Separation/Divorce – The New Law in Ontario

There is a new law which took effect on January 1, 2012 in Ontario which changes the system for pension valuations on marriage breakdown. There are several key features about the new law that you need to be aware of:

  • The valuation rules are specified in the Ontario Pension Benefits Act and result in a single value being assigned to a member’s pension benefits (versus a range of values based on various assumed retirement dates, as was done under the previous law and is currently done in many other provinces). Although defined benefit pensions cannot be fairly valued with just one value, the government has decided to create a system which proivdes just one value based on a complex formula, as they believe that this will result in increased simplicity for divorcing couples.
  • The new law is not flexible, so the pension value will not reflect individual circumstances such as intended retirement age, poor health, disability, etc. As a result, the value will be unfair in some cases. For members of Ontario regulated pension plans, it may be possible to use the new division options under the law to avoid an unfair settlement due to an unfair value (click here for more information).
  • The new valuations do not include the value of non-guaranteed ad hoc increases to pensions in payment which were previously included in the valuation of pensions on marriage breakdown. The new law requires the plan adminsitrator to disclose any ad hoc increases provided in the prior three years (but not to include their value). This will become a substantial issue for some plans, such as HOOPP, CAATT and possibly the Ontario Teachers’ Pension Plan, which have removed guaranteed indexing to some extent for future service accrual. The value of ad hoc indexing is often worth thousands of dollars and certainly may be considered a separate asset by the courts which would require valuation by an independent actuary.
  • The regulations do not address the issue of income tax. The value provided by the plan adminsitrator (the “imputed value”) is a pre-tax value which is not a fair value to include on a member’s net family property statement with other assets which are after-tax. In addition, it is often unfair to one spouse to use an approximate income tax adjustment (click here for more information on income tax adjustments).

Click here to download a PowerPoint Presenation on the new law in Ontario given in April 2012

The New Process for Pension Vauations on Marriage Breakdown

  1. The pension needs to be valued:
    • Ontario regulated pension plan members can get the value from the pension plan administrator for a fee of up to $600 plus HST for a defined benefit pension. The plan member or spouse must complete the appropriate FSCO forms (click here for a link to the application forms on the FSCO website).
    • Members of other plans may need to retain an independent actuary to determine the value of their pension under the new rules since the new law requires that all pensions be valued in accordance with the same rules, even if the plan administrator does not provide the value. Plan administrators of the following plans will not provide the new value:
      1. federal government pension plans (i.e. PSSA, RCMP, Canadian Forces)
      2. some federally regulated pension plans (i.e. banks, airlines, railways, etc.)
      3. foreign pension plans
    • Be careful with supplemental pensions for high income earners (i.e. top-up plans), as the value may or may not be provided by the plan administrator.
  2. The imputed value of the pension is inserted into the NFP.
    • There needs to be an appropriate deduction for contingent income tax; the imputed value provided by the plan administrator will not be adjusted for tax (click here for more information on income tax adjustments).
  3. Equalization payment determined.
    • For Ontario regulated plans, the member can request a division/transfer of pension to assist in equalization.
    • Division of the pension is optional.The member can buy-out the non-member spouse using other assets (i.e. assets worth 50% of the imputed value, adjusted for income tax if after-tax assets are being traded).
    • When the plan adminsitrator provides the imputed value to the plan member/spouse, they will provide forms and instructions on how to request a divsion of the pension.

 The Valuation Rules – Defined Contribution Pensions

Under the new law, defined contribution pensions are valued in the same manner as under the old law; the value earned during marriage is equal to the account balance at the date of separation less the account balance at the date of marriage. This value can be requested from the plan adminsitrator. If it is not possible to determine the account balance at marriage (i.e. records are not available), then the account balance at the date of separation can be pro-rated based on service earned during marriage versus total service to determine the portion earned during marriage. The imputed value provided by the plan administrator is a pre-tax value and needs to be adjusted by income tax.

The Valuation Rules – Defined Benefit Pensions

Under the new law, the preliminary value of an active member’s defined benefit pension who is not eligible for an unreduced pension at the date of separation is calculated as the weighting of three different actuarial values:

A – Commuted value assuming the member terminates membership and will retire at the optimal retirement age (which includes retirement with a reduced pension).

B – Commuted value assuming retirement at normal retirement age (typically age 65).

C -Commuted value assuming the member will continue to be an active member and retire at their earliest unreduced retirement date.

Specifically, a member’s preliminary value is calculated as:

T is the number of years until eligibility for an unreduced pension benefit.

