Pension Reform – Watch Out!
“Pension Reform – Watch Out”, Money & Family Law, Vol. 20, No. 7, July 2005 (jointly with G. Edmond Burrows and Penny Hebert);
PENSION REFORM – WATCH OUT!
published in: Money & Family Law, Vol. 20, No. 7, July 2005
By Gene C. Colman*, G. Edmond Burrows** and Penny Hebert ***
I wrote this article a very long time ago. Since that time, Ontario has reformed its pension division law. – Gene C. Colman
How one addresses the conundrum of pensions within Ontario’s Family Law Act is a most vexing issue. Actuarially valued, a pension may constitute a very significant asset for the pension holder. This non-cash and (usually) non cashable asset may result in the pension holder having to make a substantial equalization payment from other assets – in some cases those “other assets” may be minimal or even non-existent. It could transpire that the pension holder may not actually retire on the projected date, thus causing a retroactive distortion in the value that had been ascribed to the pension for family law valuation purposes. The pension holder may even die before the pension comes into pay – again causing a rather significant retroactive distortion of value. Can we devise a methodology for valuing and dividing the incremental increase in the value of the pension from date of marriage to date of separation in such a way that equalization of net family property (NFP) will be scrupulously fair to both spouses? Do practical resolutions exist in the real world?
The Family Law Section of the Ontario Bar Association has studied the issue and has come out squarely in favour of implementing pension reform measures that on their face appear deceptively simple and attractive. Would that life were so simple! The authors of this article applaud the OBA’s efforts ; however, we believe that the legitimate and laudable desire to bring reform to an admittedly vexing area will, as currently proposed, likely result in foisting unfair results upon both the pension holders and their spouses. Before government launches headlong into reform, we recommend that some perhaps yet unconsidered factors be taken into account. This article will outline some of the challenges to effect reform as we see them, the proposed reform measures recommended by the Canadian Institute of Actuaries and endorsed by the Ontario Bar Association along with some of our criticisms of same, and our proposed solutions. The end result of family law reform in the pension area should be that the law treats both sides equally and fairly without placing undue administrative burdens upon pension administrators.
Challenges to effect reform
The crux of the problem is that we have to include the value of a non-cash asset in the pension holder’s NFP. That non-cash asset is actuarially valued – the present value of the future entitlement increases the pension holder’s NFP while payment of one half of that increase in value from date of marriage to date of separation has to be made with immediate hard cash or other very tangible assets. Satisfaction of an equalization payment for up to ten years [FLA, s. 9(1)(c)] is possible but often, other burdens upon the payor as well as the payee’s fear that the payor’s subsequent bankruptcy could effectively cancel any unpaid amount all serve to militate against such a staged payout being implemented with any great frequency. A second alternative is an “if and when” approach; this is fraught with solicitor’s negligence pitfalls and consequently, under current practice most lawyers tend to avoid the “if and when” approach. Neither of these options (fraught as they are with a number of difficulties as described in the OBA submissions to the Lawyer General) lend themselves to an appropriate mix of flexibility, certainty or true fairness and equity for the parties themselves.
Proposed reform measures
The Canadian Institute of Actuaries has devised a system known as the Deferred SettleSM) for dment Method (Dividing the pension on retirement of the member. The “Deferred Settlement Method” [DSM] appears to have a number of potentially quite attractive features:
- A very significant advantage of the DSM is that it permits the parties to exclude the value of the pension from the calculation of net family property and instead, assigns to the non-member spouse a fixed proportion in whatever rights the member spouse has under his pension plan.
- The DSM delays the actual pension division until the member’s actual date of retirement, death or termination when the member’s actual pension benefits will be known. At that time, the DSM would allocate defined pension credits to the non-member spouse.
- The DSM permits “the pension to be shared and distributed at source upon retirement, with the non-pension member, former spouse receiving a pro-rata share based on years of marriage (or perhaps cohabitation) in relation to years of services”.
