For employers struggling in this economic uncertainty, the desire to make changes to their employee retirement income arrangements will be strong if the changes will reduce the cost of maintaining the arrangements with minimal effect on employee loyalty and morale.
Some common forms of redesign include replacing a pension plan with a tax-sheltered savings plan, such as a group RRSP and a deferred profit sharing plan (DPSP); converting a defined benefit (DB) pension plan to a defined contribution (DC) pension plan; changing the benefit formula of a DB plan; or reducing employer contribution obligations to a DC plan, a DPSP or an employee profit sharing plan (EPSP) on a going-forward basis.
Regardless of what form the redesign may take, here are seven key considerations that employers should keep in mind before embarking on a plan redesign.
Cost – A change always comes with an immediate cost, although there may be cost savings in the long run. Some costs are apparent (such as administrative expenses during the changeover), while others are less obvious (for example, exposure to employee legal claims and obtaining regulatory approvals when required). Actuarial calculations based on different scenarios will help to confirm that the redesign will achieve the desired cost-reduction objectives.
Plan provisions – The plan text and all other plan documents, including funding and service contracts, should be reviewed to determine if there are any restrictions on the employer’s ability to make the desired design changes within the contemplated time frame. For example, specific notice requirements in a service contract may affect the time frame for implementing
a change.
Some design changes involve either plan termination or plan amendment. If the plan is a pension plan, the extent of the employer’s authority may not be absolutely clear and may require legal analysis.
Legislative/regulatory requirements – When redesigning a pension plan, employers must comply with various applicable legislative and regulatory requirements. All pension legislation contains substantive and procedural requirements relating to plan amendments and terminations. Also, all pension legislation prohibits amendments that reduce accrued benefits. Furthermore, in a plan conversion, members cannot be forced to convert their accrued DB pension benefits to DC pension benefits.
Plan conversions or amendments that reduce benefits or contributions on a going-forward basis have an adverse effect on plan members. Most pension legislation states that prior notice of such amendments must be provided to the members, in addition to post-amendment notification. In some situations (for example, plan terminations or conversions), actuarial valuation reports and regulatory approval are also required.
Tax rules – Any plan redesign should take into account the applicable income tax rules. For instance, amendments to a registered plan, such as a DPSP or a registered pension plan, must be submitted to the Canada Revenue Agency (CRA) in the form—and within the time frame—required by the income tax rules.
Except in the case of certain plans viewed by the CRA as high risk, an amendment to a registered pension plan will not be reviewed by the CRA when it is submitted. However, it may be subject to review when the plan is audited.
Notification to the CRA and certain filings are required when a registered pension plan is being terminated. In some instances, the CRA may also ask for a windup valuation report.
An amendment to reduce employer obligations should take into consideration any minimum contribution requirements under the tax rules. For example, for a DC plan, a minimum employer contribution of 1% of the total pensionable earnings of all active members is generally required. In the case of an EPSP, the employer’s contribution generally should not be reduced to less than $100 per plan member.
The transfer of amounts from a terminated DB plan to a DC plan or a locked-in RRSP must comply with the maximum transfer value rules, which limit the amount that may be transferred to the new plan on a rollover basis. Any excess is generally required to be paid to the member in cash, is included in his or her income and is subject to immediate tax. If the individual has sufficient regular RRSP contribution room available, the amount can be paid into the individual’s RRSP, resulting in an offsetting deduction.
Employment issues – In a non-unionized environment, any plan redesign that results in a reduction in employees’ retirement benefits raises the possibility of constructive dismissal claims. A constructive dismissal occurs when an employer makes unilateral and fundamental changes to the terms and conditions of employment, resulting in a breach of the employment contract. While the plan redesign may not be significant on a per-employee basis, there is some risk that the change could be material for those employees who are close to retirement.
Generally speaking, a change in compensation that results in a reduction of less than 10% would not constitute constructive dismissal. Furthermore, the courts are usually reluctant to find that a change to a “fringe” benefit, on its own, constitutes constructive dismissal. However, a change from a DB plan to a DC plan, for example, is an actual transfer of the financial risks from the employer to the employees—which may be viewed by employees as a fundamental change. Employers can reduce their exposure to constructive dismissal claims by obtaining employees’ consent, providing reasonable prior notice of the change and grandfathering employees who are close to retirement.
In a unionized context, whether or not the change in the retirement income arrangement violates the collective agreement depends on its terms. When the program is covered under a collective agreement, the agreement may contain a prohibition on discontinuing or altering retirement benefits. Furthermore, it may require the union’s consent for the employer to proceed with any plan changes. If the union’s consent is needed and the union does not provide it, the matter will have to be left to the next round of collective bargaining.
HR challenges – Sometimes a change in plan design will have a negative long-term impact on employee loyalty and on the competitiveness of the employment packages to attract and retain talent. It’s important for an employer to consider the broader implications of any such change and how the new arrangement will fit within the employer’s overall corporate culture.
Implementation – A well-planned implementation has a significant bearing on the success of a plan design change. Information sessions that provide clear and detailed instructions, together with a uniform approach in dealing with employees’ inquiries, will help to provide a smooth transition from the employees’ perspective and will also minimize the risk of administrative errors.
Sonia T. Mak is a pension and benefits partner, Eva M. Krasa is a tax partner and Michelle Henry is an employment and labour associate with Borden Ladner Gervais LLP.
smak@blgcanada.com
ekrasa@blgcanada.com
mhenry@blgcanada.com
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© Copyright 2009 Rogers Publishing Ltd. This article first appeared in the August 2009 edition of BENEFITS CANADA magazine.