In their hurry to convert defined benefit plans or to set up new defined contribution arrangements, plan sponsors spend surprisingly little time selecting the type of capital accumulation plan (CAP) that best suits their situation. Yet paying a little attention in the early design stages can dramatically improve both employee satisfaction and fit with the sponsor’s needs.

CAPs are not a one-size-fits-all form of retirement plan. They normally consist of one (or a combination) of the following elements: a defined contribution (DC) pension plan, which is a registered pension plan; a group RRSP, which is a collection of individual RRSPs administered on an aggregate basis; and a deferred profit sharing plan (DPSP), where the employer, in theory, makes contributions out of current or retained profits.

All CAPs are similar in nature in that they enjoy roughly the same level of tax assistance (i.e. maximum deductible contributions) and they all operate on the principle that the plan member bears the investment risk. Likewise, they are about the same to manage from an administrative standpoint, with service providers relieving sponsors of most day-to-day tasks (member communication and education, plan Web site and call centre, etc.).

Make your choice
As with any decision process, the sensible way to start is for the plan sponsor to establish a set of objectives. Initially, the plan sponsor should have a stated purpose of the plan. Depending on how this is relayed to members in plan documentation, this may limit your CAP options. For example, “…to provide for significant retirement income…” is a much stronger statement than “…to help members save for their retirement.” Setting up a simple group RRSP with no inservice withdrawal limitations would be fine with the second statement, but quite inconsistent with the first.

Besides a statement of purpose, plan sponsors need to assess their resources. Generally speaking, governance requirements are fairly similar for all CAPs. However, DC plans come with the additional burden of ensuring compliance with pension regulations. A good example is amending the plan text, which requires filing and approval for DC plans. On the other hand, a group RRSP offering spousal accounts and the possibility of one-off contributions (such as bonus payments) may seem easier, but can quickly turn into an administrative nightmare as employees continually make changes. Even though service providers take care of a lot of these issues, the sponsor may still be in for a lot of extra work.

Key to making the right choice is understanding your employee preferences. Well-advised sponsors would gather their own members’ opinions with surveys, focus groups or input from unions. Strong opposition to locking-in rules may preclude the DC plan option, for instance a situation often seen where there is a majority of younger employees, frequently looking to use the Home Buyers Plan. However, employee preferences need to be balanced against the plan’s main purpose: How will a group RRSP regularly depleted by withdrawals afford members an adequate retirement income?

Plan sponsors however shouldn’t be too rigid once the information is gathered. Issues such as employee contributions and the flexibility of plan design come into play when assessing plan member concerns. Some employers (and employee representatives, where a union exists) might prefer the steady and predictable flow of employer contributions in a DC plan, thus allowing for more reliable retirement income projections. Then again, a fastgrowing employer with volatile annual profitability might prefer the funding flexibility allowed by a DPSP, with the additional positive reinforcement this brings in workforce management.

Similarly, some employers are looking to attract experienced or aging workers with part-time or occasional work. In such a context, flexible employee contribution commitments and easily accessible savings would be desirable features.

Repeatedly overlooked is the fact that employer contributions to a group RRSP are deemed to be salary paid to the employee. This basically means that&#8212unless the pre-contribution employee salary is over the various applicable thresholds&#8212payroll taxes will apply to employer contributions.

These costs add up and can be surprisingly high. For example, in addition to its basic contributions, an Ontario-based employer would have to pay the Ontario Employer Health tax of about 2%, nearly 5% of eligible earnings for the Canada Pension Plan, plus more than 2.5% for Employment Insurance (nearly 10% in total). Add in Workers’ Compensation premiums (which, depending on the industry, can be quite hefty), and the total will easily exceed 10% of contributions.

The vast majority of sponsors opt for a combination of plans to maximize the fit with both employer and employee needs. For instance, DC plans are typically implemented along with a group RRSP, where voluntary contributions that are not matched by the sponsor are invested. This allows the pension plan to meet the sponsor’s desire to adequately fund its employees’ retirement, while offering members additional flexibility and competitive investment management fees for their personal savings. Likewise, group RRSPs and DPSPs are generally used in tandem for employee and employer contributions respectively- thus solving the payroll tax dilemma mentioned above.

DC plan or DC component?
For many sponsors going through a conversion, it makes sense to simply open a defined contribution (DC) component in their defined benefit (DB) plan for future service of targeted employees (typically new hires). However, there are currently two significant uncertainties that, when resolved, will have a great impact on whether this remains the desirable way to go.

