Flexible Pension Plan: Enhancing Your Defined Benefit Plan

With many private sector pension plans reaching fully funded status, a growing number of plan sponsors are considering de-risking strategies. De-risking can take many forms from plan redesign to plan consolidation. The purpose of de-risking is to reduce an employer’s exposure to pension plans risks like a market downturn.

Before undertaking a de-risking strategy, it’s important to consider how it could affect employee loyalty and morale. Despite employees switching jobs more frequently today, pension plans are still considered a valuable benefit. Over three-quarters of new hires at employers offering traditional defined benefit (DB) pension plans said the retirement program gives them a compelling reason to stay on the job, according to the Towers Watson Retirement Attitudes Survey.

If you’re considering cutting your pension benefit, but you still want to offer employees a way to save for retirement, a flexible pension plan may be the answer.

What is a Flexible Pension Plan?

A flexible pension is a pension plan that allows employees with a defined benefit pension to make voluntary contributions to acquire or improve ancillary benefits. One of the biggest complaints from employees with defined benefit pension plans is a lack of RRSP contribution room. Those with a gold-plated pension plan could end up with as little as $600 of RRSP contribution room in a single calendar year.

Flexible pensions let employees choose the enhancements that matter most to them without affecting their RRSP contribution room. That’s because ancillary benefits aren’t considered in the pension adjustment (PA) formula. If you’re a plan sponsor considering trimming back your pension plan, flexible pension plans can be a good way to offset any reduction in the plan formula and offer employees more RRSP contribution room.

How does a Flexible Pension Plan Work?

Flexible pension plans work a lot like defined contribution pension plans and Group RRSPs. Contributions can be made conveniently via payroll deduction. Employee contributions are based on a percentage of annual earnings. To sweeten the pot and encourage participation, employers can offer matching. For example, you could offer matching on the first 2% of eligible earnings.

Although investment choice is limited, employees benefit from lower investment fees. Flexible pension plans are a lot more straightforward than traditional defined benefit plans and less costly to administer, making them ideal for outsourcing to third-party pension administrators. They’re also easier to value since the value of an employee’s flexible pension plan is based on his or her account balance.

The following are some examples of ancillary benefits you can offer through your flexible pension plan:

  • lowering the age at which an unreduced pension can be paid or decreasing the early retirement reduction factor;
  • indexing pensionable earnings, reducing the number of years used to calculate average earnings or replacing career average earnings with best or final average earnings;
  • providing bridging benefits;
  • indexing lifetime retirement benefits; and
  • improving survivor benefits.

For example, if you recently switching from a finale average earnings plan to a career average earnings plan, you could allow employees to improve the plan formula with their flexible pension plan.

Use It or Lose It Rule

Similar to health spending accounts, flexible pension plans come with a “use it or lose it” rule. It’s important to properly educate your employees so they don’t accidentally over contribute to their flexible pension plan. When it comes time to retire, if an employee still has money left after purchasing all the enhancements, he or she will forfeit the remaining balance.

By offering a flexible pension plan, you can help level the playing field between private sector and public sector employees and retain your best employees. Flexible pension plans are a win-win situation – employees benefit from more RRSP contribution room, while employers are able to de-risk, while still offering employees a way to save towards retirement.

More information on flexible pension plans is available on the Canada Revenue Agency website.

Written by Sean Cooper

Sean Cooper is a Pension Analyst with a global pension and benefits consulting firm. He is a financial journalist with articles featured in major publications, including the Toronto Star, the Globe and Mail and MoneySense. His areas of expertise include pensions, retirement and health benefits. He has made several media appearances, including Bell Media, Newstalk 1010 and CTV. Follow Sean on Twitter @SeanCooperWrite and check out his personal finance blog at www.seancooperwriter.com.

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