Pension limit ignores inflation impact
The federal government is finally set to do something about a long-outdated rule that is causing financial difficulties for an increasing number of middle-income seniors.
Only problem: the response is too little, too late. Worse, it doesn’t take effect until 2005, and even that date is not certain.
Ottawa’s long-standing rule caps the amount of money a retired employee can receive from an employer pension plan.
A ceiling on tax-deductible contributions to such plans is meant to prevent companies from funding outrageously high benefits for employees at taxpayers’ expense. (Pension plan contributions are tax-deductible to an employer and are not a taxable benefit for employees.)
Inflation erodes value
The formula used to calculate the cap has essentially been unchanged since 1977. That’s 25 years, during which inflation has deeply eroded the buying power of the maximum allowable pension.
The cap is determined by multiplying your years of service by $1,722.22. So, if you were with a company 20 years, the maximum initial annual pension you could draw would be $34,444.40.
The cap provides for indexing in the anal pension payment, based on increases in the Consumer Price Index (CPI), to a maximum of four per cent a year. (Unfortunately, many private sector pension plans do not include indexing provisions.)
However, the basic formula itself is not indexed, quietly ignoring the harsh reality that $1,722.22 simply doesn’t buy the same today as it did in 1977.
As a result, a cap that may have seemed generous a generation ago is stingy by today’s standards.
Next page: Check the numbers
Check the numbers
I went to the Statistics Canada website and checked out Canada’s CPI increases since 1977 to the end of 2001.
Using those figures, I calculated that if the pension formula had been indexed to inflation over that time, the base figure would have almost tripled, to $5,008.12.
For someone with 20 years of service, the maximum allowable annual pension entitlement would increase to $100,162.40! The numbers speak for themselves.
Of course, few Canadians would qualify for an employer pension of more than $100,000. But many people with 20 years of service would qualify for much more than $34,000-and-change, based on career earnings or final average earnings.
Ottawa’s plans postponed
So what does Ottawa plan to do about it? I talked to the Finance Department and was told that the current plan is to begin indexing the base figure to increases in the average annual wage.
But that’s not scheduled to cut in until 2005, some 28 years after the formula was put into place. And there’s no guarantee it will happen even then.
The government at one time said indexing would be introduced in 1995, then put it on hold. This postponement will have lasted a decade, if indeed it does happen in 2005.
It certainly should not be delayed again.
Make RRSP contributions
The pension cap is yet another incentive to take full advantage of RRSP contribution room. If you are still working and in a middle- to upper-income bracket, the chances are that your employer pension won’t be enough to maintain your lifestyle.
I recommend that you meet with your pension plan administrator to find out exactly how much you can expect to receive at retirement.
Based on the outcome of that discussion, you may want to make it a priority to use any carry-forward RRSP room you’ve accumulated as quickly as possible to provide the supplementary income you’ll need in the future.
Gordon Pape is the co-author with David Tafler of The Complete Guide to RRIFs and LIFs, published by Prentice Hall Canada.