How to Manage Pension Benefits on Employment Termination

August 6, 2010

A complex subject is about to get a bit more complicated, at least in Ontario, as recent amendments to the Ontario Pension Benefits Act (PBA) will extend the entitlements of terminating employees under registered pension plans.

The treatment of employees' pensions and other benefits is an important component of termination of employment situations, and can often be the source of disputes. For instance, the issue of whether and how long to continue coverage and accruals under employer pension and other benefit plans is a frequent point of contention in negotiating termination packages, and has often been contested before the courts.

Under common law, employees who are involuntarily terminated by their employers (without cause) are entitled to reasonable notice of termination, or pay in lieu of notice. A corollary of this principle is that employees who are wrongfully terminated are entitled to be put in the same position that they would have been had they continued in active employment to the end of the reasonable notice period (subject to the duty to mitigate damages).

To comply with these legal duties in the pension and employee benefits context, an employer can choose to allow the terminating employee to continue to participate in and accrue benefits under the employer's plans until the end of the reasonable notice period. But in many cases, continued participation in the employer's benefit plans is not possible (for example, where the employee elects a lump sum severance payment in lieu of notice).

If continued plan participation is not possible, the general rule is that an employer who terminates an employee without cause is liable for damages, measured by the loss of salary and other benefits that would have been earned during the reasonable notice period. In other words, a terminated employee is entitled to damages for the difference between the benefits the employee is entitled to from the plan and what he or she would have been entitled to had employment continued to the end of the notice period.

These principles are easy enough to state, but implementing them in practice can be complex:
  • Employment standards legislation deems terminated employees to be employed to the end of the statutory minimum notice period, for benefit plan purposes. As a result, the termination package should include plan participation/benefit accruals to the end of the statutory notice period;
  • Allowing employees to remain covered under registered pension plans beyond the statutory notice period can be risky. If the employee is on salary continuance, and their income is treated as "employment income" (as opposed to a "retiring allowance" ) for purposes of the Income Tax Act (Canada) (ITA), then pension plan participation and accruals can continue for the duration of the notice period;
  • If the employee receives a lump sum severance payment, then the ITA will restrict accruals of benefits and/or making of employer contributions under registered pension plans beyond the end date of the statutory notice period;
  • In situations where continued pension accruals are not possible, the employee is entitled to damages for the lost benefits accruals. But putting a value on these accruals can often be complex, particularly for defined benefit pension plans. And since pension plans are tax-deferred arrangements, it has been held by some courts that the employer should have to gross-up such amounts such that the employee is kept whole on an "after tax" basis.
  • Employers must also now consider recent changes to the PBA made by Bill 236, which received royal assent on May 18. In particular, Bill 236 introduced new "immediate vesting" provisions and expanded the application of "grow-in" benefits under the PBA. These will have important implications for terminating employees and will likely increase the cost of termination packages for employers who sponsor registered pension plans.

    Once Bill 236 comes into force, the PBA will provide for immediate vesting of pension benefits for employees who are members of a registered pension plan. This is a departure from the current two-year vesting period and will mean that all employees who are members of a pension plan will now be entitled to pension benefits on termination of employment.

    This is likely to translate into increased costs for employers to administer these small pensions, in particular for employers with a high employee turnover rate. To mitigate against the effects of immediate vesting, employers may want to consider implementing a waiting period for new employees to join the plan.

    Under the PBA, members of defined benefit pension plans qualify for "grow-in" benefits if their age plus service equals 55 points or more on a full or partial wind-up of a pension plan. (Basically, if the plan provides enhanced early retirement benefits to members who meet certain conditions, members who are terminated before meeting those conditions, but who meet the 55 points threshold, are deemed to "grow-in" to and qualify for such enhanced pension benefits even after their employment is terminated.)

    Bill 236 eliminates the concept of partial wind-ups under the PBA, but extends grow-in rights to all involuntary employee terminations, unless there is "wilful misconduct, disobedience or wilful neglect of duty by the member that is not trivial and has not been condoned by the employer."

    While the changes to the PBA expanding grow-in rights do not take effect until July 1, 2012, the expansion of such benefits raise a number of potential employment law scenarios that should be considered by employers immediately. For example, employees who are terminated without cause prior to July 1, 2012 may take the position that they are entitled to grow-in benefits based on common law or statutory notice periods that extend past July 1, 2012.

    In cases where an employee is terminated for wilful misconduct, employers should be aware that it is not yet clear what criteria will apply to determine whether such termination is excluded from the expanded grow-in benefits. Wilful conduct is likely to be different than simply establishing "just cause."

    It may be possible for employers to avoid giving terminated employees grow-in benefits under the PBA if they are able to negotiate an acknowledgement by the employee that the termination is voluntary. But in such cases, one can expect negotiations to factor in the value of any grow-in benefits under the PBA, whether given under the pension plan or as part of the severance package.

    Paul Litner is a partner in the pension and benefits department at Osler, Hoskin & Harcourt LLP in Toronto.

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