Several tax changes in this year’s federal budget recognize that more people want to work past the usual retirement age.
For instance, if proposed budget changes are translated into law, it may soon be possible for employees who belong to defined-benefit pension plans to receive some of their pensions while continuing to work and contribute to the pension plans. And they will not necessarily have to reduce their hours of work or accept a salary reduction.
Current tax rules do not allow employees to collect pension benefits from DB registered pension plans if the employees continue to accrue benefits in those plans.
Opportunities for tax planning around the proposal, however, may be limited. For example, pension income, unlike employment income, is eligible for the pension income credit, which can be used to offset tax liabilities. But this credit is worth a maximum of $310.
A more promising possibility of generating tax savings might be the decision to take some pension income — if a phased-retirement program is in place at the taxpayer’s workplace — and split that income with the spouse in order to reduce taxes. This is allowed under the pension income-splitting provisions, also proposed in the 2007 budget and now in effect. However, this option is only of value to individuals who have a spouse or partner in a lower tax bracket.
In situations in which this is the case, up to half the pension income may be allocated to the lower-income spouse, who then pays taxes on the income at a lower rate. But the income is allocated only on the spouse’s tax return. Pension-income splitting does not mean pension income will actually be paid to the lower-income spouse. Scott McKenzie, regional vice president and general manager, Ontario region, of T.E. Wealth in Toronto, notes net tax savings would depend on how much income is transferred to the lower-income spouse and the difference in marginal tax rates between the spouses. (See page B14).
But a phased-retirement decision involves more than tax planning. Making it easier to ease into retirement is one way of persuading older workers to postpone retirement and stay in the labour market longer. As the government sees it, getting people to go on working will ease the pressure the large number of retiring baby boomers will put on pension plans, as well as address the potential shortage of skilled workers when the boomers retire.
The budget proposes to change the tax rules so that employees — who are aged 55 or older and are otherwise eligible to receive a pension without the pension plan imposing an early-retirement reduction — will be able to receive up to 60% of their accrued DB pensions while continuing to work and accrue further benefits under their plans. The 60% limit will be based on the amount of pension benefits — including bridging benefits — that would be paid from the plan if the employee were fully retired.
The changes are due to take effect within the 2008 taxation year. But provincial pension legislation will probably have to be amended to accommodate the changes, and the federal government plans to allow time to consult on the technical aspects of the proposal before implementing it. In due time, the feds will make the necessary changes to the federal Pension Benefits Standards Act, which applies to pension plans under federal jurisdiction.
Whether or not employers will go for the idea remains to be seen. Actuary and pension expert Ian Markham, director of pension innovation at Watson Wyatt Canada in Toronto and a member of Ontario’s Expert Commission on Pensions, says that phased-retirement provisions are aimed at people who can afford to retire.
“At that point,” he says, “many factors come into the decision about whether or not these employees should retire or reduce their work time.” Financial considerations aren’t the only thing influencing the employees’ choice.
He believes few employers will take advantage of the proposed phased-retirement option. And it may not work in their favour. Offering a blanket phased-retirement program to all employees could mean take-up may be higher than the employer intended. Or employees who were willing to stay on full-time may decide to reduce their hours of work instead.
“Employers will realize it is too generous for some employees and not generous enough for others,” Markham says. “They will gradually realize they’re better off designing something for the individual, in an individual negotiation.”
@page_break@Although the government says tax rules will not prevent a pension plan from limiting participation in phased-retirement programs to employees identified by the employer, other employees may want to be included when they learn about the program.
Markham says employers have other ways of designing compensation packages — without involving the pension plan — that will allow them to hold on to valuable older workers who are eligible to retire with unreduced benefits. Employers may perhaps offer cash bonuses, continued training, time off or reduced working time, and other options to encourage valued employees to postpone their retirement, he suggests. These kinds of deals happen already, he adds.
If phased retirement is an option, an employee eligible for an unreduced pension — that is, an individual who has worked long enough to get a pension without it being reduced because of early retirement — will have to calculate whether the amount that could be added to the pension by continuing to work is worth more than the amount of pension the employee could receive if she or he retired completely.
While continuing to work and contribute to the pension plan may eventually increase the amount of the pension, the employee will be giving up years of full pension income by staying in the workforce. Markham notes this loss of pension income is a form of taxation on the additional earnings generated by continuing to work. He suggests that in most cases, employees eligible for an unreduced pension would be better off financially to retire and take the pension rather than trying to improve the amount of the benefit by continuing to work and contributing to the plan.
Loris Giusto, associate partner with KPMG LLP’s enterprise practice in Toronto, says the budget changes recognize the fact that the current tax regime makes it difficult to stay employed. But the proposed changes may prove to be a “two-edged sword.” While flexibility is always better than inflexibility, he says, some people who may want to retire completely may feel pressured to stay on and may regret their decision. IE
Phasing into the golden years
Budget proposals may persuade older Canadians to stay in the workforce
- By: Monica Townson
- October 15, 2007 October 15, 2007
- 14:07