers to take advantage of the changes.
Why Phased Retirement?
A recent survey of senior officers in the business community conducted by Watson Wyatt and The Conference Board of Canada found that well over one-half of CFOs and vice-presidents of HR were “very concerned” with attracting and retaining highly skilled and high performing employees. In order to address this concern, one-third of respondents have implemented, or plan to implement, some sort of phased retirement program.
Many organizations already make informal phased retirement accommodations on an individual basis, by allowing an employee to retire, begin receiving their pension, and then return to work on a part-time contract basis. Until recently, Income Tax Regulations (Regulations) prohibited employees from accruing any further benefits under a defined benefit (DB) provision of a pension plan if they were receiving retirement benefits under a DB provision of the plan or another of the employer’s DB plans. As a result, informal phased retirement arrangements were often the only way to allow individuals to start their pension while continuing to work for an organization. However, the resulting loss of seniority, job security, active member benefits (e.g., medical and dental) and discontinued pension accrual made them less than ideal. The changes to federal legislation will now provide employers and employees with better options for developing and implementing phased retirement programs.
Changes in the Federal Budget Implementation Act and
Budget and Economic Statement Implementation Act
The Budget and Economic Statement Implementation Act (Bill C-28) contains provisions to implement measures from the 2007 Budget that were not included in Bill C-52, the Budget Implementation Act, 2007 (Bill C-52). Bill C-52, which received Royal Assent on June 22, 2007 defined phased retirement and provides the framework for its implementation.
Bill C-52 amended the Income Tax Act (ITA) and Regulations to allow DB registered pension plans to give qualifying employees bridging benefits on a stand-alone basis or receive up to 60% of their accrued pension while they continue to accrue additional benefits. The 60% limit will be based on the amount of lifetime pension benefits (and bridging benefits) that the employee would receive if he or she were instead taking full retirement. However, the phased retirement rules set out in Bill C-52 only changed the relevant income tax legislation. Before a plan sponsor can take full advantage of this new flexibility, changes are required to provincial pension standards legislation. As a first step, Bill C-28 amends the federal Pension Benefits Standards Act (PBSA) which will permit an employer with a federally-regulated pension plan to proceed with phased retirement.
Federal Phased Retirement Amendments
Bill C-28 defines a phased retirement benefit as a pension benefit that is equal to a portion of the immediate pension benefit that a person is entitled to receive upon either reaching normal retirement age or qualifying for early retirement under the terms of their pension plan.
As a result of Bill C-28, a federally-regulated pension plan will be able to provide for the payment of a phased retirement benefit if the following criteria are met:
The plan member enters into a written agreement with either
an employer who contributes to the pension plan from which the phased
retirement is to be paid, or a prescribed administrator that indicates that
the member and employer/administrator have both agreed to the phased
retirement;
The member continues to accrue a pension benefit during the
phased retirement period pursuant to the Regulations; and
A phased retirement benefit can only be paid to a person who was receiving a joint and survivor (J&S) pension benefit prior to the phased retirement period if the spouse or common-law partner in question consents in writing to the cessation of the payment of the benefit. According to Department of Finance representatives, this provision was designed to provide currently retired persons the opportunity to take advantage of the new phased retirement options. Requiring the consent of the beneficiary of the J&S pension benefit ensures that spouses and common-law partners do not lose any rights without input. Once the phased retirement agreement is finished, there is no return to the formerly agreed-upon J&S pension benefit. The initial election is rendered void and the retiree is required to make a new decision regarding any further pension benefits payable.
1. During the Phased Retirement Period
Bill C-28 contains a number of amendments that create exceptions to the current PBSA provisions during the phased retirement period, including the following:
Employees will still be considered plan members during a
phased retirement period, will not be considered “retired” under the
PBSA, and will be deemed not to be receiving an immediate pension benefit;
The 50% rule does not apply at the time of commencing a
phased retirement period. Since the member on phased retirement is not
considered to have retired, the 50% rule in a contributory plan would
not apply until the member ceased employment with the employer.
The phased retirement benefit can be paid to the member only and there is no requirement to pay the benefit in a joint & survivor form if the member has a spouse when the phased retirement benefits begins.
2. After the Phased Retirement Period
Bill C-28 also contains provisions governing the treatment of pension benefits after the conclusion of the phased retirement period. These include the following:
Pension benefits accrued during the phased retirement period
are treated as vested “without regard to conditions as to age, period of
membership in the pension plan or period of employment;”
The amount of the phased retirement benefit received is not
taken into account when determining the immediate pension benefit to which a
plan member is entitled or eligible to receive when they retire in full.