If “T” for the member is at least zero but less than 10,
(0.1T/10) × A + [(4 − 0.04T)/10] × B + [(6 − 0.06T)/10] × C

If “T” for the member is at least 10 but less than 20,
[(0.3T − 2)/10] × A + [(4.8 − 0.12T)/10] × B + [(7.2 − 0.18T)/10] × C

If “T” for the member is at least 20 but less than 30,
[(0.45T − 5)/10] × A + [(6 − 0.18T)/10] × B + [(9 − 0.27T)/10] × C

If “T” for the member is 30 or more,
(0.85 × A) + (0.06 × B) + (0.09 × C)

The preliminary value of an active member’s defined benefit pension who is eligible for an unreduced pension at the date of separation is calculated using the following:

(1 – 0.6 × E/D) × B + (0.6 × E/D) × F

D – years between earliest unreduced retirement date and normal retirement date
E – years between date of separation and normal retirement date
F – commuted value of pension benefits

The preliminary value for a retired member is the commuted value excluding any survivor pension payable to the spouse. The preliminary value of a spouse’s survivor pension is the commuted value.

 The Imputed Value (Family Law Value)

The imputed value or family law value is determined by pro-rating the preliminary value based on the portion of the member’s credited service earned during marriage (as was previously done).

If spouses agree, a period of cohabitation can be included in the marital period for the purpose of division.

 What is the Commuted Value?

The commuted value is calculated in accordance with the Canadian Institute of Actuaries’ Standards of Practice – this is the termination value. The law specifies that the standard in effect on June 3, 2010 must be used for the calculation.

The Canadian Institute of Actuaries’ has different Standards of Practice for commuted value and marriage breakdown pension values.  The new law specifies commuted value which is problematic on marriage breakdown for a number of reasons:

  1. Unisex mortality
  2. Unvested spousal benefits likely included (i.e. based on a probability of being married at retirement)
  3. Full generational mortality (separations after Jan 2011) with no allowance for substandard mortality
  4. Discount rates set differently.

The Family Law Value of a Pension in Pay on the Date of Separation

Pension Payments in Arrears

If a pension is in pay on the date of separation (i.e. the retirement occurred prior to the date of separation), in accordance with the Ontario Pension Benefits Act and regulations, the family law value of the member’s pension is equal to the commuted value on the date of separation; the commuted value is calculated as the present value of all future pension payments after the date of separation (i.e. payable for the member’s lifetime).

Under the Ontario Pension Benefits Act any pension payments that are made between the date of separation and the date the pension is divided represent a partial overpayment to the member.  As a result, when a pension in pay is divided, a pension arrears adjustment is determined by the plan administrator representing the present value of the portion of the member’s pension paid from the date of separation to the date of division that was assigned to the former spouse; the arrears adjustment decreases the pension payable to the member and increases the pension payable to the former spouse.  This arrears calculation is always done when dividing a pension in pay and it is not possible to request that a pension in pay be divided going forward only.   Since there is always a period of time between the date of separation and the date of pension division, after the division of a pension in pay, the former spouse will always receive a pension greater than what is specified in the separation agreement or court order and the spouse will always receive a lesser pension amount.

For example, take a member who has a monthly pension of $2,000 per month which was entirely earned during the period of marriage.  Two years after the date of separation, the spouses complete a separation agreement which specifies that the former spouse will receive 50% of the member’s pension or $1,000 per month.  After the division of the pension, the member receives a pension of $900 per month and the spouse receives a pension $1,100 per month; there is a $100 per month arrears adjustment to the member’s pension representing two years worth of pension payments at $1,000 per month that should have been paid to the former spouse instead of the plan member.  If the goal in this situation is that the former spouse will receive 50% of the member’s pension going forward (i.e. since spousal support was being paid), the separation agreement will need to specify that the former spouse receive less than 50% of the member’s pension.  The exact percentage of the member’s pension that would need to be specified in the separation agreement to ensure that the former spouse receives 50% of the member’s pension going forward would need to be actuarially determined.  If the member’s pension plan administrator is not willing to do this calculation (they are not required to under the law), an independent actuary will need to be retained to do this calculation.

Survivor Pension

If the member and former spouse were married at the date of separation, most likely there is a survivor pension payable to the former spouse (i.e. unless the former spouse waived this survivor pension at the time of the member’s retirement).  The family law value of the former spouse’s survivor pension is equal to the commuted value of the survivor pension; the commuted value is calculated as the present value of all future pension payments based on the probability of the former spouse outliving the member.

The survivor pension cannot be divided and will remain the asset of the former spouse.  As a result, this asset should be included in the former spouse’s family property and equalized using other assets.

