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.