Pension Plan Basics

Prof. Robert Brown of the University of Waterloo explained some of the basics behind pensions.

There are two kinds of pension plans, defined benefit and defined contribution plans.  A defined benefit plan provides flat benefits at a specified amount per year of work.  They can present a pretty good idea of what to expect in terms of benefits, but if investments are hit hard it can decrease amount of funds, and they are often open to the vagaries of the market.  A defined contribution plan allows you to determine how much goes into the plan, but you don’t know what you will get when you retire.

A multiple employer pension plan allows you to work for many different people, all of whom contributing to funds in your pension, and are common in the building trades. Single employer pension plans are far more common, and are usually what people think about when they refer to pensions.

A further refinement of types of plans are jointly sponsored pension plans, quite common in the public sector, where there is a shared risk with the government, who matches contributions to the plan. The largest of these Ontario Teachers’ Pension Plan, which is considered one of the better plans available, with a 12% matching.

There have been four major panels on pension reform across Canada in five different provinces.  The Province of Quebec came up with a member funded pension plans which are defined benefit, but the benefit is not a guarantee but a target benefit.  The plan sponsor just has to make a defined contribution, with very little risk to them, in a large co-mingled asset pool providing risk-sharing.   Indexation of benefits, both before and after retirement is contingent on funding health of plan.  They can be multi-employer or single employer, and is intended to stay funded at all times.

The Nova Scotia Pension Review Panel pointed out in their report early this year that existing rules inhibit innovation, and they liked the idea of some multi-employer and jointly sponsored plans in the province that a jointly-governed with share decision-making, but with some contingent benefits.  They suggested joint governance and transparency would create a lot less regulation. They also suggested a province-wide plan by an independent agency that would be voluntary but open to everyone, and could take over some orphaned pension plans or fully managed ones, as a target-benefit plan.

Alberta and B.C.  had a joint commission, the ABC Report, which also criticized the inflexibility in pension plans, and said there was a need for someone to champion pension reform. Plans should state how they will be governed and their funding policies.  Both are starting their own defined contribution provincial plans that will be available to everyone, with co-mingled assets and pooling of risk, and expenses of less than 0.4% basis points.  Defined target benefits and indexation would not be available unless the funding was healthy.  You have to act to opt-out, but it is not mandatory.  An independent board would do the investing, similar to the Canada Pension Plan.

Prof. Brown worked for the Ontario Expert Commission on Pensions and made similar recommendations, stating that the rules under the Pension Benefit Act and Income Tax Act stifle innovation.  He said it was a good idea to co-mingle assets because you get lower administration costs, lower investment expenses, can hire in-house expertise, and invest in some new types of plans, and pool some of the risks.  The size they are considering are in the magnitude of $10 billion.  If there was shared responsibility for the plan, they could have a lot less regulation.  He suggested they should have consultation with retirees, which are not normally considered part of the plan, and provide more information more often. It could be used by single employers, but there would be co-mingling of assets, through an Ontario pension agency or one of the large existing plans like Ontario Teachers Pension Plan (OTPP), OMERS, or Hospitals of Ontario Pension (HOOP).  Management fees would be kept down.

If none of this works, they would consider expanding the Canada Pension Plan.  The similarity in findings between all of these panels suggests that there might be some merit behind the recommendations.

Looking for an Alternative

Mitch Frazer, a Partner at Torys LLP and adjunct faculty at UofT specializing in pensions, continued the discussion, focusing on the creation of a supplemental pension plan. He joked that pension law was a bit like the Maytag repair-person – people sit around and ask you questions without understanding what he does.  Then suddenly because of the economy pensions are a big topic with considerable media attention.

He saw two major portions for reform – trying to fix the system in the way described by Prof. Brown, but also looking at alternative solutions.  A lot of politicians are interested in this as well, and he noted that Glen Pearson and Doug Ferguson were in attendance.

Frazer provided some background behind pension alternatives.  Canada’s aging population is foremost among this.   By 2031, over 25% of the population will be older than 65, and only 13% of the population was over this age in 2005, almost a doubling of the aging population.  There is also less participation in occupational pension plans, anything not a CPP, by private sector employees.  Pension plan participation is just over 20% in Alberta and B.C., 25% in Ontario.  As people are getting older and need some form of pension plan, there are less people contributing to them.

