PENSIONS. When to Hold Them: How to Fold Them. Deryk Kendall

Transcription

1 PENSIONS When to Hold Them: How to Fold Them Deryk Kendall

2 LAW SOCIETY OF SASKATCHEWAN These materials have been prepared for use in conjunction with a seminar presented by the Law Society of Saskatchewan. Reproduction of any portion of these materials without the express written consent of the Law Society of Saskatchewan is strictly prohibited. These materials are reproduced by the Law Society of Saskatchewan as part of its mandate to provide continuing professional development activities to its members. The views expressed herein are the personal views and opinions of the individual authors and do not necessarily represent the position of the Law Society of Saskatchewan or other seminar participants. These materials are the result of substantial commitment and dedication on the part of the authors. However, the authors of these materials have assumed that its users will exercise their professional judgement regarding the correctness and applicability of the material. No warranty is made with regard to these materials. The Law Society of Saskatchewan can accept no responsibility for any errors or omissions, and expressly disclaims any such responsibility.

3 PENSIONS WHEN TO HOLD THEM: HOW TO FOLD THEM Aside from the valuation of a complex business enterprise, the proper valuation and division of a pension is perhaps the most misunderstood and difficult concept in family law practice. It lead Mr. Justice Cameron to recently comment: Before leaving the matter we might add that this business of valuing pension benefits on marriage or spousal relationship breakdown is complex and uncertain, arcane even. It is so much so as to make it difficult for few but actuaries to confidently come to grips with its intricacies and so much so as to suggest the whole business should perhaps be clarified by legislation, as remarked upon in Best v Best, legislative beyond The Pension Benefits Act, 1992, s.s 1992 c R See Dubelt and Moranetz Dubelt (Sask C.A. Jan ), 2010 Carsewell Sask 15 para 23; 343 Sask R. 215 WEBINAR: D. Kendall Division of Pensions, April 12,

4 TYPE OF PENSION While sometimes difficult and sometimes arbitrary decisions have to be made, the starting point in valuation is to determine the type of plan. Generally, they fall into one of two types: A. Defined Contribution Plan A smaller percentage of plans fall into this type. In this plan, both the employer and the employee make regular contributions. All contributions are invested. At retirement, the balance on the fund is used to purchase an annuity. This type of pension is easy to value as its really no different (in this respect) to an RRSP. Its value is simply the contributions and growth thereon at any particular point in time. B. Defined Benefit Plan A defined benefit plan obligates an employer to pay a retirement benefit based on income earned from the employment and the number of years worked for the company. A typical defined benefit plan would have you calculate the average of your best five years of employment income and multiply such average amount by 2% (or such other percentage as the plan provides) for each year he or she worked for the company. There is generally a maximum percentage of such annual income that will be paid out in such a pension plan irrespective of the years worked. Often that maximum is 70% which means that if you worked for more than 35 years, you would not receive more than 70% of the averaged yearly income. The method of valuation of this type of pension and the various contingencies in relation thereto that will take up most of the remainder of this seminar. The employee will generally receive an annual statement showing the pension the employee has earned to December 31 st of the statement year. Unfortunately, this simply states that the employee has earned a certain monthly pension amount that would be payable to that employee at normal retirement date. Unfortunately it does not provide us with a lump sum or capitalized value of that pension. The primary objective is to arrive at a capital value that fairly represents the present value of that future stream of income that the member will receive from his or her pension at some point in the future. This valuation will generally require the retaining of an Actuary to calculate that capital sum. Unfortunately even that valuation is not an exact science as WEBINAR: D. Kendall Division of Pensions, April 12,

