Will DSM Really Result In Greater Equity?
By: Penny Hebert
An employee’s pension is difficult to divide when a marriage breakdown occurs. With Ontario looking at reforms to make this division fairer, Penny Hebert, of Pension Valuators of Canada, examines the Deferred Settlement Method.
Under current Ontario family law legislation, when a marriage breaks down, the property that accumulated during the marriage period must be shared equally by both parties. Many people in Ontario are fortunate enough to have a pension. Often the pension is the second most valuable asset they own, after the matrimonial home.
It is a well-known fact that a pension and/or its value is not as easy to divide as most other assets. This is particularly true for Defined Benefit pensions, which a majority of people in Ontario own. For the person who owns the pension, the value of that pension often increases the net family property (NFP) significantly enough that they must make an equalization payment to their spouse. There are often insufficient liquid assets to satisfy the equalization payment, so the lawyers must resort to ‘if and when’ arrangements, which can be planadministered or spousal.
Effective and equitable ‘if and when’ agreements are very difficult to draft and sometimes are unenforceable under the terms of the pension plan and pension legislation.
A Better Way
The Ontario Law Reform Commission, in its Report of Pensions as Family Property: Valuation and Division, 1 proposed reforms that would permit spouses to divide pension assets at source to satisfy an equalization entitlement by either transferring a lump sum out of the pension plan at the time of marriage breakdown or by creating a benefit split payable on the member spouse’s retirement. It recommended that section 9(1) of the Family Law Act2 be amended to permit the settlement of an equalization entitlement in accordance with proposed pension division- at-source legislation.
The Canadian Institute of Actuaries (CIA) suggests that pension assets have unique characteristics because they are not like other assets and, therefore, may warrant different treatment than other family assets. The CIA has discussed this problem for many years and has come up with the Deferred Settlement Method3 (DSM), which would eliminate the current, cumbersome ‘if and when’ method. The DSM purports to allow for the greatest degree of equity between the member and non-member spouse without changing the financial obligations of the pension plan. Under the DSM the division of the pension would be delayed until the member’s actual date of retirement, death, or termination when their actual pension benefits will be known. At that time, the DSM would allocate Defined Benefit (DB) pension credits acquired during the period of marriage to the non-member spouse. Theoretically, since the actual pension benefit would be split, the total value of the pension would be preserved, so the pension fund would not be at risk.
The DSM has been accepted by the Ontario Bar Association which has made a submission to the attorney general in an attempt to effect the necessary changes to the appropriate legislation. The proposed DSM would mean changes to the Ontario Pension Benefits Act,4 the Family Law Act,5 and the Income Tax Act.6 The philosophy of the DSM looks very appealing to the Ontario Bar, which is anxious to find a better way to deal with the pension issue.
A Better Way For Plan Sponsors?
While the philosophy of the DSM allows for the protection of the interests of the spouses, the pension fund, and the other members of the pension fund, this method could result in increased costs for plan sponsors and inequitable results for the spouses.
The CIA says that the DSM is crafted so that the added administrative burden on a plan is minimal. If the DSM is implemented, there will be added administrative costs. Who will cover the cost of the valuation of the member’s pension at retirement, death, or termination to determine the non-member spouse’s equitable share? Who will cover the cost resulting from the responsibility of maintaining records now, not for one plan member, but for two?
Record-keeping and pension reporting could be a challenge, especially if the separation happens several years prior to the member’s actual retirement, death, or termination. What happens if the non-member spouse remarries and has a new last name? How will confidentiality issues be managed? Who will cover the costs of managing not one, but two pensions when payments are being paid out of the pension fund?
The DSM considers the case where a plan member elects to work beyond the plan’s early retirement age. It suggests, in that case, that the nonmember spouse “would be allowed to elect to ‘retire’ and to receive what amounts to a (sic) ‘draw,’ consisting of an allowable proportion of the member’s normal retirement pensions, with an appropriate adjustment to occur, as required” at the time of the member’s actual retirement. Who will cover the cost of two actuarial valuations in this case: the valuation when the non-member’s ‘pension’commences and the valuation when the member’s pension actually commences? The DSM suggests that each party should be able to designate a beneficiary of choice and, at commencement of the pension, provide spousal survivor rights to a subsequent spouse in accordance with the plan terms and applicable legislation. Will this result in additional administrative costs and create an additional burden to the pension fund?
The CIA suggests that under the DSM “it is possible that the sum of amounts of lifetime retirement benefits, provided to the member and the non-member spouse, will exceed the amount of lifetime retirement benefits provided prior to conversion” under a retired member’s benefit split arrangement. Where would the funds come from to cover the excess?
What about situations involving a member or a non-member spouse with health issues that could affect their normal life expectancy? Are plan sponsors willing to cover the costs of determining the value of the pension taking this into consideration? Who will keep track of both spouses and non-member spouses in a plan wind-up situation? Who will cover these costs?
What will happen in a situation where there have been several changes of plan administrator (pension administration was managed in-house, then outsourced, and there have been successive administrative changes)? Some of the pension data pertaining to the full history of the pension plan member could be lost through the transfers.
