Federal Budget Contains Important Measures Impacting Pensions, Employee Benefit Plans, and the Labour Force Yesterday, the federal government delivered its budget, or Economic Action Plan 2012. Certain measures, such as changes to OAS eligibility, were widely anticipated; others, perhaps less so. Regardless, the government is continuing its focus on a return to balanced budgets over the medium term. 1. Pension Measures OAS Eligibility As suggested by the government and various commentators in recent months, the Budget has announced that the eligibility age for Old Age Security (OAS) and the Guaranteed Income Supplement (GIS) will be increased from 65 to 67. It is interesting to note that the OAS, when first introduced, had an eligibility age of 70, when at that time, Canadians' life expectancy was about 20 years less than it is now (for a brief history of the OAS, see the accompanying Side Bar). This change will be phased in commencing April 2023 and will be fully implemented by January 2029. Fortunately, a long lead time for planning this major change is being allowed. The measure will affect Canadians born in April 1958 and later. Effectively, the eligibility age will increase by one month for every two months of elapsed time. The ultimate age 67 eligibility will apply to Canadians born in or after February 1962. What had not been previously indicated was that, unlike the current situation, Canadians will be able to defer the start of their OAS Old Age Security (OAS) According to Service Canada, the Old Age Security (OAS) program is one of the cornerstones of Canada's retirement income system, and has undergone extensive evolution since its primary component, the Old Age Security pension, was first introduced in 1952. The age of eligibility, initially set at 70, was gradually reduced to 65 between the years 1965 and 1969. During this period the Guaranteed Income Supplement was also introduced in 1967. Subsequently, the Spouse's Allowance was introduced in 1975 and extended 10 years later to all lowincome widows and widowers between the ages of 60 and 64. Full cost-of-living indexation, first annually and then quarterly, occurred during the early 1970s. "Clawback" provisions, by which pensioners earning an income over a given threshold ($69,562 in 2012) have to pay back part or all of the pension, were introduced in 1989. Benefits and obligations were extended to same-sex common-law partners in 2000. Although financed from Government of Canada general taxation revenues, the Parliamentary Budget Officer recently reported that OAS is sustainable in its present form until at least 2037. Aon Hewitt 2012 Aon Consulting Inc./Hewitt Associates Corp. (Aon Hewitt). All Rights Reserved. 1
benefits (but not GIS) for up to five years, starting July 1, 2013, where the starting pension will be increased actuarially due to the delayed pension commencement. This measure parallels existing CPP/QPP features designed to encourage senior Canadians to stay in the workforce longer and increase the ratio of workers to nonworkers. We are however, disappointed that the government did not also include a provision for earlier commencement of OAS benefits via actuarial reductions (as is the case for CPP/QPP benefits). The government has pointed out that 22 out of 34 Organisation for Economic Cooperation and Development (OECD) countries have raised their public pension eligibility ages, including Australia, France and Germany (to 67 between 2012 and 2029), the U.S. (to 67 by 2025) and the U.K. (to 68 by 2046). Ages of eligibility for the Allowance and the Allowance for the Survivor (for low-income seniors) will also be increased by two years in the same manner, from the current 60-64, to 62-66. Other federal government income support programs will be adjusted to pay beyond age 65 to dovetail with the announced OAS changes. Obviously, provincial government support programs will be strained by these changes as they will be required to pay out greater benefits to lower income Canadians between the ages of 65 and 67. The federal government has therefore announced that they will compensate the provinces for the net additional costs they face due to the increased OAS/GIS eligibility age. Commentators have been justifiably criticizing the application system for OAS, as many older Canadians are not aware of the program and accordingly do not apply for and miss out on benefits to which they are entitled. To address this concern, the government has announced that they will put procedures in place to eliminate the need for seniors to apply for OAS and GIS. This will reduce the administrative burden on both seniors affected and the government, and will be implemented between 2013 and 2015. Pension plan sponsors may wish to consider these changes in OAS benefits for several reasons. Financial/retirement planning services to members should be even more important than in the past, to enable employees to properly prepare for retirement at or beyond age 65, with less public pension benefits from ages 