© Copyright 2000 Rogers Media. The following article first appeared in the November 2000 edition of BENEFITS CANADA magazine.

Unlocking pension assets

Pension assets are supposed to remain locked until retirement--for the good of plan members. Increasingly however, the opposite is happening.

By Sheryl Smolkin

If pensions were a religion, until recently locking-in would have been a principle tenet of the faith. Locking-in means that an employee who is vested in a pension cannot access their retirement savings before their early retirement date. These rules generally apply even if employment with the plan sponsor is terminated and money is transferred into a locked-in retirement account or a locked-in registered retirement savings plan (RRSP).

The tides are changing, though. Over the last few years amendments to pension standards legislation by a number of provinces as well as the federal government have made it easier for younger individuals to access money in locked-in accounts in a variety of circumstances. This leaves pension plan sponsors and other pension professionals who still fervently believe in locking-in wondering if they will be forced to adopt a new liturgy.

Actual or proposed changes to locking-in rules fall into the following six main categories:

• Financial hardship.
• Shortened life expectancy.
• Temporary pension/lump sum withdrawals.
• Changes to the execution/attachment rule.
• Increased maximums for the small pension rules.
• Non-resident status.

In a recent discussion paper, Saskatchewan legislators also suggested that if a pension plan permits the commuted value to be transferred out at retirement, transfer to an unlocked registered retirement income fund (RRIF) should be an available option in all cases.

To understand the nature and extent of actual and proposed changes to the unlocking rules in each of these categories we need to assess whether they are merely a regional aberration or the harbinger of a new heresy. One thing is certain though, new developments in Ontario are a cause for concern.

In May, Ontario provisions allowing withdrawal based on hardship came into effect. Applications for withdrawal must be made to the superintendent of pensions and funds can be withdrawn from locked-in transfer vehicles held by financial institutions but not directly from pension plans.

There are six circumstances where an individual may apply to withdraw money from locked-in accounts because of financial hardship:

• To avoid eviction due to a creditor's claim secured on the property of the owner, their spouse or same-sex partner.
• To avoid eviction for rent owing by the parties noted above.
• To pay first and last month's rent.
• To pay medical expenses of the parties noted above or a dependant.
• To renovate a property to accommodate a personal illness or disability, or that of the parties noted above.
• To increase a low income if the expected personal income before taxes for the next 12 months is less than 66.75% of the yearly maximum pensionable earnings, which is $25,066 this year.

Applications can be made during any given 12-month period for each category of financial hardship. The regulations describe how permissible withdrawals are calculated and the method of application.

Official statistics relating to the quantity and nature of applications under the financial hardship rules are not yet available. But the Financial Services Commission of Ontario provided benefits canada with some preliminary information. As of Aug. 17, they received 1,274 applications, processed 837, denied seven and approved about 800. The leading category by far is low income.

This development raises an interesting question. How many low income applicants are required to tap into their retirement assets before they are approved for welfare? It would be unfortunate if early access to pension funds keeps more people off welfare today only to have their standard of living after retirement seriously compromised.

SHORTENED LIFE EXPECTANCY

All jurisdictions except Ontario provide that the plan or the administrator may commute benefits or commence payment of benefits if an individual is disabled. Most of these jurisdictions require medical evidence that the individual's life expectancy will be shortened considerably.

Since March, all Ontario registered plans have allowed a variation in pension payments in the case of a shortened life expectancy (SLE) of two years or less. This means that pensioners who become aware of a serious illness can also ask to have their pension commuted or payments revised.

When the new regulations were released, plan sponsors and industry associations advised the Ontario government that applying the policy to pensions in pay posed some serious problems. Use of the Canadian Institute of Actuaries' (CIA) existing recommendations to commute pensions after payment commenced would impose unexpected and unintended costs on pension plans because the pension would have to be valued on the basis of a normal life expectancy, not an SLE.

In July, the CIA issued a notice to provide guidance on the calculations of actuarial present values from pension plans to allow for variations in payment in these circumstances. A number of actuarial consulting firms are developing an interim approach while they await the release of a more authoritative recommendation by the CIA.

Allowing pensions to be commuted or payments revised in instances of SLE makes sense. However, many organizations are not able to assess medical evidence, and would prefer not to deal with this issue. As a result, the new deeming provisions in the Ontario rules, combined with their potential application to pensions in pay, have created considerable controversy.

For example, requiring Ontario physicians to certify an individual's life expectancy at two years or less presents obstacles. A doctor may be prepared to state that the individual's life expectancy has been considerably shortened, but not be willing to predict the individual will die within two years.

TEMPORARY PENSIONS

The Quebec Supplemental Pension Plans Act allows individuals under 65 years old, who are less than 10 years away from the normal retirement date under their employer-sponsored pension plan, to apply for a temporary pension. That would come in the form of an annual lump sum, up to the prescribed maximum from the private pension plan, until age 65.