- The DSM essentially converts the rights of the non-member spouse into a pension (or certain other vehicles) and that pension will not cease because the plan member predeceases his non-member spouse.
- One could argue that the tax problem inherent in pension valuations is resolved by virtue of the fact that each party pays tax on the pension payments that he/she receives. Since we are dividing credits at source, the proponents of the DSM would argue that there is no need to consider tax implications when the division is made. Each side simply pays whatever tax is exigible upon receipt of his/her benefits.
- The DSM essentially allows as clean a break as possible as between the spouses. The non-member spouse need deal only with the pension plan administrator as opposed to dealing with the ex spouse.
The Canadian Institute of Actuaries proposed that people be given a choice of electing to divide the pension this way, or by way of accounting for property including the value of the pension in the normal fashion. What the actuaries have devised is deceptively striking, inviting and indeed quite simple. The Canadian Institute of Actuaries has recommended the DSM for dividing the pension at source on retirement of the member. The OBA proposed that the DSM be the “presumed method for dealing with a pension”. According to the OBA, the presumption would be rebuttable according to an as yet undelineated list of factors. With respect to the valuation method, the OBA report recommends that consideration be given to statutorily enshrining the pro-rata valuation method or to enshrine some other method such as the value-added method. Of course, not taking a stand with respect to valuation methodology leaves open the possibility of inviting inconsistent and possibly unfair legislative solutions. The OBA argues that the “double dipping” problem (as addressed by the Supreme Court of Canada in Boston v. Boston ), will now all but disappear if the DSM is adopted. Just how this will happen is not really made clear.
Adoption of the DSM as currently envisioned engenders its own set of challenges:
- Sharing in post separation events: Dividing the pension on retirement of the member based on the method set out in the DSM allows the non-member to effectively share in the increase in value of the pension that accrues after the date of separation. This is clear from the Actuaries’ Report at page 13: “Using this method, the NMS [non-member spouse] is entitled to benefit from salary increases that occur after the date of separation.” This philosophical approach is squarely contrary to the Family Law Act’s intention of sharing value acquired only during cohabitation under the marriage. There is no doubt that a pension increases in value each year as salaries increase, plan provisions improve, and the person gets closer to collecting their pension. A pension does not necessarily increase in value evenly each year. A non-member spouse has no right to share in the increased value of other assets after the separation date; why should a reformed scheme of pension credit division entitle a non-member spouse to greater rights in this area?
- Prorating: In the Best v. Best decision, the court prorated the benefit earned to the date of separation, thus achieving some form of equity as between the two sides. Under the DSM method, we would prorate the benefit earned right to the date of retirement – effectively reducing the pension of the member spouse and correspondingly increasing the pension of the non-member spouse – all relating to factors inherent in events that take place after the date of separation.
- Tax: The DSM will cause the non-member spouse to incur income tax on the payments received. Under current pension valuation practice, the value of the pension should be reduced by taking the present value (as at date of separation) of the likely future tax to be incurred by the member spouse when the pension comes into pay. Under the DSM, the member spouse loses a portion of his pension with no deduction for tax while the non-member spouse receives her share but subject to tax at her own tax rate when her share comes into pay.
- Exposure to reductions: Dividing the pension on retirement leaves the non-member spouse open to reductions in future value of the pension due to pension reductions because of the subsequent insolvency of the pension plan. This is not fair to the non-member.
- Control: The DSM would leave the member effectively controlling when the non-member will start to receive his/her pension. Most individuals want to separate their financial affairs on marriage breakdown and prefer a clean break from their ex-spouse.
- Changes in plans: Some employers cease their defined benefit pension and start a defined contribution pension after the member’s date of separation but before his retirement. Should the separated non-member share in both?