This will ensure that the amount and value of the pension payable on
complete retirement is not reduced or diminished because of the earlier
phased retirement; and
A member who passes away during the phased retirement period will be deemed to have retired for the purposes of the survivor benefit and to have chosen a joint and 60% survivor form of pension. As a result, the surviving spouse of that person will be entitled to the 60% survivor benefit commencing as of the death of the member.
Phased Retirement in Other Jurisdictions
The amendments to the PBSA are only relevant to federally-regulated entities such as banks, telecommunication companies and airlines. Provincially-regulated pension plans will have to wait until the relevant pension standards legislation is amended to accommodate the new phased retirement provisions now permitted under the ITA.
Currently, the only provinces that permit phased retirement are Alberta and Quebec, although Manitoba has produced legislative amendments yet to be brought into force. The current provisions in Alberta and Quebec only allow payment of a lump sum at the beginning of each year directly related to the reduction in work time, and permit the member to continue to accrue benefits during the phased retirement period. Once the member is eligible to retire in full, the provisions permit the member to commence receiving a pension but the accumulated value of the lump sums received must be offset against the ultimate pension and the member has lost the value of any early retirement reductions and bridging benefits that would have been payable had he or she simply retired at the beginning of the phased retirement period. The changes to the tax rules will overcome this drawback by allowing partial payment of the early retirement pension.
However, based on the changes to the ITA and Regulations made by the federal government, Alberta and Quebec will need to amend their legislation in order to permit plans to offer the accrual and payout of pension at the same time, without having to offset the accumulated pension against the ultimate pension upon full retirement. Finally, as Manitoba’s phased retirement regime is based upon the Quebec and Alberta models, amendments will also be required in order to match up with the new income tax provisions.
Implications
For federally-regulated employees, the federal government has taken steps to eliminate the pension standards obstacles to the phased retirement provisions of the ITA.
Phased retirement can serve as a useful tool for employers to help keep older workers who possess expertise, knowledge and skills that are in high demand. The introduction of provisions amending the PBSA in order to define phased retirement and provide the framework for its implementation is an important step in the introduction of phased retirement in all Canadian jurisdictions. A number of Canadian jurisdictions have noted that they are waiting to see the final ITA and PBSA regulations from the federal government before deciding whether or not to implement their own phased retirement provisions.
Without phased retirement programs, employees who continue to work despite being eligible to receive reasonably generous early retirement pensions often end up working for substantially less than the wages received, when the value of missed pension payments is taken into account. By permitting the continued accrual of a DB pension while allowing for receipt of a portion of the unreduced pension, the new measures will reduce the likelihood of this loss of income. Under the ITA changes, the employee in this situation can collect on the value of the early retirement pension by receiving as much as 60% of that pension and still accrue more at the same time.
Employees will have to ensure that phased retirement is the correct option for them. Since only 60% of the pension can be received, it remains to be seen whether the 60% pension with continued accrual will be sufficient to entice employees to remain at work instead of collecting 100% of the pension and working elsewhere or for the same employer as a contract employee. And while the option of returning to work and recommencing to accrue a pension may be an attractive one to some retirees (if, for example, the entire pension can be recalculated with more favourable reductions upon subsequent retirement), they will need to seriously consider the pros and cons of stopping the pension payments in order to begin a phased retirement period.
Finally, employers will need to consider all the ramifications of offering a phased retirement program, to ensure that it succeeds in its objective of encouraging key employees to stay a bit longer rather than tempting employees to reduce working hours earlier than intended. With the PBSA changes, it appears that federally-regulated employers will be permitted to offer phased retirement on a selective basis, employee by employee, although it is not certain whether the package terms can differ from person to person depending on their circumstances. For other jurisdictions in Canada, until the required amendments are made to pension standards legislation, it will remain unclear whether an employer will be able offer phased retirement on a selective basis or whether it will have to be made available to broad-based membership.
This is an issue that needs to be resolved. If it is certain that different members can be treated in different ways (such as the degree of generosity of the pension offering, or the ability to refuse to offer phased retirement to some members based on individual circumstances, without risk of being deemed to be discriminating or using plan assets to benefit some members and not others), then the pension plan route may prove advantageous. Otherwise, employers will likely continue to create phased retirement packages for individuals based on current pension plan provisions, and will instead use cash or other financial and non-financial rewards to entice the employee to continue working.
Please contact Cindy Boates, Dean Taylor or your Watson Wyatt consultant for additional information.
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