5 the Actuary will typically provide various values dependent on factors that will be discussed shortly. In pensions in which the provincial legislation (The Pension Benefits Act, 1992) applies, the Pension Administrator is obligated to provide the commuted value of the pension that accrued from the commencement of spousal relationship and ending with the date mentioned in the order or agreement. (See Section 47 of The Pension Benefits Act, 1992) Information about the pension and its benefits must be provided not only to the member of the pension plan but to the spouse of a member or the solicitor of the spouse in a case where the pension is being divided. (See Section 13(1)(f) of The Pension Benefits Act, 1992) This calculation is done quickly and without cost and in cases of a short employment period of where the pension member is a long way from retirement, might be a quick and easy way to use for division purposes. It is important, however even in such a case to consider whether the employee has made excess contributions to his or her pension. Section 31(1) of The Pension Benefits Act, 1992 provides that a member shall not contribute to more than one half of the commuted value of his/her pension. If for example the commuted value of a pension is $40,000.00, then the member must only contribute a maximum of $20, towards that pension. If the member s contributions and the interest exceed $20,000.00, the amount by which the contributions and interest exceed $20, is called excess contributions and those excess contributions would be returned to the member in the event the member was terminated. As a result, if you do obtain a commuted value under the provision of The Pension Benefits Act, 1992, you must also obtain a statement showing the contributions and interest thereon made by the member. One last factor to be considered when using The Pension Benefits Act, 1992, is that the commuted value as determined by the Administrator is based on what is referred to as the termination method. In some circumstances it is more appropriate to calculate the pension by using the retirement method. WEBINAR: D. Kendall Division of Pensions, April 12,

6 RETIREMENT METHOD vs. TERMINATION METHOD For a very detailed review of pension issues, including the retirement method vs. the termination method, you should read the case of Knippshild [1995] 5 W.W.R 257. Mr. Justice Klebuc describes in significant detail not only the actuarial valuation but the various contingencies that should be addressed. An overly simplified difference between the two methods is as follows: A. In the termination method we assume that the member spouse terminated his/her employment on a specific date. When calculating his/her average annual earnings for the purpose of determining the value of the pension we look at the average of the best five years prior to that date. B. In the retirement method we assume that the member continues to work until retirement. The average salary is thus based on the five years prior to retirement and therefore there are assumptions made as to the earnings at that time. This would generally result in a higher value. A good example illustrating the significant difference that could occur between those methods could be found in the case of Cavers v. Cavers [1996] S.J. 25. In that case the Plan Administrator valued the member s termination benefits to be $187, An Actuary valued the pension based at the earliest possible retirement date with full pension to be $331, WHAT METHOD WILL THE COURT CHOOSE? That determination is based on the facts of each particular case. Many earlier cases felt that if the period of time left until retirement exceeded five years then generally the fairest method would be to use the termination method. (See Harrop 37 R.F.L. (3d) 433) The Knippshild case by Mr. Justice Klebuc suggested that the retirement method provides a fairer approach if retirement is not more than ten years away. The further a member is away from retirement brings into play factors such as whether the employee might quit, be fired, become disabled or die prior to retirement. The closer a member is to retirement, the more likely he/she will remain with the company until retirement. It is clear, however, from the cases that the determination of that issue is a factual one, when is the member most likely to retire. WEBINAR: D. Kendall Division of Pensions, April 12,

7 STILL MORE FACTORS Unfortunately, choosing either a retirement method or a termination method does not completely resolve the matter. The determination of that issue will only resolve the average income to be used (at date of termination or date of retirement) but it does not decide the date of which the retirement benefits would be paid. The Plan Administrator (pursuant to The Pension Benefits Act, 1992) provides the pension income earned at termination date and such payment starting at normal retirement age (often 65 years of age). Many plans allow for retirement at various times. For example, a typical plan may include the following options: A. A reduced pension at a specific age or after minimum number of years with the company. B. A non reduced retirement pension at a specific age or after a minimum number of years with the company. C. An unreduced pension at normal retirement age. The longer a plan must pay pension benefits to an employee, normally the higher the capitalized value of the pension. If a person takes an unreduced pension starting at age 55, the capitalized value of that pension would be significantly higher than that same person not taking his/her pension until age 65. As a result the Court must determine not only whether the pension member will work until retirement but at what age is that person likely to retire. INDEXING If the plan to which the member belongs is indexed (ie. Receives automatic increases on a regular basis based on some percentage of the consumer price index) the Actuary will take this into consideration when he/she values the pension. A more difficult issue arises when the plan is not automatically indexed but the plan receives ad hoc increases from time to time. The City of Saskatoon Police Service is an example of pensions that fall into this category. Although not automatically indexed, they have received ad hoc increases approximately each second year. I have talked with two Actuaries about this factor. Both indicated that those pensions are clearly worth more than an non indexed pension but not as much as a pension that is automatically indexed pursuant to the provisions of the plan or by legislation. WEBINAR: D. Kendall Division of Pensions, April 12,