Equalizing the Pension

If there is a pension in pay at the date of separation, the after-tax family law value of the member’s pension should be included in the member’s assets and the after-tax family law value of the survivor pension should be included in the former spouse’s assets; FSCO Family Law Form 4E provides both the family law value of the member’s pension and the survivor pension.

The family law values provided by the pension plan administrator are pre-tax values.  As a result, a deduction for contingent income tax should be made from both the family law value of the member’s pension and the family law value of the survivor pension when including these values in the net family property statement.  The deduction for income tax can be accurately determined by an actuary based on the member and former spouse’s sources of retirement income.  Alternately an arbitrary approximate can be applied (i.e. 10% or 20%), however, in the case of pensions worth a large amount of money, an approximate deduction can result in a significant gain or loss to the member or former spouse compared to a more precise calculation.

For example, take a couple who only have two assets: a pension and the matrimonial home.  The pension plan administrator provided the Statement of Family Law Value which indicates that the family law value of the member’s pension is $800,000 and the family law value of the survivor pension is $160,000 (these values are both pre-tax).  The matrimonial home is worth $600,000.  The couple retains an actuary who determines that the appropriate income tax deduction for contingent income tax is $160,000 for the member’s pension (i.e. 20% of $800,000) and $24,000 for the former spouse’s survivor pension (i.e. 15% of $160,000).  The net family property is determined as follows:

Family   Asset

Member

Former   Spouse

Matrimonial   home

$300,000

$300,000

Member’s   pension

$800,000

Survivor   pension

$160,000

Deduction   for contingent income tax on pension

($160,000)

($24,000)

Net   family property

$940,000

$436,000

 

To equalize these assets, the member would owe the spouse an after-tax equalization payment of $252,000 ($940,000 less $436,000, divided by 2).  This equalization payment could be satisfied in one of the following ways:

  1. The former spouse could receive $252,000 of the member’s equity in the matrimonial home.  In this case, the former spouse would keep their full pension.
  2. The former spouse could receive $252,000 worth of the member’s pension from the plan.  An independent actuary is hired who determines that $252,000 grossed-up for income tax is $305,000 (i.e. since the equalization payment is an after-tax amount and the pension division is done on a pre-tax basis).  As a result, the separation agreement specifies that the former spouse receives 38.125% of the member’s pension (i.e. $305,000 divided by the family law value of the member’s pension of $800,000); as mentioned above, the actual percentage of the member’s pension that will be paid to the former spouse will be higher than 38.125% due to the arrears adjustment.  If the member and former spouse are expected to have similar levels of retirement income, the portion of the member’s pension payable to the former spouse can be determined using the pre-tax family law values.  In this example, this would result in the spouse receiving $320,000 worth of the member’s pension (i.e. the family law value of the member’s pension of $800,000 less the family law value of the survivor pension of $160,000, divided by 2), which is equivalent to 40% of the member’s pension (i.e. $320,000 divided by the family law value of the member’s pension of $800,000).  This percentage is only approximate in this case since the actuary has determined that the member will have a higher income tax rate in retirement than the former spouse.
  3. The former spouse could receive a combination of option #1 and option #2.

Double Dipping and Spousal Support

After property equalization, the portion of the member’s pension earned during marriage has been equalized.  In order to avoid ‘double dipping’, when determining the member’s income for the purpose of spousal support, the portion of their pension earned during marriage should be excluded from their income (i.e. since the former spouse already received 50% of this pension as part of property equalization, regardless of whether the pension was divided or not).

For example, a member is currently receiving a pension of $4,000 per month, 75% of which was earned during marriage.  The family law value the member’s pension was included in the property equalization between the spouses (i.e. the family law value was based on 75% of the member’s pension).  To avoid double dipping, when determining spousal support payable, the pension income earned during marriage should be excluding from the income calculations.  In this example, a pension of $3,000 per month was earned during marriage (75% of $4,000) and was equalized, so pension income of only $1,000 per month should be included in the member’s income when calculating spousal support.

The question of whether or not it is appropriate to double dip when determining spousal support is a legal issue and not an actuarial issue.

 Special Situations

There are many special circumstances that can arise that are not addressed in the new law – the new law provides a “one size fits all” approach to pension valuations. Generally speaking, it appears that special circumstances that were previously taken into account in pension valuations can no longer be reflected. Possible examples of these special circumstances are:

  1. Past service purchases. The regulations are silent. Will FSCO develop a policy?
  2. Substandard mortality not taken into consideration in values.
  3. Contingently vested survivor pensions.
  4. Disability pensions. Not specifically addressed in regulations
  5. Many other possible situations?

 Which Type of Plan do you have?

For detailed information on the pension valuation rules on marriage breakdown in Ontario, click on the applicable category below: