Time to Fix the Maximum Transfer Values

With the expansion of the CPP checked off the Federal Government’s ‘to-do’ list, it is my hope that they still have the appetite to work on other worthwhile pension reform initiatives.  While I could reiterate Fred Vettese’s recent comments about overhauling the federal Public Service Pension Plan, or talk about the need to update the pension legislation and tax code to allow more flexibility in plan design, these issues are complex and will require political capital to initiate the necessary change.  Instead, I will talk about something that should be uncontroversial and more straightforward – the need to update the Maximum Transfer Value rules.

What is the Maximum Transfer Value and why does it matter

The Maximum Transfer Value (“MTV”) is a tax limit that applies to members in DB pension plans who terminate and elect to transfer the commuted value of their pension entitlement to a locked-in RRSP or a DC pension plan.  The MTV is determined as the annualized pension payable at the Normal Retirement Date, multiplied by a MTV Factor – which ranges from 9 for members under age 49, to 12.4 for members age 65.

Generally, any portion of a commuted value that is in excess of the MTV (the “Excess”) is paid to the former member in cash, less withholding tax.  While some former members may appreciate this windfall cash payment upon their separation from a DB pension plan, it should be understood that this Excess is no longer in a registered savings plan, abetted with the tax deferral, and intended for their retirement.  Worse, the Excess needs to be declared as income in the year it is received, and taxed at the member’s highest marginal tax rate.

My main reason for concern is the fact that the MTV Factors are static, and have been based on the assumptions consistent with those underlying the ‘Factor of 9’ used for the Pension Adjustment (“PA”) calculations – which, for clarity, were developed back in 1984!

In today’s low interest rate environment, it is becoming commonplace to see DB plan members, even in their late 30’s and early 40’s, to be impacted by the MTV limits, and forced to take a portion of their commuted value in cash.  Furthermore, in some unique circumstances, I have seen situations where the MTV limits prevented the member from transferring even half of their commuted value pension entitlement – that is, their Excess payment is greater than the amount they can transfer to a registered savings plan!

How some Members and Plan Sponsors have reacted to this trend

Some industry observers believe that we are seeing more separating members elect to retain their deferred pension because of the negative tax consequences of the MTV.

We also see an increasing desire, on behalf of either the separating member or the plan sponsor, to facilitate a direct transfer of all, or a portion of, the Excess directly to the member’s RRSP.  However, there is no legislative requirement to offer this choice, and many plan sponsors do not make this option available to their separating members.  Furthermore, for this option to be available, the member must have sufficient RRSP Contribution Room; and plan sponsors typically require the member to obtain approval for such a transfer from the Canada Revenue Agency in advance of the payment.

As an even more complex solution, it is permissible to allow the separating member to leave a portion of the Excess in the pension plan, and have it paid out at early retirement as a bridging benefit.  However, I have not seen a plan permit this choice in practice.

A Rational Outcome to a Simple Problem

While one solution would be to update the assumptions underlying the ‘Factor of 9’ and overhaul the factors used to calculate Pension Adjustment (“PA”), Pension Adjustment Reversal (“PAR”), and Past Service Pension Adjustment (“PSPA”) – I am not going to be that ambitious.  Such a change would not be straight forward or easy for the government to implement.

Instead, I would propose that the MTV Factors simply be increased to reflect current market conditions.  Whether they are updated using some razzle dazzle actuarial mathematics, or simply increased by a certain percentage, I am not all that fussed… but I would like to see this on the Federal Governments ‘to-do’ list.

 

Dean Newell
Dean Newell
Dean Newell is a Vice President of Actuarial Solutions Inc. and manages ASI’s actuarial practice. Dean performs valuations for pension and post-retirement benefit plans for the purpose of funding, accounting, and plan wind-up. In addition, he has experience consulting with plan sponsors on matters affecting pension and post-retirement benefit plans, including plan design, plan conversion, benefit improvement costing, legislative compliance, plan documentation, plan administration, and risk management.

3 Comments

  1. Mel Norton says:

    An aspect that should support an increase in the MTV is that upon marriage breakdown, 50% of the Family Law Value (Ontario rules) – inclusive of prescribed interest – may be transferred to the non- member spouse’s LIRA, with no MTV limitation.

    That said, my personal view is that most times, electing commutation will harm a former member of a DB pension plan, and that provisions to deter such action may be beneficial to many members. After all, the Plan’s promise was a pension…not a cash settlement.

  2. Marilyn Lurz says:

    I couldn’t agree more, but I think it is difficult to talk about one static thing without including the others. They are all related! If, for example, the factor of 9 is static, then everything else surrounding it will likely not become fluid. I’m not saying this is right – but it is built into the system. Here’s the funny thing – the system was totally overhauled in the 80s (officially early 90s) because of its stacicity – RRSP room was reduced in the prior system by $4,000 no matter what you were earning in your RPP – ridiculous! So that was remedied. But the remedy also has stacicity, sadly. So the solution to remove the static situation must be holistic. And it’s not easy! Should it change with the vagaries of the interest rate market?

    Probably not – because looking short-term means there are winners and losers.

    Such an interesting topic!! So thank you for shedding the light. I would like to think that the federal department of finance is looking at this…but it is NOT EASY!! The creative minds that looked at this from the late 70s to the 90s – I have huge respect for them. But they are not there any more. An easy solution? You tell me…

  3. Bob says:

    I agree and disagree. I agree the “rule of 9” was created in an era when interest rates were high and annuity rates low and thus there should have been a mechanism to adjust.

    The purpose of the introduction was to level the playing filed for DB, DC and RRSP retirement savers, so the Factor of 9 should change for all not only to keep the playing filed level but to allow all to contribute and possibly earn the same benefit.

    If one changed as suggested, then those in DB plans would be advantaged over those in DC and RRSP arrangements who could only save at the “rule of 9” rate. Essentially the concept was $9 saved each year would produce $1 of pension indexed at age 62. If the target was 70% of best 5 income earned over 35 years then the need was to save 9 times 2% or 18% of income each year.

    Thus those saving in their cash accumulation programs in a low interest environment cannot achieve what one can in a DB plan. So the system is already out of balance for those lucky enough to be in a generous DB plan.

    If one is to fix the system, the “Rule of 9” should be adjusted more to a “rule of 14” and all adjusted, this is simple and more fair to the great majority who are not in DB plans now or will be in the future.

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