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Introduction: 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 Attorney General) lend themselves to an appropriate mix of flexibility,
certainty or true fairness and equity for the parties themselves.
There is an
enlightening discussion of the problems and the OBA recommendations by Wendela Napier
in the January 2005 issue of Money & Family Law.
Proposed
reform measures: The Canadian Institute of Actuaries has devised a
system known as the Deferred Settlement Method (DSM) for dividing the pension on retirement of the
member. The “Deferred Settlement Method” [DSM]
appears to have a number of potentially quite attractive features:
1.
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.
2.
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.
3.
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”.
4.
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.
5.
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.
6.
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:
1.
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?
2.
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.
3.
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.
4.
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.
5.
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.
6.
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?
7.
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.
8.
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.
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