Editorial: An interesting tax mechanism to boost DC outcomes

At Benefits Canada’s Defined Contribution Plan Summit in Montreal in February, member engagement and communication were a clear focus of many of the presentations.

Case studies presented at the conference provided a number of solutions. Larry Schmidt, director of human resources at U.S.-based Searles Valley Minerals Inc., noted his company used automatic enrolment and escalation tools, as well as re-enrolment into a more appropriate target-date fund, to improve member outcomes. The result was a significant increase in both assets and participation rates. Particularly noteworthy is the fact that about 80 per cent of employees are now on track to meet the targeted replacement ratio of 75 per cent or more of their income in retirement.

Read: DC Plan Summit: Company harnesses inertia to get majority of workers to 75% income replacement

At Britain’s Nationwide Building Society, key elements of its efforts to improve outcomes include education (through funny videos about the plan, as well as mandatory learning modules for staff) and changes to the plan design that significantly boosted contributions on the company side. The changes allow employees to save up to 23 per cent of their earnings in the plan, with the company putting in 16 per cent as its contribution if members contribute the maximum on their side. It’s clearly a very generous program.

Both are great examples of proactive plan changes. But what about options that don’t come with a significant price tag, as is the case with the Nationwide Building Society plan? On the tax side, Britain offers another interesting example. There, some employees have the tax deduction they get from their retirement contributions go directly into their pension plan. So rather than the tax relief partially offsetting the impact of what they contribute to their plan on their take-home pay, the pension provider adds it to their account to give them an even bigger contribution. It then seeks to claim the tax deduction back from the government.

The system, called relief at source, offers the chance for someone to put in, say, 80 pounds, to get a total contribution of 100 pounds (based on the simplified example of tax relief at 25 per cent; Britain’s basic tax rate is, in fact, 20 per cent). In Canada, people see the tax benefits of their contributions directly on their paycheques, whereas the British option of relief at source provides for increasing how much is going into their pension savings instead. Britain also provides for what it calls a net-pay arrangement, in which employers deduct pension contributions before taking off tax. In that case, employees see the tax relief on their paycheques instead of in their pension accounts.

Read: DC Plan Summit: Mandatory e-learning among British company’s large DC revamp

Is the relief-at-source approach feasible in Canada? Certainly, there would be administrative complexities, and it’s clear the many Canadians who are well aware of the tax benefits of pension savings would prefer to have the amounts go directly into their own pockets, rather than in their retirement accounts. It’s also worth noting that the relief-at-source approach applies the tax deduction to an individual’s pension pot at Britain’s basic rate. Those in a higher tax bracket would thus have to claim the remaining tax deduction later on, which partially blunts the benefit of the additional pension contribution and, arguably, conveys an advantage to the government. Still, the approach is worth exploring as an option for the pension system given the potential benefits of boosting contributions overall.

Interestingly, Britain is in the midst of enacting further changes to its system of automatic enrolment by boosting minimum workplace pension contributions to five per cent as of April 6, 2018. Under the changes, employers contribute at least two per cent, with employees putting in the balance to bring the total to five per cent. The total contribution will increase yet again to eight per cent in 2019. “That’s one way for the government to try to encourage people to save,” says James Mason, a London, England-based senior retirement consultant at Aon. Mason notes that while the increased contributions can be a challenge for some people, particularly for lower-income workers, there’s a fairly widespread recognition of the need to boost pension savings.

Read: What can Canada learn from Britain’s pension reforms?

While the approach has merit, Canada is already in the midst of boosting the retirement system by beginning to phase in contribution increases, along with corresponding benefit improvements, to the Canada Pension Plan in 2019. As such, it’s not the right time to mimic what Britain is doing on automatic enrolment under workplace pension schemes.

The tax issue, however, is another matter. From a cost perspective, it would likely be quite doable. And given the focus on improved member outcomes, it’s an option that’s worthy of consideration in Canada.

Glenn Kauth is the editor of Benefits Canada.