A lot of employers are terminating plans, or not offering it at all.  His clients do not approach him these days about creating a new pension plan.  The decline in the stock market has resulted in diminished retirement funds, so there is a decrease in personal savings rate coupled with record-high debt.

There have been some initiatives to address the problems, including the provincial reviews of legislation mentioned above.  The Federal government has also initiated consultations on the federal regulatory framework, and there is increased commentary by professionals and academia.  But only Quebec has been successful in considerably revising their pension plan, and they continue to revise it on an annual basis to keep abreast of changes, leaving all the other provinces behind.  The one positive thing out of the economic crisis is that everyone is now focusing on pension plans, similar to the mid-90s and the focus on CPP reform.

The objectives of reform would be improving retirement income security and enhancing pension coverage.  Pensions are going down, and we need to address that halt and figure out a way to prevent it from going further down.  We can take advantage of economies of scale by pooling assets, and benefit from the management and expertise in larger plans top reduce administrative burdens and costs.  We need to improve benefit portability and reduce risk and uncertainty.

The details of a supplemental plan are difficult to list, because there is no ideal plan, it is to be custom tailed for everyone.  But a lot of the discussion around a supplemental plan is going to be what the features are about.  There are some ideas of what it could consist of.  There could be automatic enrollment of employers and employees, with an opt-out option.  If the employer opts out, an employee could still participate by contributing.  There could be an option for self-employed individuals to opt-in, or not.  A minimum earnings threshold for eligibility, so the plain does not catch people with no discretionary income.  All these features provide flexibility for the type of coverage offered.

Some of the possible features for contribution and participation include allowing employees to transfer the value of their current pension plan to a new plan, to provide some portability.  You could allow an employee to continue to contribute to a plan even if the employer discontinues or terminates the pension plan.   There could be a minimum contribution rate, with an option for additional voluntary contribution beyond that.

Governance and administration could also take different forms.  It could be governed by an expert board with full transparency, so that participants would have confidence in the management of money.  Confidence in the plan is essential.  The reason why CPP works is transparency and their ability to provide confidence that their managed properly.  Alternatively, some cost savings might be realized by a fully governmental body controlled plan with no options for contributions, even though it would compromise flexibility.  Reducing administrative burdens by direct payroll contributions might work, but how do you deal with self-employed individuals?  Efficiency comes with trade-offs.

The role of government in an alternative plan is also debated.  They could the legislative and regulatory framework for operation of the plan, and probably should.  They could provide investment at the initial stage to ensure a successful launch, or put out a tender for private bidders so that it doesn’t cost the government anything.  But government involvement might also be needed to create confidence in the public.

Some of the criticisms of the alternatives are that since participation would not be mandatory, people would out and choose not to participate at all.  Most people don’t have extra money.  Even worse, employers could participate and then drop out of it when there is a recession.  They could use it as a recruiting tool during good times, and lost it during bad ones.  The plan may not require employers to match employee contributions, which reduces one of the key benefits for employees and encourages they to save.

If based on a defined contribution model, there is a big risk during a downturn of not getting the returns would would want.  Although RRSPs can be held out as an alternative benefit to those without pension plans, there are enormous benefits that those excluded from pensions are missing out on as well.  Some argue that creating a pension is the responsibility of each individual, and people should be able to make their own decisions about retirement.

Perspectives from the Community

The panel also included some comments from community members, to provide some perspectives from people who would be affected by pension reforms.

Janis Mark, a local teacher in London and President of the local chapter of the Congress of Black Women pointed out that with all the living expenses, it’s difficult for the average person to put away money.  Many people get older and then realize they haven’t saved as much as they would have liked, and they wonder, “Is it too late for me?”

She also noted that most of what is being considered by the other panelists wouldn’t even affect our generation, it would be for our grand-kids.  But this is also why for many citizens this is too much of a headache to figure out, and they don’t want to even worry about it.

Robert Sexsmith, a local retiree, added that workers everywhere feeling pressure.  Governments have advocated responsibility in name of economic realism or competitiveness, but the reality is that the “war against pensions” has received less attention than it should.

People complain about taxes, and they complain when it rises.  They understand wages.  But pensions baffle us, and the implications of pensions is not something we understand.