Similarly, consider a Quebec employee who is under 69 years old and less than 10 years away from the normal retirement date in an employer-sponsored pension plan. He can reach an agreement with his employer to reduce working hours and receive money up to a prescribed maximum from the pension plan to supplement employment income.

Recent Alberta amendments permit a form of phased-in retirement. This past summer Newfoundland also announced it was proceeding with similar changes.

Although official figures are not available, it appears that few Quebec plan sponsors have expressed an interest in phased retirement. One reason may be that the maximum pension pay-out to top-up reduced earnings is not a sufficient incentive compared to the resulting reduction in the member's benefit when he fully retires. Many pension plans have rich early retirement provisions that make full retirement prior to the normal retirement date a better deal.

In most cases, money payable under a pension plan is exempt from execution, seizure or attachment by creditors. The exception in all Canadian jurisdictions is that a pension in pay is subject to any of these actions if an order is outstanding for support or maintenance, generally to a maximum of one-half of the money payable.

In 1995, Manitoba took this exception one step further. The Manitoba Pension Benefits Act now allows up to 100% of active and former members' pension benefit credits to be garnished by a designated officer of the maintenance enforcement program of the Department of Justice (Manitoba) to satisfy delinquent family maintenance payments.

At the time, it was suggested that this legislation set a dangerous precedent. Since all provinces were looking for ways to enforce family maintenance orders, the concern was that others would follow suit. But to date, only Saskatchewan has adopted the Manitoba model. In addition, the Manitoba maintenance enforcement office concedes that attaching pension credits of active and former members is not the remedy of choice.

SMALL PENSION RULES

The small pension rules state that unlocking is required or permitted if the annual pension is less than a certain value, the commuted value of the benefit is below a certain amount, or in cases where the commuted value of the benefit is less than 25% of pre-reform benefits. Prior to the most recent round of pension reform benefits, unlocking was required or permitted, depending on the jurisdiction, if the pension was less than 2% of the yearly maximum pensionable earnings (YMPE), or the commuted value of the pension was less than 4% of the YMPE.

So far British Columbia has been the most aggressive on this front. Plans must allow unlocking where the annual pension is less than 10% of the YMPE ($3,760 in 2000), and the commuted value of the benefit is less than 20% of the YMPE ($7,520 in 2000).

Although Ontario set up an infrastructure to rule on unlocking in hardship cases, unlocking of small amounts is still at the discretion of plan sponsors and only if the annual pension is less than 2% of the YMPE. While most pension professionals agree that increases in the small pension amounts are long overdue, the downside is that provincial regulators have all come up with different solutions to the same problem.

Allowing non-residents to unlock pension funds doesn't appear to be a contentious issue. Yet to date, only three jurisdictions have amended pension standards rules to permit this measure. British Columbia and the Office of the Superintendent of Financial Institutions allow an individual who has been a non-resident of Canada for more than two years to have money released from pension plans and other locked-in transfer vehicles held by financial institutions.

Alberta provides that once an individual becomes a non-resident for the purposes of the Income Tax Act, only funds in locked-in transfer vehicles held by financial institutions can be unlocked for transfer out of Canada.

The biggest thorn in the side of multi-jurisdictional pension plan sponsors, however, is that changes to locking-in rules across the country are not uniform.

PLAN PROVISIONS

Despite the ample evidence that reverence for the formerly sacred locking-in rules have waned, in most parts of the country they are still alive and well.

Indeed, plan provisions allowing withdrawals for SLE are at the discretion of plan sponsors, except in Ontario. In addition, temporary pensions/lump sum withdrawals--permitted in Quebec, Alberta and Newfoundland--could lead to seriously eroded retirement benefits. But to date, plan members have shown little interest in taking advantage of these provisions.

Execution and attachment rules that apply to active plan members have been adopted only in Manitoba and Saskatchewan, and even in those two provinces they are used infrequently. Increased maximums for small pension rules and withdrawals for non-residents are generally non-contentious, with the latter exception still available only in B.C., Alberta and for federally regulated plans. If adopted, Saskatchewan's proposal to allow pension funds to be transferred to a RRIF at retirement would apply only where plan sponsors permit portability.

The most significant challenge to the standard locking-in liturgy is clearly the Ontario provisions permitting hardship withdrawals. While other jurisdictions have not indicated that they will adopt similar rules, this development is significant because the largest number of Canadian pension plans are registered in the province.

Allowing indiscriminate withdrawals will not encourage Canadians to manage money wisely or educate them about the long-term advantages of a tax-assisted retirement savings program. If employees can treat pension funds like a bank account, they may decide to substitute additional cash or a group RRSP for a registered pension plan--and ultimately both governments and taxpayers will pay the price for this experiment.

Sheryl Smolkin is a lawyer and director of Watson Wyatt Worldwide's Canadian Research and Information Centre in Toronto. sheryl_smolkin@watsonwyatt.com.

The Romanow Commission has released its final report on the future of healthcare in Canada.

For Commissioner Romanow's recommendations, click here.

Click here for Senator Michael Kirby's report, "The Health of Canadians – The Federal Role: Recommendations for Reform."