Setting Up a Defined Contribution Pension Plan

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by | Dianne Tamburro, CFA*

The primary focus of this article is the discussion of defined contribution (DC) pension plans. The need for such an examination is twofold:

  1. There continues to be a proliferation of DC arrangements and a consequent decline in highly regulated defined benefit (DB) plans.
  2. Concern exists regarding the level of income these plans will provide, the ability of members to make sound investment and decumulation decisions, and the frequency and effectiveness of communications provided by plan sponsors.

This article looks at the shift from DB to DC retirement plans, the evolving legislation supporting DC retirement plans and considerations for plan sponsors offering these plans to their employees.

The Changing Retirement Market

From 2001 to 2021, the percentage of Canadians in the labour force participating in Registered Pension Plans (RPPs) declined from 40% to 38%.1 RPP coverage changes across sectors is not universal. The private sector experienced a decline in plan coverage, while the public sector experienced a small increase (28% to 23% coverage versus 87% to 88% coverage, respectively).2 Today, less than one in four Canadians working for a private organization continue to accrue pension benefits.

Looking beyond the absolute levels of decline in coverage, there is another trend—Employers are moving away from DB plans. A 2009 article from Statistics Canada indicates that 78% of the decline in membership in DB plans can be attributed to plan conversions, primarily to hybrid/mixed plans.3

The trend away from DB plans is primarily a private sector phenomenon. There has been an overall decline in the proportion of DB plans in the private sector from 74% (2001) to 41% (2021). This contrasts starkly with the public sector where the proportion of DB plans marginally declined from 94% to 91%.4 While the proportion of private sector DB plans decreased, the proportion of DC and hybrid DB/DC plans (DC plans with a minimum or DB provision) increased. The percentage of public sector hybrid plans increased marginally from 1% to 4% of the plans offered, while there has been a large increase in these plans in the private sector from 4% (2001) to 25% (2021).5

With the decline in private sector pension plan coverage, there has not been a corresponding increase in Registered Retirement Savings Plan (RRSP) contributors. The number of employed tax filers who contributed to an RRSP remained relatively constant, increasing by only 1% between 2001 and 2021.6 It is important to recognize that during this same period, the number of people in the workforce grew—so the percentage of tax filers contributing to an RRSP actually dropped from 29% in 2001 to 22% in 2021.7

While DB plans are generally associated with larger employers, the move to DC plans is significant. Many employers with small numbers of employees are shifting to other capital accumulation plans (CAPs), such as group RRSPs and Deferred Profit-Sharing Plans (DPSPs).

Why the Shift to Defined Contribution Plans?

Changing and declining DB pension coverage can be attributed to various factors. In the mid-to-late 1990s, the following factors were significant contributors to the shift:

  • Onerous legislative and regulatory requirements for DB plans under federal and provincial pension statutes, as well as income tax legislation—the latter being the primary catalyst
  • Disputes occurred over the ownership of DB plan surpluses resulting from conservative actuarial assumptions and better-than-expected investment results
  • DB plans added complexity to business mergers and acquisitions
  • DB members felt they could earn higher investment returns and, therefore, receive a better retirement income if they were allowed to manage their retirement assets themselves
  • It was anticipated that new and younger employees would work for many employers during their careers, making pension portability increasingly important.

During the 2000s, regulation and plan complexity continued to be issues, but two severe market corrections (the dot-com bubble and global financial crisis), a recession and a declining interest rate environment created new reasons for making a move from DB to DC plans.

  • Low interest rates on fixed income securities provided marginal investment returns and increased plan liabilities.
  • Many DB plans had difficulty reaching their actuarial investment return assumptions, which resulted in underfunded plans.
  • Of 126 publicly listed Canadian companies surveyed, one-quarter had DB pension liabilities that were 50% to 270% of the size of their corporate liabilities.8
  • Volatility in equity markets and interest rates made it difficult for DB plan sponsors to accurately predict future required contributions.
  • The culmination of the severe market corrections and the rock-bottom interest rates in the late 2010s and 2020s have led to an increase in annuitization in the 2020s as plans matured.
  • More recently (April 2023), Bill C-228 passed, giving pensioners super-priority ahead of other creditors for unfunded liabilities in private-sector DB plans, thereby making borrowing more costly and/or difficult for plan sponsors and ultimately leading to more DB plan closures.