Even before the recession it was clear that pensions were under the gun.  Retirement benefits interfere with the labour market’s flexibility, and the willingness of people to take low-wage jobs.  There is even serious discussion about raising retirement age to 75, and many of these people do not want to work.

Tax reforms not enough, and tax concessions don’t work because retirees are not paying taxes.  The labour movement has argued for immediate improvements to old age security for this increasingly vulnerable population.  He believes that nationalizing all private pensions would be a first step, because they are almost always underfunded, unlike public sector.

A Human Rights Perspective of Pension Reform

Michael Lynk, currently Associate Dean (Academic) at UWO, addressed the human rights and equality issues and dimensions of pension issues, which are very much becoming in the forefront in Canada and the world.

The Organisation for Economic Co-operation and Development (OECD) has produced reports and documents relating to the pension issue.  So has the World Economic Forum (WEF), with a report looking at scenarios to 2030.

All Western societies are facing the same types of demographic and financial challenges, with a greying and shrinking workforce, with less resources.  In Canada 2/3 of our workforce will not have a pension plan.

There are three major reasons why pensions are becoming topical in Canada:

1. Charter issues and human rights legislation does apply to pension plans
2. Age discrimination is becoming more prevalent in litigation
3. Pension issues already play a discreet role in advancing human rights, especially in the area of sexual orientation

We already have an extraordinary human rights Canada.  According to Lynk, we probably have the most advanced human rights system anywhere in the world, with major breakthroughs in gender issues, race, family status, and sexuality.  This is something to revel in.  Even Europe laws on human rights is still about 5-15 years behind us.

However, one of our major deficits has been in age discrimination.  Most of the case law has focused on mandatory retirement.  Virtually every case at the Supreme Court of Canada through the 90′s were unsuccessful, based on the “lump of coal” trade-off.  Retirement allows others to progress in society by making room for others, and was an exception in respect to other human rights cases.  Most of the cases also assume a declining ability with older age.

Unions did have the resources to fund further litigation, but just weren’t interested in it.  They often had seniority clauses that they felt provided adequate protection.  Same-sex benefits cases at the tribunal level started to side-step the stance taken by the Supreme Court, and by the late 90′s the Court started to agree with them.  This was one example of how litigation was able to advance interests for these types of benefits.

But the court was unwilling to apply these broader tests developed in this period for disabilities to age discrimination cases, despite the 1999 B.C. v. BCGSEU ["Meiorin"] case that said we have to make human rights standards higher.  The test in Law v. Canada imposed a higher and more difficult threshold in respect to Charter litigation.

A more recent case in N.B. v. Saskatchewan Potash dealt with the term “bona fide pension plan,” and whether the appropriate test was Meiorin or Law.  The decided with the more modest standard, and said the differential standard used in N.B. did not offend the Charter.

Although Lynk was discouraged that the Court has left age discrimination behind, there are a range of questions that need to be asked on how we structure our pension plans.  He was pessimistic in the way age discrimination has been treated in the past, but he was optimistic that the Court or legislatures were going to catch up and enforce a more broader, enlightened, and liberal view towards age discrimination.  It would be impossible to keep building a higher silo of other human rights, and keep out other forms such as age discrimination out of it.

He reached this conclusion because:

1. Average age in Canada is steadily increasing.  This cohort of aging population is the most educated in our history, but also most healthy, and some will want to continue to work.
2. Pension benefits are rising to the forefront.  There is a huge amount of money involved in this, and it will continue to be an important policy and litigation issue.  The sheer volume of cases will eventually force the issue.

Lynk pointed to one upcoming case before the SCC, Withler v. Canada, dealing with supplementary death benefits, but with the potential to provide a wider interpretation for pension benefits.  Survivors of spouses receiving benefits would decrease by 10%, and the question was whether it is discrimination if the benefits are decreasing as people get old.  The trial judge ruled against claimants, and the B.C.C.A. decision upheld the decision. The dissent held that it was a s. 15 violation on equality, and not justified by s. 1, because an improper distinction was made.

The decision is expected some time in March 2010, and will likely be published about a year from now.  Even though the case is a small and discreet issue, it could determine the direction of age discrimination for future cases to come.

Cross-Posted from Slaw

To sort out these complicated legal dilemmas operators frequently have to hire counsel.  Should these expenses be reportable for tax purposes?

The now-defunct Exchequer Court examined the issue back in 1964, in Canada (Minister of National Revenue – M.N.R.) v. Eldridge, when several employees of the respondent were arrested on prostitution charges.

