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In his case, the university plan, from its inception in the 1960s, provided for fully offsetting CPP contributions paid by both employees and the employer. While the previous iteration of the plan called for 10 percent contributions from the university and five percent from employees, they would contribute less once the CPP came into effect in 1966. With the original CPP formula of 1.8 percent of each of the employers and employees, this meant that the university plan would require contributions of 8.2% and 3.2%, respectively, for earnings above the basic exemption and below the maximum earnings annual pensionable. For earnings below the basic exemption and earnings above the annual CPP threshold, contributions to the university plan would drop to 10% and 5%, respectively.
As governments gradually sought to increase CPP contributions, the faculty association began to worry about the impact academically given the integration formula. As such, the design of the plan changed in 1989 to maintain contributions at 8.2% and 3.2%, regardless of any increase under the CPP formula. This framework is still in place today.
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CPP contributions, of course, are on track to increase to 5.95 percent (from the current 4.95 percent) for each employer and employee by 2025. The CPP enhancement also includes additional contributions for people whose income exceeds the maximum annual pensionable earnings. . So, with the increase in CPP contributions, what are some of the options for reorganizing defined contribution pension plans?
A range of options
One of the easiest ways to look at integration is to reduce company contributions to reflect changes to the CPP. So, with the CPP rate increasing by one percentage point by 2025, employers could simply reduce the contribution rate to their defined contribution plan by the same amount. This would offset the increased costs of the CPP for workers and employers.
While many defined contribution plans operate on a relatively simplified basis providing for employer-employee contributions of, say, five percent each, the approach is not always ideal. As Michelle Loder, a partner at Morneau Shepell Ltd., points out, the approach provides full CPP and employer pension plan coverage for low-income employees earning less than the maximum annual pensionable earnings. For those earning above this threshold (currently $ 55,300), they do not have CPP coverage on their full income. Thus, the low-income employee may, in fact, have a higher replacement rate in retirement.
Loder notes that integration into many defined benefit plans generally takes into account CPP coverage. The theory, she says, is that members would need less of their employer pension to replace income up to the annual income threshold since they would also receive CPP benefits. They would thus obtain more of their occupational pension in order to replace income above the threshold.
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Loder acknowledges that defined contribution plans have generally been less explicit about the income replacement rate they aim to provide. But she encourages plan sponsors to consider the problem, even if they don’t communicate it to employees. That may mean setting a replacement rate within a certain range, she says, suggesting that the CPP expansion represents “an opportune time to look at it now.”
Opportunities and challenges
So what does integration look like in the context of defined contributions? Loder gives the example of a plan that provides for an equal contribution of 2% up to the maximum annual pensionable earnings, then 4% for earnings above that threshold. While this would appear to be different from the current approach typically used in defined contribution plans, Loder notes that it would still represent a uniform formula.
“It would be the same formula for everyone,” she said, adding that even the current approach provides for different overall contributions based on changes in employee income.
“Even five percent of the salary, the dollars are different,” she said.
While Loder acknowledges the approach would involve introducing more complexity into the plan and causing communication issues, she says it has the potential to reduce disparities in replacement rates. At the same time, she suggests that this is an opportunity to improve plan members’ understanding of how the CPP works and the contributions they pay.
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But Corey Vermey, director of pensions and benefits at Unifor, is not so sure about the prospects for integrating defined contribution plans into the CPP. The big challenge, he suggests, would likely come from employers increasing the complexity of the scheme.
“It can be intimidating,” he says, noting that he has yet to see any money purchase formulas that incorporate the CPP.
And when it comes to the general question of a simpler integration of the CPP by offsetting the increase in premiums with corresponding decreases in the defined contribution plan, Vermey says discussions on this issue have largely died down. .
“That conversation seems to have ended,” he says, suggesting that the long phase of implementing the CPP enhancement means that employees won’t see many improvements in their benefits for a long time. And beyond that question, he says concerns about the adequacy of retirement remain even with the CPP enhancements.
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“That won’t be the full answer, especially when it comes to CD,” said Vermey, noting that the union would be looking at the plan’s suitability and the replacement rate it provides when it comes to reviewing issues. proposals to offset the increase in CPP contributions. .
“I think it will be situational,” he says, suggesting that defined contribution plans have generally not fully taken into account the additional costs of funding retirement caused by factors such as increased longevity.
And rather than seeing a trend toward CPP offsets, Vermey says he’s seen a trend toward increasing contributions.
Beyond the issue of offsets and integration, there is the fact that the CPP itself is about to get more complex. In addition to increasing contributions by one percent on earnings below the maximum annual pensionable earnings, the CPP enhancements include the introduction of a new layer of coverage.
As a result, employers and employees will each contribute 4% on income in the maximum pensionable annual earnings bracket, which the government says will rise to $ 82,700 by the time the changes are made. CPP come into full force in 2025.
While this introduces an additional hurdle to Loder’s idea of an integration above the maximum annual pensionable earnings, she notes that employers could simplify matters by providing for a higher contribution rate above it. of the new income threshold. As she points out, the CPP reforms aim to replace 33 percent of income, up from the current 25 percent, with earnings up to the two thresholds.
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Loder suggests that no matter what employers decide to do about the CPP, it helps to consider the goals of the plan, especially if the idea is to provide for equal outcomes or equal contributions.
“Even if they don’t change, it’s good exercise for plan sponsors,” she says.
Glenn Kauth is the editor of Benefits Canada.
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