Eliminating Mandatory Retirement: Impact On Pension Plans
By: Jerry Loterman & Zahid Salman
Experience in Canada shows eliminating mandatory retirement does not lead to employees working longer. In fact, the opposite has occurred. However, the combination of an aging population and declining birth rates may mean employers have to find ways to encourage workers to postpone their retirement. Jerry Loterman and Zahid Salman, of Hewitt Associates, look at the impact abolishing the mandatory retirement age will have on pension plans and what it means to employers.
By the end of the current decade, Canada will experience pronounced labour shortages, says the Conference Board of Canada. One reason for this deficiency will be the growing number of Canadians who are retiring at an average age of 62. Even if the early retirement trend subsides, the first wave of baby boomers will be 63 by 2010 and Canada may expect to see a significant number of older workers leave the labour market in the following years.
Compounding the labour shortage problem is the fact that fertility rates have decreased so that there are fewer new workers to replace those of retirement age.
To address this problem (and for other human rights related reasons), many Canadian jurisdictions have moved to extend protection against discrimination in employment to those aged 65 and over.
In these provinces and territories, employers are not permitted to implement mandatory retirement policies (except perhaps in limited situations, such as where a bona fide occupational requirement exists).
Ontario is the latest jurisdiction to consider abolishing mandatory retirement. It introduced Bill 68, the Mandatory Retirement Elimination Act, 2003, on May 29, 2003. If passed, Ontario employers would no longer be able to compel workers to retire at age 65. The Ontario Human Rights Code safeguards that currently protect employees between the ages of 18 and 65 from discriminatory employment practices would be extended to all workers aged 18 and over. Ontario has been slow to jump on the anti-mandatory retirement bandwagon. In fact, only British Columbia, Saskatchewan, and, for the moment,
Ontario currently permit mandatory retirement at age 65 at the employer’s discretion. New Brunswick, Nova Scotia, and Newfoundland and Labrador still allow some form of mandatory retirement, in certain circumstances over and above the usual bona fide occupational requirement. All other jurisdictions do not permit employers to implement mandatory retirement policies.
To date, jurisdictions that prohibit mandatory retirement have not noted an increase in the number of employees working beyond age 65. In fact, the opposite is true. For example, Manitoba has banned mandatory retirement since 1974 and Quebec since 1982. Numbers from Statistics Canada indicate that the median retirement age between 1991 and 1995 was 62.3 in Manitoba and 61 in Quebec. During the 1996 to 2000 time-frame, those figures dropped to 61.7 in Manitoba and 59.4 in Quebec.
We do not expect to see a marked increase in Ontario’s retirement age either so the impact of Bill 68 on pension plans will likely be minimal. The current trend to early retirement suggests that most people would retire earlier than age 65 if they could afford to do so. If employees have the benefit of a company sponsored pension plan (especially if it includes subsidized early retirement provisions), they are in a better position to consider retirement at age 65 or sooner.
Organizations caught in the talent crunch will still want to consider carefully the role their pension plans can have on the longevity of employees’ careers. Abolishing mandatory retirement will have some necessary implications for pension plans – at least in theory – and employers need to be aware of those repercussions now. However, if an organization’s business strategy calls for a sizeable skilled workforce, it is in its best interests to align the design, communication, and delivery of its retirement plans with that strategy and make changes before the labour shortage is in full swing.
Similarly, if a business anticipates that technology or some other factor will make much of its workforce obsolete, it may want to consider offering early retirement incentives. In either case, pending changes to Ontario mandatory retirement law present an opportunity for employers in this province to review plans and strategies. Employers elsewhere may also want to keep these points in mind to ensure their plans are synchronized with their overall goals:
National Approach to Mandatory Retirement
Since there is a growing trend towards abolishing mandatory retirement and it’s only a matter of time before the remaining jurisdictions in Canada follow suit, employers with operations in several provinces may want to do away with mandatory retirement policies, even in jurisdictions where they are still allowed. This national approach will enable employers to implement a common pension plan design strategy across the country, where that is desirable.
Pension Plan Design
Over the last several years, there has been a shift away from Defined Benefit (DB) towards Defined Contribution (DC) pension plans. The poor investment returns of the last three years, however, have highlighted the risks (from an employee perspective) inherent in DC plans. What impact will the elimination of mandatory retirement have on the DB vs. DC debate? What will the impact be on individual DB and DC plan designs? It is obviously impossible to answer these questions with certainty at this point, so employers should examine all considerations and possibilities.
The traditional DB vs. DC employee value proposition suggests that a DC plan provides more value to employees at younger ages (due to the longer time horizon for compounding investment returns), while a DB plan, especially one with rich early retirement subsidies, provides more value at older ages (See Example #1). This value proposition, however, assumes a retirement age of 65 or earlier. To the extent that employees delay retirement beyond age 65 (or the plan’s normal retirement age, if earlier), the value of DB pensions at these older ages decreases (See Example #2).
