Canada: Pension tax laws loosened

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Canada: Pension tax laws loosened

By DEREK DeCLOET, Globe and Mail

June 16, 2003

Canada - The federal government is changing tax laws so that some pension funds can generate larger surpluses in boom times to help them endure market downturns. Under the Income Tax Act, most employers must stop making contributions to their pension funds when the plan has 10-per-cent more money than needed to pay benefits. New regulations drafted by the Department of Finance will permit them to continue to make contributions at a reduced level until the surplus hits 25 per cent.

But Ottawa will apply the new rules only to certain kinds of pension funds -- primarily public-sector funds such as the Ontario Teachers Pension Plan Board and the Ontario Municipal Employees Retirement Board (OMERS). Most corporate plans will continue to have a 10-per-cent limit on surpluses, a decision that is drawing criticism from some in the pension industry.

"We think that is short-sighted," said one senior executive at a large pension fund who spoke on condition of anonymity. "Finance is clearly worried about the tax implications. They hold this silly notion that corporations have wanted to hide profits in their pension plan."

Many companies stopped putting cash into their pension funds in the late 1990s because roaring equity markets pushed employee retirement plans well into the black.

But a lengthy bear market has pulled most of these plans into the red. Of the largest 50 public companies with pension plans, more than 70 per cent have deficits, and several, including Bombardier Inc. and Nortel Networks Corp., have pension gaps of more than $1-billion. Many of those companies have now been forced to increase their cash pension contributions even as they face a downturn in their businesses.

Air Canada, which had a pension surplus of about $915-million as recently as 2001, was ordered by the federal Office of the Superintendent of Financial Institutions to inject $200-million to help fix a growing deficit in its pension fund. The order was one factor in the airline's decision to file for bankruptcy protection in April.

The speed with which a pension fund's finances can deteriorate proves that governments must encourage companies to build large surpluses, rather than discouraging or even prohibiting them from putting extra cash in their plans during periods of prosperity, said Keith Ambachtsheer, president of pension consultancy K.P.A. Advisory Services Ltd.

"You need to be able to contribute more surplus in good times to withstand the kind of period we're in now," he said.

However, a Finance Department official said there is little evidence that extending the 25-per-cent surplus rule to corporate plans would cause companies to put more money in their pension funds, because chief executive officers prefer to spend cash in other ways. In fact, many companies add as little money into employee retirement schemes as they can, said the official, who asked not to be identified.

Whether tax laws should be loosened for private-sector pension schemes is "certainly a legitimate question, something the department will look at," the official said.

Public-sector plans such as OMERS and Teachers will get to use the looser surplus rules because they have unique "fixed-cost-shared" provisions with employees. When the plans have a big surplus, both workers and the employers enjoy a holiday from contributions. When they are in deficit, both sides share the burden of fixing it.

That's in contrast with the majority of corporate plans, which are designed so that the company can get a contribution holiday.

Dale Richmond, president and CEO of OMERS, said current rules forced municipal workers and governments to abruptly stop contributing to their pension plan in 1998. That cost the fund between $1-billion and $1.2-billion a year in cash.

Now, after two successive years of losses, both sides will have to begin making contributions in 2004 that were larger than they were five years ago. OMERS represents about 325,000 current and former municipal employees, including firefighters and police officers.

"It was just an absurd situation, and from that perspective it cost us the goodwill of our members," he said. "It was no way to run a pension plan."