CAPs—particularly the non-RPP variety such as group RRSPs—are alluring due to:

  • The stability and predictability of contributions
  • A less regulated environment
  • Much reduced administrative costs
  • A reduced need for advisors (e.g., actuaries, lawyers, pension consultants).

Pension Legislation for DC Retirement Plans

DC RPPs are subject to provincial or federal pension legislation.

The Ontario Pension Benefits Act (PBA) provides examples of retirement plans that are not subject to the regulations and administrative requirements:

  • An employee’s profit-sharing plan or a DPSP as these terms are defined by the Income Tax Act (ITA)
  • A plan to provide a retiring allowance as defined by ITA
  • A plan in which all benefits are provided by member contributions.9

Federal legislation has similar exclusions with one minor variation—It includes supplemental pension plans for which member eligibility is contingent upon mandatory membership in another pension plan, and the supplemental plan is an integral part of the other plan.10

U.S. Pension Legislation

The Canadian regulatory environment starkly contrasts with the legislative framework in the United States for similar retirement arrangements. In general, plan sponsors and other plan fiduciaries in the U.S. are subject to the exact fiduciary requirements as administrators and advisors under Section 4.04 of the Employee Retirement Income Security Act of 1974 (ERISA).11 The U.S. Congress, however, has recognized that when control over retirement fund investment remains with employees, fiduciaries may be exempt from ERISA fiduciary standards and liabilities by virtue of a safe harbour provision in Section 404(c). These regulations were strengthened by the Pension Protection Act (PPA) of 2006 and subsequent updates from the U.S. Department of Labor.

Detailed regulations set the standards to be met by sponsors wishing to take advantage of the safe harbour provisions. These regulations deal primarily with the conditions that must exist for a participant to have effective control over the assets. The regulations deal with the participant’s ability to give investment instructions, the availability of adequate investment alternatives to make control meaningful and the participant being provided with sufficient information (or an opportunity to obtain such information) to make informed investment choices.12 Updates to PPA extend safe harbour protection to the sponsor’s selection of a default fund for plan participants who have not decided how funds in their account are to be invested.

Currently, widespread regulations do not exist in Canada that provide plan sponsors with the same level of protection as the PPA. However, some provinces do have provisions in their Pension Benefits Standards Act that provide parameters around the investment options offered to members in a DC plan (e.g., the British Columbia Regulations include requirements such that members are offered a sufficient number of investment options of varying degrees of risk and expected return and the default investment option must be a balanced fund or a portfolio of investments that takes into account the member’s age (i.e., a target date fund)).13 Moreover, the increase of DC RPPs and other CAPs will inevitably lead to a call for more regulation, which may mirror, in many respects, the U.S. legislative scheme.

CAP Guidelines

On May 28, 2004, the Joint Forum of Financial Market Regulators (Joint Forum) released a final version of the Guidelines for Capital Accumulation Plans (CAP Guidelines). The Joint Forum was founded in 1999 by the Canadian Council of Insurance Regulators (CCIR), the Canadian Securities Administrators (CSA) and the Canadian Association of Pension Supervisory Authorities (CAPSA). It also includes representation from the Canadian Insurance Services Regulatory Organizations (CISRO). The goal of the Joint Forum is to continuously improve the financial services regulatory system through greater coordination of regulatory approaches. In preparing the CAP Guidelines, one of the objectives was to provide a standard set of operating practices that could apply to all CAPs regardless of what regulatory body the plan administration fell under. It must be noted that the CAP Guidelines are not law; they are meant to provide direction to plan sponsors, service providers and members.

On September 9, 2024, CAPSA released the much-anticipated updated CAP Guideline (CAPSA Guideline No. 3). Since its introduction, the CAP Guideline has been widely accepted as the base principles for the administration of CAPs, and many CAP sponsors have adopted them. The CAP Guideline intends to outline and clarify the regulators’ views on:

  • the responsibilities of CAP sponsors, administrators, service providers and CAP members;
  • industry best practices in the maintenance and administration of a CAP; and the information that should be provided to CAP members.14

For tax assisted investment or savings plans or programs where members choose between two or more investment options selected by the CAP sponsor, the CAP Guideline outlines the responsibilities of CAP sponsors, service providers and CAP members—covering these areas:

  • Setting up a CAP
  • Investment options
  • Educating members about the CAP
  • Decision-making tools and investment advice for CAP members
  • Ongoing communication to CAP members
  • Maintaining oversight of a CAP
  • Communication to CAP members on termination of active participation
  • Communication to CAP members on termination of a CAP.

