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The decline of DB pension plans in Canada is being exacerbated by federal laws and regulations that foster employer underfunding
Toronto (15 April 2008) – The decline of defined-benefit (DB) pension plans in Canada is being exacerbated by federal laws and regulations that foster employer underfunding, says a study released today by the C.D. Howe Institute.
The study, Lifting the Lid on Pension Funding: Why Income-Tax-Act Limits on Contributions Should Rise by Robin Banerjee and William B.P. Robson refers to the prohibition by the federal Income Tax Act (ITA) of sponsor contributions to such plans when their assets exceed recorded liabilities by 10 percent. “Recent volatility in asset prices and interest rates, and resulting volatility in DB plan balance sheets, highlights the desirability of raising — or even removing — this restriction.’
The study notes that the10 percent limit exists to prevent companies making pension contributions, which are tax deductible, to reduce taxable profits. It suggests, however, the benefit of the limit is marginal at best since (i) businesses will typically prefer to reinvest their earnings or pay them out as dividends, (ii) pension funds attract tax when distributed or withdrawn, and (iii) regulations prevent deliberate overfunding of designated plans.
“Easier to demonstrate are the problems the limit creates. First, and fundamentally, limiting contributions in good times stops plan sponsors saving in fat years to cushion against lean ones. Having the flexibility to time investments can also help firms buy assets when they are cheaper, and enjoy longer compounding periods.”
“The ITA limit on contributions is not the only problem afflicting DB plans,’ the authors of the study say, “but raising it to 25 percent or removing it entirely would be a useful step toward more healthy DB pension plans in Canada.”