- Administrators: DSM places significant additional burdens upon pension administrators, along with creating a host of administrative practical problems relating to cost of the valuation of the member’s pension by the plan administrator (who are notoriously unqualified to value for family law purposes), the cost of maintaining two sets of continuing records and preserving confidentiality for both the member and his/her former spouse, and the cost of managing two sets of payments out of the pension fund. While the creation of a prescribed form that would serve to assign a defined portion of the member’s pension credits to the non-member spouse would itself be a cost effective and efficient means of effecting a transfer of pension credits, the pension plan would still be saddled with the added cost of administering in effect, two pensions, in contrast to its former obligation of administering one pension.
- The DSM proposed by the Canadian Institute of Actuaries:
- does not accomplish an equal sharing of value increases that accrue only during cohabitation under marriage;
- allows the non-member spouse to share in the increases outside the marriage period and thereby reduces the member’s share of the pension improperly;
- would effectively legislate a continued sharing in post separation value increases by virtue of the member’s post separation service.
In short, the DSM method would not fairly share the value of the pension that actually accrued during the marriage and would impose upon pension administrators an unduly complicated and administratively expensive and cumbersome regime. Someone would have to bear these added costs.
An example demonstrating inequity
The following is an example of how the DSM proposed system would work:
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 2% of salary for each year of service. Ten years later Tom and Jerry each separate from their wife. At this point each has earned an annual pension of $10,000 (2% of $50,000 salary times 10 years of service). The spouse’s share would be $5,000.
Both continue to work for the same company for ten more years and then both retire.
Tom continues to be a plodder and does not earn any increases in salary. Therefore, his pension on retirement is $20,000 (2% of $50,000 salary times 20 years of service). Since he was married for ten of his twenty years, his ex wife will receive an annual pension of $5,000 [½ x 10/20 x $20,000 = $5,000].
On the other hand, Jerry (whose first wife had held him back in his career) remarried a woman who inspired him to work hard and he went on to become CEO of the company. Post separation, Jerry is rewarded for his efforts with a special pension of 4% of his salary (which was now $250,000 annually). Therefore, his pension is $200,000 annually (4% of $250,000 x 20 years). Since he also was married for ten of his twenty years, his ex wife will receive an annual pension of $50,000 [½ 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 totally on account of Jerry’s efforts and accomplishments achieved after the date of separation. This is an example of how implementation of pro rata valuation and division of pension credits can cause a very real injustice to the member spouse and blatant distortion of the philosophy of the Family Law Act. The fact that a former spouse could effectively participate in post separation efforts of the pension member is patently contrary to the intention of the Family Law Act.
Our proposed solution
We advocate for reform but of a different and much fairer nature. Why adopt a “deferred” settlement method when other measures are readily available and already proven to work? We advocate for an “immediate” settlement method. Pensions should continue to be professionally valued (as at present) perhaps with some legislated reforms to introduce standards that treat pension members and non-members fairly and equitably. The value that is thereby derived should be allowed to be split at source by way of transfer of appropriate pension credits to the non-member’s pension if any and if that non-member does not have a pension, then to a locked in Registered Retirement Savings Plan or other vehicle with similarly protected status.
In 1995 the Ontario Law Reform Commission studied the valuation and division of pensions extensively. Their report of 366 pages and their Executive Summary set out in detail their recommendations for pension division. After reviewing the problems with “If and When” settlements, the Commission explained the provisions of both the Pension Benefits Standards Act, 1985, R.S. 1985, c. 32 (2nd Supp.) and the Pension Benefits Division Act (1992, c. 46) Sch. II. Both acts govern different types of federal pensions. The PBSA allows for division of pensions at source by virtue of court order or written agreement. The non-member spouse is treated like an employee who has terminated employment and therefore that non-member spouse can:
- transfer the pension credits to another pension plan, or,
- transfer the pension credits to a locked-in RRSP with the financial institution chosen by the non-member spouse, or,
- purchase an immediate or deferred life annuity; or,
- can also elect to take a deferred pension in the same plan.