To Encourage Longer Employment
To encourage longer employment, employers with DC plans may want to restructure the employer contribution formula in the plan to increase at specific service, or age plus service (‘points’), thresholds to encourage postponing retirement. However, to the extent the average age of the covered workforce increases and the head count does not decrease, such a graded contribution formula will increase the overall cost of the plan.
Employers with DB plans could reduce early retirement incentives and increase late retirement incentives. For instance, for those retiring beyond age 65, the plan sponsor could increase the earned pension at 65 actuarially and include additional accruals past that age.
To Encourage Earlier Retirement
To encourage earlier retirement, employers whose business strategy favours a younger workforce can use DB plans to their advantage. For example, they can improve the early retirement benefits under the plan. Alternatively, they can implement service caps that cease accruals after a maximum number of years of service or they can lower the benefit formula at this point in order to discourage a prolonged working career.
Those with DC plans could implement service or points caps and use a flat contribution formula to discourage a prolonged working career.
Collectively Bargained Plans
Unions typically favour DB plans with rich early retirement incentives so that older employees make way for younger workers. Union demands, as usual, will be a significant factor to consider in any potential redesign.
Whatever plan design decisions are made in light of the elimination of mandatory retirement, these key legislative requirements must be kept in mind:
- Bill 68, as currently worded, does not alter the definition of ‘normal retirement age’ in the Ontario Pension Benefits Act. That means even after the bill becomes law, employers may continue to state a normal retirement age in pension plans to establish when a member is eligible for full benefits (not later than one year following age 65). However, they will not be able to require employees to retire at that age. It is certainly possible the Ontario legislature (and others where the same situation arises) may consider an amendment to the definition of ‘normal retirement age’ to recognize the fact that age 65 is no longer the norm.
- Almost all jurisdictions require DB plans (that do not have a service cap) to provide for the continued accrual of pension benefits beyond the plan’s normal retirement date. Only Quebec does not have this requirement. In Quebec, however, a member’s accrued benefit at normal retirement must be increased on an actuarially equivalent basis in the event of postponed retirement.
- The Income Tax Act prohibits an individual from simultaneously collecting and accruing a pension from the same organization. This makes phased retirement a significant challenge from a pension perspective. To date, only Quebec and Alberta have attempted to address this issue by allowing lump sum payments from the pension plan during phased retirement to replace lost income. The value of these payments is then deducted from the value of the pension available at full retirement.
- The Income Tax Act requires pensions to commence no later than the end of the year in which the employee reaches age 69. This means that an employee who chooses to continue working into his or her 70s will be working and collecting a pension at the same time (although he/she won’t be able to accrue additional benefits).
- Pension legislation prohibits reducing accrued benefits. However, the situation is less clear when it comes to ancillary benefits, such as early retirement subsidies, at least in situations where a member may have already qualified for these ancillary benefits. Recent court decisions have determined that a reduction in benefits, if sufficiently significant, may amount to constructive dismissal.
- Under the Old Age Security Act, clawback provisions mean that employees who receive a certain income level may lose some benefits. Higher benefit levels due to delayed retirement could result in further unintended OAS clawbacks.
DB Plan Retirement Age Assumption
When funding a DB pension plan, an assumption must be made about an employee’s age at retirement. However, even if Bill 68 becomes law and mandatory retirement is eliminated, there will be little cause for DB plan sponsors to reconsider the plan’s assumed retirement age, primarily because so few employees will likely take advantage of the opportunity to work past age 65.
Investment Policy for DB Plan Sponsors
Where a sponsor believes that many employees will delay their retirement beyond age 65 and that the average duration of the post-retirement period will, therefore, decrease, the plan’s asset mix guidelines should be revisited.
Investment Options/Education for DC Plan Members
DC plan members will continue to need investment education. Delayed retirement will generally make retirement more affordable. Members will require information regarding differing needs resulting from delayed retirement. They will also need information about appropriate investment strategies that accommodate a later retirement date and a shorter post-retirement life span. In turn, DC plan sponsors may need to offer additional or alternative investment options to better serve older workers.
The recent downturn in the economy – and the resulting negative affect on asset values – has left many DC plan members wondering whether they have saved enough to retire. Some may realize (or assume) that they haven’t and their concern may lead to some employees working past age 65, if that option is available.
Plan sponsors of DB and DC plans will need to ensure that plan members have a good understanding of their pension plan (nothing new there), as well as of the new legislation. Employees will need to realize they may work after age 65 (unless mandatory retirement at some age is a bona fide occupational requirement), but they don’t have to. Employers may want to enable staff to do some modelling (assuming there is a platform available for doing so), so they can truly appreciate the impact on their income of retiring at various ages.
Abolishing mandatory retirement is not the answer to impending labour shortages. However, enabling employees to work beyond age 65 and making it attractive for them to do so by means of retirement plan provisions may provide some relief for employers caught in the talent crunch.
Jerry Loterman and Zahid Salman are both actuaries and consultants in Hewitt Associates’ retirement and financial management practice in Toronto.
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