65-67, particularly for plan sponsors with defined contribution or other money-purchase plans. Employers must consider their workforce planning now, as there will be a disincentive for employees to retire at or near age 65, with many opting to work longer, perhaps with age 67 becoming the new "normal retirement age." On the one hand, this could be beneficial where employers wish to retain older experienced workers; however, in other cases, where it is necessary to make room for younger staff, employers may need to re-evaluate their severance and retirement benefits designs to encourage employees to retire in dignity. We note that last week's Quebec budget added a tax incentive for workers to stay at work beyond age 65. Aon Hewitt 2012 Aon Consulting Inc./Hewitt Associates Corp. (Aon Hewitt). All Rights Reserved. 2
Pension Plans for Public Servants and Parliamentarians With an emphasis on ensuring the sustainability of the pension plans provided to federal public service employees, the Budget contained the following proposals, which will introduce changes gradually following consultation with key stakeholders: Adjust employee contributions to the Public Service Pension Plan over time, to be equal to those of the employer. Comparable changes will be made to the pension plans for the Canadian Forces, the RCMP and Parliamentarians; Raise the normal retirement age from 60 to 65 for employees joining the federal public service after 2012; Introduce adjustments to the pension plan for Parliamentarians in the next Parliament (i.e. after the next federal election which will probably not occur for at least several more years); and Work with Crown corporations to ensure their pension plans are financially sustainable and broadly aligned with those available for federal employees. Needless to say, these proposals may have broader implications for employers with pension plans modeled after the public sector pension plan and also for public sector plans at the provincial and municipal level. Changes to RCA and EPSP Rules The Budget proposes changes to Retirement Compensation Arrangements (RCAs) and Employee Profit Sharing Plans (EPSPs). RCA's are non-registered funded retirement savings arrangements typically enjoyed by higher-income individuals whose pension benefits from a Registered Pension Plan exceed the government maximum. Employer contributions to an RCA are tax deductible, but a refundable tax of 50 per cent is imposed on contributions as well as income and capital gains. The tax is later refunded when taxable distributions are made from the RCA. A rule exists allowing the payment of the refundable tax to take place in circumstances when the RCA assets are severely depleted. However, some individuals and their employers have used this rule in an attempt to access the refundable tax by artificially reducing the RCA assets. Budget 2012 has responded by introducing "prohibited investments" and "advantage" rules to prevent RCA's from engaging in non-arm's length transactions. The custodian of an RCA set up for an employee with a significant interest in his or her employer will have to pay a 50 per cent tax on the fair market value of any prohibited investment. Similarly, the RCA custodian will need to pay a tax equal to the fair value of any advantage, which will occur when an RCA buys an investment and the value of such investment is later intentionally eroded or transferred from the RCA without adequate consideration. These measures will apply in respect of investments acquired, or that become prohibited investments, on or after March 29, 2012. Aon Hewitt 2012 Aon Consulting Inc./Hewitt Associates Corp. (Aon Hewitt). All Rights Reserved. 3
Many small business owners have been directing company profits to their EPSPs which primarily benefit their family members. Since such contributions are taxdeductible to the company, payment of income tax on such profits are reduced or deferred. Note that all allocations to individuals within the plan are taxable in the year of allocation. To discourage excessive employer contributions, employees receiving EPSP benefits will be taxed at the highest possible marginal federal and provincial tax rates on "excess EPSP amounts" which are defined as EPSP allocations for an individual that exceed 20 per cent of that individual's salary from the employer. An exemption from regular income tax will be allowed to avoid double taxation on the excess EPSP amount, and there will also be a provision for the Minister to waive or cancel this new tax if it is just and equitable to do so. CPP and Pension Legislation The government reiterated the strong financial position of the CPP. Actuarial reports have indicated that it is self-sustaining for at least the next 75 years using the current combined employer/employee contribution rate of 9.9 per cent, so no changes are required to the CPP at this time. The government also stated that it will continue to work closely with provinces to encourage implementation of a PRPP framework in a timely manner to help Canadians reach their retirement objectives, but noted that a high level of harmonization across jurisdictions will be required to increasing the availability of PRPPs and achieve lower costs with respect to such plans. In light of the Quebec and Ontario budgets, released last week and earlier this week respectively, such harmonization may prove difficult to achieve. The government is also reviewing stakeholder comments received on draft ITA and regulatory changes, proposed last fall, and expects to implement new tax rules for PRPPs some time this year (for further information on PRPPs, see Aon Hewitt s on topic: Federal Government Introduces PRPP Enabling Legislation). 