The Taxation Division provided Notices of Assessment of $22,046.75 and $19,103.77 for the previous two years.  Objections over the government collecting taxes on illegal revenue were dismissed by Mr. Justice Cattanach,

25 … it is abundantly clear from the decided cases that earnings from illegal operations or illicit businesses are subject to tax. The respondent, during her testimony, remarked that she expressed the view to the officers of the Taxation Division that it was incongruous that the government should seek to live on the avails of prostitution. However, the complete answer to such suggestion is to be found in the judgment of Rowlatt, J. in Mann v. Nash ((1929-1932) 16 T.C. 523.) where he said at p. 530:

It is said again: “Is the State coming forward to take a share of unlawful gains?” It is mere rhetoric. The State is doing nothing of the kind; they are taxing the individual with reference to certain facts. They are not partners; they are not principals in the illegality, or sharers in the illegality; they are merely taxing a man in respect of those resources. I think it is only rhetoric to say that they are sharing in his profits, and a piece of rhetoric which is perfectly useless for the solution of the question which I have to decide.

The court was more lenient with some of the substantial business expenses excluded, namely $1,925 legal fees for some of the girls who had been arrested.

The court held that the fees were properly deductible because:

1. it was for the purpose of income, because the call girl could not earn any income while she was imprisoned
2. it was part of the arrangement that the operator would assume legal fees in the possibility of legal troubles

Most criminal lawyers would say that $1,925 is  not a lot of money for that kind of an operation, even back then.  And maybe there’s good reason why they skimped on legal fees.  A more sizable deduction for $16,500 was rejected, because it was claimed as “protection fees.”  The recipient of the fees was none other than the local law enforcement.

So if prostitutes can claim their legal fees as a tax deduction, can lawyers claim prostitutes as a legitimate tax deduction as well?  It’s a disbursement that many Bay St. firms probably wouldn’t flaunt in their recruiting brochures.

Garry Slapper of Times Online suggests that the answer, at least before the U.S. Tax Court, is that they cannot.

William G Halby, a tax lawyer from Brooklyn, claimed $111,364 in 2002 for therapeutic sex.  His 2005 claims were more detailed, $5,005 in books, magazines, and videos, and $42,152 for specifically for prostitutes.  He cited section 213 of the Internal Revenue Code:

§ 213. Medical, dental, etc., expenses
(a) Allowance of deduction
There shall be allowed as a deduction the expenses paid during the taxable year, not compensated for by insurance or otherwise, for medical care of the taxpayer, his spouse, or a dependent (as defined in section 152, determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B) thereof), to the extent that such expenses exceed 7.5 percent of adjusted gross income.

Brian L. Friedman, Administrative Law Judge, said in the case,

…portions of petitioner’s “sex therapy” were, in fact, sex for a fee, in violation of Penal Law § 230.02. Such expenses were not paid to medical professionals or for activities prescribed by medical professionals but were made to unlicensed providers for legally proscribed services. (See Penal Law § 230.00.)

Additionally, even if it were accepted that sex constitutes medical care, such expenses would be more for petitioner’s general well-being rather than cure, mitigation, treatment or prevention of a specific disease or condition.

…petitioner failed to produce evidence that the claimed expenses were for prescribed activity, and he had little regard for physician’s advice on sexually related matters. As the periodicals cited by petitioner were neither specific towards him nor for a specific illness, they cannot possibly constitute a prescription or medical advice. Because petitioner purchased the videos, books, periodicals, pornographic materials and sexual performance aids without prescription, and they were not medically necessary to treat a specific disease or condition, they are not medical expenses for which an income tax deduction is warranted.

We still have to overcome cases like Nina Baccala of North Providence, cum laude from the New England School of Law and clerk for Superior Court Judge Raymond J. Brassard, one of the many new law graduates who moonlight as an escort. Her case was only revealed after an assault last year while on the “job.”

With a clever title for a Constitutional paper like, “A Guide to Aborting Roe v. Wade and All of Its Bastard Progeny,” I would’ve hoped Baccula could come up with some fundamentally different choices in life.

But at least next time someone cracks, “What’s the difference between a prostitute and a lawyer,” you can give them a different answer:

“Taxes.”

Cross-posted from Slaw