Setting Up and Administering a DC Plan

When setting up a new DC plan, sponsors can refer to the CAP Guideline for minimum standards and their responsibilities as sponsors. Although this section deals specifically with DC plans, it should be noted that the responsibilities of plan sponsors offering CAPs, such as group RRSPs and DPSPs, would be very similar.

The first step in setting up a CAP is defining and documenting the purpose of the plan. Examples include:

  • income at retirement;
  • tax efficient compensation;
  • profit sharing; and

savings for other financial goals such as education, home purchase, etc. For DC plans in particular, the primary purpose is to enable member to eventually receive lifetime retirement income from their savings.

In addition, the CAP sponsor should establish and document a governance framework for administration of the plan appropriate for the size, complexity, and other characteristics of both the CAP and the CAP sponsor, which may include:

  • a description of the roles, responsibilities and accountabilities of any stakeholders or parties involved in the governance of the plan (e.g., employer, union, board of directors, pension committee, governance committee, service providers, plan members);
  • a communication process, including a process for addressing member complaints;
  • a code of conduct, including a policy to manage conflicts of interest;
  • a risk management framework (as may be applicable to the CAP);
  • a framework for the regular review of the performance of service providers, including investment managers (with articulated performance criteria); and
  • a process for the regular review of the governance process.15

During the setup phase of a plan, two key administrative concerns are (1) the selection of a recordkeeper to assist with the administration of the plan and (2) the documentation of decisions and outcomes. Both of these areas are discussed in the following text. Other elements in the setup of a plan, such as investment selection and communication with members, are addressed in later chapters.

Selecting a Recordkeeper

The CAP Guideline does not specifically identify how to evaluate a recordkeeper during the selection process, but they offer general criteria to consider. These include:

  • Potential conflicts of interest;
  • Reputation;
  • Professional qualifications or designations;
  • Historical and expected stability of the service provider team;
  • Experience;
  • Specialization in the type of service to be provided;
  • Controls in place to secure CAP members’ personal data;
  • Consistency of service offered in all geographical areas in which members reside;
  • Quality, level and continuity of services offered;
  • Competitiveness and reasonableness of the cost of services provided; and
  • Appropriate level of access to information from the service provider to allow the CAP sponsor to meet CAP member disclosure requirements as outlined in the CAP Guideline.16

It should be noted that a significant number of lawsuits in the U.S. relate to the competitiveness of fees. Canada tends to lag behind the U.S. regarding pension plan trends, so fees in Canadian CAPs may come under scrutiny in the future.

In addition, a CAP sponsor should periodically review the performance of its service providers, including those providing financial planning or investment advice. Criteria to consider when performing reviews of service providers include:

  • Evolving CAP requirements;
  • Updating the criteria to reflect the current marketplace, including fees and range of services available;
  • A performance assessment of the service provider and the quality of its product or service;
  • Reassessing any perceived or actual conflicts of interest; and
  • Assessing the CAP sponsor’s satisfaction and CAP members’ satisfaction regarding services rendered by the service provider.17

Maintaining oversight of a CAP

While CAP sponsors can delegate many of the duties outlined in the CAP Guideline to a service provider, the responsibility ultimately rests with the plan sponsor. CAP sponsors must maintain and monitor a plan after setup. They must regularly review all aspects of the plan, including:

  • CAP features to determine if they continue to meet the purpose and objectives of the CAP;
  • Governance framework, ensuring the CAP sponsor is fulfilling its roles and responsibilities;
  • Fees and expenses;
  • All service providers;
  • Investment options and funds;
  • Member education and decision-making tools; and
  • The maintenance of plan records.18

Maintenance of Records

Throughout the plan's setup and ongoing maintenance, the CAP sponsor needs to maintain records regarding the decision-making processes and outcomes. Documentation can help protect a CAP sponsor should a member question or complain about a decision or action. It is also important for the CAP sponsor to ensure that all service providers to whom responsibilities have been delegated maintain appropriate member records and have formal policies about document retention and storage. The CAP sponsor should also consider controls necessary to secure CAP members’ personal data.

The CAP Guideline recommends that CAP sponsors develop a formal written retention policy that identifies the types of documents that should be retained, how long they should be retained and who can access them. The policy should also address how the record retention policy will be reviewed internally and at the service provider level.