The PBDA also acts based upon court orders or written agreements. Under this legislation the non-member spouse is entitled to have immediately transferred up to 50% of the value of the member’s accrued pension benefits to another pension plan (if the plan so permits), to a locked-in RRSP, or to a financial institution for an immediate or deferred life annuity. Unlike the PBSA, the PBDA does not permit the non-member spouse to take a deferred pension in the same plan but allows only for transfers out of the member’s plan.
We urge the province to adopt a similar regime to that found in the above two federal statutes. However, we would vary that regime to make certain that a proper and fair valuation is effected. This will ensure that both sides are treated equally and fairly. By allowing legislated division at source, we relieve the member’s problem of financing a large equalization payment from other assets. On the other side, we ensure that the non-member spouse receives her entitlement up front (but with payment possibly being delayed according to designated statutory criteria) and with no risk to her (as at present with current “if and when” contracts) that the member’s pension may never come into pay.
Under the DSM the non-member spouse will be obliged to pay tax on whatever she receives and the DSM does not appear to take such tax into consideration. Under our proposal we must ensure that the non-member spouse receives her entitlement effectively on a tax-free basis since equalization payments must be tax-free. Tax repercussions can and should enter into the calculations. However, we maintain that the tax in first instance must be calculated based upon the member’s projected average tax rate at retirement since it is, after all, his asset that we are valuing and it is from his asset that we are siphoning off a portion of the benefits that he would otherwise have received. We deduct from the value of his pension the present value of that future tax obligation. By doing so, we are being scrupulously fair to the member spouse.
But what about the non-member spouse? Surely we must be equally fair to her! She will incur tax when she receives her payments either from the pension or the RRIF that we have legislatively required be maintained for her. It is not fair to her to have to pay tax when she should receive her entitlement tax-free. We therefore need to gross up the amount that is transferred to her pension or RRIF so that when she receives payments, the amount received allows for her to pay an amount of tax that will effectively net her out the same amount she would have received had the member spouse transferred to her the entire amount in one capital amount. Again here it would be advisable to set out legislative standards with respect to tax assumptions.
Pension plan administrators might argue against our proposals since they would be required to pay out hard cash to other plans and financial institutions well prior to the date when they would otherwise have been required to make any payments to anyone. Against that argument, we would suggest that there would likely be payments going out of and into various pension plans and financial institutions. It is likely that no one plan or institution would suffer a significant net loss.
Some might argue that there is no need to actually value pensions if we adopt a system of immediate division at source. We would respond that the use of commuted values and values determined by pension administrators (such as currently under the PBDA and the PBSA) should be limited for purposes of equalization of net family property since it is evident that such values have rarely been accurate or fair for marriage breakdown purposes. It is still necessary that pension values be calculated by those qualified to do so – professional pension valuators – who have the qualifications, experience and expertise to provide such valuations. A professional valuation ensures fairness to both sides. And surely, judges and lawyers would want to achieve fairness to both sides in family law cases.
Our reform proposal has all of the advantages of DSM while avoiding many of its pitfalls. Our reform proposal would achieve a level of convenience and fairness along with ease of practical application that would be of great service to those whom we are mandated to assist.
*Gene C. Colman, B.A., LL.B. practises family law in Toronto . He is the author of
“Fuss About Pensions – Practical Suggestions” in Money & Family Law, Vol. 11, No. 8, August 1996.
** G. Edmond Burrows, F.C.A. is the President of Pension Valuators of Canada. He has valued thousands of pensions and has published widely on matters affecting pensions and family law.
*** Penny Hebert, B.A.S. (Hons.) is a senior pension valuator.
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. formerly at http://www.actuaries.ca/publications/2003/203015e.pdf – no longer available at actuaries’ website.
Best v. Best (1997), 31 R.F.L. (4 th) 1, 35 O.R. (3d) 577 (Ont. C.A.); affg 50 R.F.L. (3d) 120 (Ont. Gen. Div.); revd on other grounds 49 R.F.L. (4 th) 1, 174 D.L.R. (4 th) 235, 242 N.R. 1, 43 O.R. (3d) 740n,  2 S.C.R. 868 (S.C.C.)