8 FUTURE TAX DISCOUNT In many cases the spouses agree to divide their registered assets equally. There is no immediate tax consequence to such a division and each spouse would pay tax on his and her registered assets when they cash them in in the future. As a result, in such a case discussion of a tax discount is not relevant. If however one party receives more than one half of the registered investments, the spouse receiving the greater amount will seek a discount because he/she will incur tax on that excess amount at some time in the future. Many cases have used a 25% to 30% discount more often as result of an agreement between the parties through their solicitors rather than any evidence called in relation to that issue. Mr. Justice Klebuc in Knippshild agreed to a 30% reduction with reluctance because it was agreed between the parties. His review of tax discounts suggested that 30% in most cases was probably far too generous. DISCOUNT FOR LUMP SUM PAYMENT Our Court of Appeal in Tataryn [1984] 38 R.F.L. (2d) 272, determined Mr. Tataryn s pension benefit to be worth approximately $56, Although they agreed that Mrs. Tataryn was entitled to an equal share they ordered that she be paid an immediate lump sum benefit of $25, rather than $28, because it would be available to her now to use and enjoy as she will while her husband s share would continue to be locked in and restricted. There does not appear to be many cases that have followed such discounting but it is not clear whether there has been much argument or evidence called in respect to that issue. WEBINAR: D. Kendall Division of Pensions, April 12,

9 OTHER FACTORS Mr. Justice Klebuc in Knippshild reviews a number of other possible discounting factors and made the following determination in respect to each of those factors: A. Loss of Opportunity 0 B. Cost of Borrowing 0 C. Immediate use in employment benefit 0 D. Possibility of loss of job 1% per year prior to retirement E. Risk of premature death 1% per year to date of retirement F. Risk of errors in interest and inflation assumptions 2% per year to date of retirement Mr. Justice Klebuc therefore used the retirement method but discounted the value thereof based on the factors described above. Again, this type of discounting does not appear to have been generally used in subsequent cases. Whether you agree with such discounts or not, this case should certainly be read as it conducts a very good discussion about all of the factors dealing with valuation of pensions, issues and possible discounting factors. WEBINAR: D. Kendall Division of Pensions, April 12,

10 VALUE OF PENSION AT COMMENCEMENT OF A SPOUSAL RELATIONSHIP FOR EXEMPTION PURPOSES If a spouse was a member of a pension plan at the time of commencing a spousal relationship, that spouse is entitled to an exemption for the value of the pension at that date. If the pension is a defined contribution pension, that value is easily determined. It is simply the value of the employer and employee contributions and the growth thereon effective the date the spousal relationship commenced. If the pension is a defined benefit plan, the value of the pension at the time of the marriage might be valued either using the value added method or the pro rata method. In the value added method the value of the pension at the time of the spousal relationship is valued by looking at the income earned at the time of the spousal relationship. In the pro rata method, the pension is valued at the current date and the exemption amount is simply the number of years of the pre spousal relationship pension divided by the total years of pension service. The Supreme Court of Canada in Best v. Best [1999] S.C.R. 868, found that in a defined pension benefit the pro rata method was the appropriate method to use. LEGISLATION Reference has been made to The Saskatchewan Benefits Act, (1992). This statute is not applicable to all pensions. For example, federal government employees and employees of federally regulated industries such as railways, airlines, RCMP etc. are governed by federal legislation. In addition, many provincial pensions such as public service pensions are governed by their own acts. For example we have The Public Service Superannuation Act and The Teacher Superannuation Disability Benefits Act etc. There is obviously no time in this discussion to discuss various pieces of legislation. Suffice it to say, however, that you must determine any particular case whether the pension is governed by a legislation other than The Saskatchewan Benefits Act, (1992). WEBINAR: D. Kendall Division of Pensions, April 12,