Although now only theoretical for many, it was customary for sponsors to use the surplus under the DB provision to meet their contribution requirements under the DC provision. In fact, when there is excess surplus in the registered pension plan as defined under the Income Tax Act, the Canada Revenue Agency requires that the surplus be used to satisfy the employer contribution requirements under the DC component. Moreover, in cases where a DB plan is replaced by a DC plan or where a DB plan is converted to a DC plan, the transferred surplus must be used to satisfy the employer’s contribution obligations under the DC component.

The recent Kerry decision in Ontario considers this practice inappropriate and goes against the Income Tax Act in that regard. This decision has disturbing implications for plan sponsors and has created great uncertainty- which would get worse if jurisdictions other than Ontario were to take a similar stance under similar circumstances. Any sponsor thinking about entering that territory should therefore tread very carefully.

Another uncertainty that will likely be clarified shortly is the treatment of DC members upon the termination of a combined DB/DC plan. Technically, in some jurisdictions, DC members would be entitled, if the plan were in a deficit situation, to the same portion of their assets as the DB members would be. Quebec has just introduced Bill 30, which would exclude DC members from this situation and consider their accumulated assets separately in the event of plan wind-up. But this has not made it into law, and other jurisdictions have yet to amend regulations to correct this awkward situation.

Moving on
Once the right type of CAP has been chosen, the next steps will focus on fine-tuning the design, again keeping in mind the plan’s main purpose. One of the most important items will be setting basic employee and employer contribution rates, as well as any sponsor-matching formula, by which the sponsor oftentimes encourages voluntary additional contributions from members by adding some form of matching contribution. It is worth noting that as DB plan sponsors have found funding their pension promises ever more expensive lately, contribution rates in DC plans and other CAPs have generally not been set at a level that would be sufficient to provide members with equivalent pension income. The next challenge for the industry may very much then be the increase of contributions to allow adequate funding for members’ pensions, just like in DB plans.

Finding the Right Fit

To better illustrate how to find a good fit between program objectives and plan type, let’s look at some real-life examples.

Example #1: A small public sector organization was forced to terminate its traditional DB plan and was looking to implement a CAP to replace it. The objective in this case was unambiguous: to encourage the accumulation of savings solely for the transition to retirement-just as the DB plan was doing previously.

Solution: The protection of accumulated savings provided by lockingin rules and the clear retirement objective made the DC plan the obvious choice (the notion of keeping a “pension plan” was also important to employees). To further ensure the attainment of the desired objectives, participation remained compulsory, eligibility rules were broadened and a generous 100% matching rule over and above the minimum employee contribution was added to top off a basic employer contribution and encourage optional employee contributions. Finally, younger female members of the plan (a significant portion of employees), were happy that the sponsor would be able to continue making contributions during periods of maternity leave.

Example #2: A call centre organization fighting to attract and retain employees in a very competitive market was looking to put a retirement arrangement in place to improve its employee benefits package. The relatively high cost of the initial four-week training period made the high employee turnover rate (well above 20% in the first year of employment) very expensive. The relatively young workforce favoured a group RRSP for the flexibility of unrestricted savings, such as access to the Home Buyer’s Plan. The new plan was to encourage a minimum tenure so vesting became an important consideration.

Solution: A combination of a group RRSP and DPSP was introduced. Employees now make their contributions to the group RRSP and the employer makes its matching contribution to the DPSP. A 24-month vesting rule in the DPSP allows the organization to recover its share for employees leaving early. These forfeitures are used to fund staff replacement-related training costs.

Example #3: A large public technology company sought to improve its competitiveness in attracting a highly skilled workforce. The results of a company-wide survey showed that employees (mostly engineers) were very comfortable with investments, and looking for maximum flexibility with their savings—including the ability to transfer them to their personal self-directed RRSPs. Salaries were quite high, with few employees earning less than $50,000 a year. Long-term incentives included an employee stock purchase plan, with a very good participation rate.

Solution: The employer thought that a group RRSP offered the best fit in this situation. The flexible access to funds was desired by many employees and the high income levels mitigated the payroll taxes on employer contributions for earnings under the CPP and EI thresholds. No limits were imposed on transferring savings outside the plan. A large number of employees elected to open spousal RRSPs to attribute income to the lower-earning spouse at retirement.

Copyright © 2020 Transcontinental Media G.P. This article first appeared in Benefits Canada.

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