2. Health and Benefits Taxation of Group Sickness and Accident Plans Employer contributions paid on or after March 29, 2012 for coverage in 2013 and beyond to a group sickness or accident plan are considered a taxable benefit to the employee. This is a change to subsection 6(1) of the Income Tax Act (ITA). While group sickness and accident plans are not formally defined in the ITA, Aon Hewitt's preliminary view on this change is that the following benefits will now become taxable benefits across Canada: Employer-paid Accidental Death & Dismemberment (AD&D) insurance premiums; and Employer-paid premiums for Critical Illness insurance. Aon Hewitt 2012 Aon Consulting Inc./Hewitt Associates Corp. (Aon Hewitt). All Rights Reserved. 4
The budget documents have also clearly stated that this change does not impact the tax treatment of private health services plans (PHSPs). Accordingly, PHSP's (such as medical, dental and prescription drug plans, and Health Spending Accounts) remain non-taxable benefits for federal income tax purposes. PHSPs have been considered a taxable benefit for Quebec provincial income tax for approximately 20 years. Due to the wording of the change to subsection 6(1), further research is needed to confirm the benefits affected by this ITA change. However, if the benefits indicated above are now considered taxable benefits as of March 29, 2012, this will impact all employer plans that offer these benefits, either through traditional insurance arrangements, or in flexible benefit plans where employees may pay for benefits with employer provided flex dollars. Changes to both employee communication materials and administrative systems will need to be made to reflect this change. LTD Plans at Federally Regulated Employers Must be Insured The government has committed to introducing legislation which will require federally regulated employers to insure their Long-term Disability (LTD) plans going forward. This change is part of a government initiative originally announced in 2010 to better protect workers when their employers go bankrupt, and will only affect federally regulated employers currently self-insuring their LTD benefits. Confirmation of Canada Health Transfer Through 2024 As originally set out in December 2011, the budget confirms the annual increases in the Canada Health Transfer (CHT) to the provinces will be: 6 per cent per annum for the next five years; Increase based on three-year average nominal GDP growth (minimum 3 per cent) until 2024; and To be reviewed in 2024. With the future decrease in rate of growth of the CHT, we would anticipate that even greater pressure will fall on provincial budgets, and specifically with respect to health care. As we are already beginning to see, changes will be required in many provinces in order to return to balanced budgets. Given the inter-relationship between public health plans and workplace equivalents, employers should expect more changes in government health care that will affect their plans. In addition, with separate decisions being made in each province, both the cost and complexity of managing a national employer health plan will increase over the next few years. Aon Hewitt 2012 Aon Consulting Inc./Hewitt Associates Corp. (Aon Hewitt). All Rights Reserved. 5
3. Job-creation incentives The following measures have been proposed by the federal government to address Canada's evolving labour force needs: The Hiring Credit for Small Businesses will be extended one more year to defray the costs of hiring new workers. As such, the credit will be applied on 2012 employers' EI contributions, based on contributions made in 2011; In addition, small and medium-sized businesses and their employees will be protected against large annual EI premium rate increases. Indeed, these increases will be capped at 5 cents annually; and - Changes to the immigration system are proposed. Among other things, improvements to the process of recognizing foreign credentials will be supported by the government. Also, target occupations within this context will be identified, with the collaboration of provinces and territories. Should you wish additional information on this topic, please contact your local Aon Hewitt Consultant, or send an email to info@aonhewitt.com. Aon Hewitt 2012 Aon Consulting Inc./Hewitt Associates Corp. (Aon Hewitt). All Rights Reserved. 6