What if the plan member did not have continuous membership in the pension plan in this type of situation? How would the proportionate share of the pension be accurately determined if the appropriate records are no longer available? Who will cover the costs of the administrator attending at court to justify the pension split if it is challenged?
Who will speak for the plan sponsors and/or the other plan members who must bear the additional costs? How will already over-worked pension administrators be able to handle the extra work of administering more pensions per member?
The DSM could also be used for Defined Contribution plans. However, who would cover the costs involved with managing the additional non-member spouse’s investment choices and educating the non-member spouse regarding their investment choices?
The DSM could also be the process used to divide other formal non-registered pension plans of a DB nature, including ‘top hat’ or ‘executive supplemental’ plans. Currently the Income Tax Act7 places a limit on the amount of pension benefit available from a registered pension plan. Where will the funds come from to cover this division?
There could even be increased liability risks through new confidentiality provisions. Who will maintain the confidentiality of both the member and the non-member spouse during the period from marriage separation to retirement and through the retirement years?
A Closer Look
The intent of the current Family Law Act8 is to divide 50 per cent of the assets, between the parties, that were earned during the period of the marriage. The intent of the DSM is to provide a 50 per cent share of the DB pension credits acquired during the period of marriage to the non-member spouse. This amount is calculated by pro-rating the total benefit accrued at the date of retirement, death, or termination. The amount then assigned to the non-member spouse would include all entitlements (basic, bridge, special allowance, value of survivor rights). It would specifically include all future growth with respect to such entitlements including contractual and ad hoc indexing (both pre- and post-retirement), and negotiated benefit improvements.
This clearly includes increased pension value earned by the member after separation. This allows for the non-member spouse to share in the growth to the benefit acquired after separation assigns a greater portion of the member’s retirement pension to them.
The DSM clearly has a non-member spouse bias at the expense of the member and perhaps the pension fund itself. The following example illustrates this point.
Tom and Jerry (who are twins) both start work the day they get married. They both work for the same company and earn the same salary. The company pension plan provides a retirement benefit of two per cent of salary for each year of service.
Ten years later Tom and Jerry each separate from their wife. Both continue to work for the same company for 10 more years and then both retire. Tom continued to be a plodder and didn’t earn any increases in salary. Therefore, his pension on retirement is $20,000 (two per cent of $50,000 salary times 20 years of service). Since he was married for 10 of his 20 years, his ex-wife will receive an annual pension of 1⁄2 x 10/20 x $20,000 = $5,000.
On the other hand, Jerry (whose first wife had held him back in his career) remarried to a woman who inspired him to work hard, and he went on to become CEO of the company. He was provided with a special pension of four per cent of his salary (which was now $250,000 annually). Therefore, his pension was $200,000 annually (four per cent of $250,000 x 20 years). Since he also was married for 10 of his 20 years, his exwife will receive an annual pension of 1⁄2 of 10/20 x $200,000 = $50,000.
The reason that Jerry’s ex-wife will get more pension than Tom’s ex-wife is because Jerry’s pension increased after the date of separation. This is not fair and raises questions, including:
- How can an equitable share of the member’s retirement pension be determined based on service when the person’s pension benefit is based on contributions made on the member’s behalf, or on hours worked, and they worked many hours after the marriage and fewer hours during the marriage?
- How equitable is proportionate share based on service?
- How is it equitable to take the person’s benefit at retirement and determine the spouse’s share based on years married and years worked in total?
Where To From Here?
There is no question that change is demanded and that change is inevitable. It seems that the solution proposed by the DSM has not changed anything. It has merely transferred the pension problem from the legal community to the plan administrators. It has also transferred the problem from the date of separation to the date of the member’s retirement. Why a ‘deferred’ settlement method? Why not an ‘immediate’ settlement method similar to that of the Pension Benefits Division Act9 or the Pension Benefits Standards Act?10
Before legislation is changed at the request of the Family Bar and on recommendation of the CIA, all the stakeholders involved with pensions and their division on marriage breakdown need to be part of the process of change. All the issues need to be assessed in detail so a workable solution can be presented to the government for change that can meet the needs of everyone involved, not just a few. A change is needed that can survive the test of time.
Penny Hebert is a senior pension valuator at Pension Valuators of Canada.
1. March 1995. The Ontario Law Reform Commission recommends reform in statute law, common law, jurisprudence, judicial and quasi-judicial procedures, and in issues dealing with the administration of justice in Ontario.
2. Family Law Act, R.S.O. 1990, c F.3
3. The Division of Pension Benefits Upon Marriage Breakdown, Task Force on the Division of Pension Benefits Upon Marriage Breakdown, February 2003, Document 203015, Canadian Institute of Actuaries
4. Pension Benefits Act, R.S.O. 1990 c. P.8
5. op. cit.
6. Income Tax Act, R.S.C. 1985
7. op. cit
8. op. cit.
9. Pension Benefits Division Act, S.C. 1992, c. 46 (Schedule II)
10. Pension Benefits Standards Act, 1985 R.S.C. 1985 c. 32
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