Other Relevant Industry Guidelines

CAPSA Guideline No. 8—Defined Contribution Pension Plans Guideline

CAPSA Guideline No. 8—Defined Contribution Pension Plans Guidelines was first introduced in March 2014 to clarify the rights and responsibilities of DC plan stakeholders and to provide guidance to administrators on the tools and information they should give members during the accumulation phase, when approaching the payout phase and during the payout phase.

This Guideline was drafted in response to the maturing of DC plans and the increase in the number of plan members retiring with a sizeable portion of their retirement assets deriving from DC plans. In February 2019, CAPSA updated Guideline No. 8 as follows:

  • Clarified that the Guideline includes the DC component of hybrid plans
  • Offered guidance to DC plan administrators on tools and information to provide to members receiving a variable benefit
  • Expanded the responsibilities of plan administrators to consider relevant factors when selecting investment options for members
  • Stated that plan administrators should provide useful and relevant information on fees payable by the member
  • Stated that plan administrators are expected to provide details regarding the anticipated value of the plan member’s accounts at retirement and the level of benefits that could be generated from that value, disclosing assumptions used to arrive at these estimates, and should clearly indicate that actual future values or benefits will likely differ from the estimates
  • Offered extensive new guidance on DC plans with a variable benefit product, noting that these plans require a continued relationship with the member even during the payout phase
  • Expanded the type of advice members are recommended to obtain (if they need help managing their DC plans) to include financial planning and retirement advice as well as investment advice.19

CAPSA Guideline No. 10—Guideline for Risk Management for Plan Administrators

In parallel with the release of the updated CAP Guideline, CAPSA released Guideline for Risk Management for Plan Administrators of all pension plan types (including DC plans), which defines the key elements of a risk management framework and sets out principles to: identify, evaluate, manage, and monitor material risks. This Guideline outlines overarching principles of risk management and risk considerations for specific topics, including

  • third-party risk;
  • cyber security risk;
  • investment risk governance;
  • Environmental, Social, and Governance (ESG) risk; and
  • use of leverage.20

These industry guidelines provide more detailed expectations for operating DC plans and reflect concerns raised by stakeholders.

It should be noted that while this chapter was focused on DC plans during the accumulation phase, as of 2023, there is lots of innovation underway for converting DC plan balances into retirement income.

Additional information

*originally authored by: Jill Taylor Smith

Endnotes

  1. Statistics Canada. Pension Plans in Canada, as of January 1, 2022, Tables 11-10-0133-01 and 14-10-0027-01.
  2. Statistics Canada. Supra note 1.
  3. Statistics Canada. Shifting Pensions (May 2009) Catalogue no. 75-001-X, p. 19.
  4. Supra note 1.
  5. Supra note 1.
  6. Statistics Canada. Table 11-10-0044-01 Selected characteristics of tax filers with Registered Retirement Savings Plan (RRSP) contributions, (formerly CANSIM 111-0039).
  7. Supra note 6.
  8. “Today’s Risks Faced by Pension Plans,” The Analyst (September 2011), pp. 14-15.
  9. Ontario Pension Benefits Act, R.S.O. 1990, C. P. 8, s. 1.
  10. Pension Benefits Standards Act, 1985, R.S.C. 1985, c. 32, s. 4(2)(3).
  11. Employee Retirement Income Security Act of 1974, 29 U.S.C.A. S.1011 (1974).
  12. Pension and Welfare Benefits Administration, U.S. Department of Labor, Rules and Regulations for Fiduciary Responsibility: ERISA Section 404(c) plans, 29 CFR s. 2550.404c-1 (1992).
  13. Pension Benefits Standards Regulation, BC Reg 71/2015s. 68(4).
  14. Canadian Association of Pension Supervisory Authorities. Guideline No. 3 – Guideline for Capital Accumulation Plans, (2024), p. 4.
  15. Ibid. p. 9.
  16. Ibid, pp. 10-11.
  17. Ibid, p. 26.
  18. Ibid, p. 25-27.
  19. Eckler Special Notice, February 20, 2019. Updated CAPSA Guideline No 8. Provides Best Practices for Variable Benefits.
  20. Canadian Association of Pension Supervisory Authorities. Guideline No. 10 – Guideline for Risk Management for Plan Administrators (2024), p. 4.

Bio

Dianne Tamburro, CFA, has spent her entire career, spanning more than 25 years, consulting to organizations on their capital accumulation plans. Learn more about her contributions here.