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Pension Plans

Defined Benefit Pension Plans are commonly referred to as “gold-plated pensions.” About 30 percent of the Canadian workforce has a DBPP. Most of those people that have a DBPP work in the public sector. The fact is these pensions bestow very generous payouts that can’t be replicated by the private sector. Many are indexed to inflation and guarantee employees 70 percent of their pre-retirement income.

Defined Benefit Pensions Are Not Guaranteed

A company may change the terms of a pension plan or type of plan offered.  For example, in 2008; a prominent Canada retail store froze their existing Defined Benefit  Plan and introduced a new Defined Contribution Pension Plan.

For affected employees, any benefits accrued in the Defined Benefit Plan when it was frozen will remain in that plan until their normal retirement date (age 65). Any and all future contributions will be made to the Defined Contribution Plan only.

A company’s bankruptcy may also affect pension recipients depending on the status of the plan at the time. If the plan is fully funded at the time there should be enough money to continue paying pensioners. These companies would also have to pay out a lump sum payment to their non-retired employees.

However, very few Defined Benefit plans allow for a total removal of funds at retirement.

When you retire, the DB Plans require you to receive a monthly income (purchased by an annuity in some cases) or funded on a pay-as-you-go plan. The reason they don’t want members to take all the money out at once is simple. If the retired employee dies, the surviving spouse gets a reduced pension. This helps the company pay for any pension shortfalls. The company’s management can then remove any surplus funds and use the money as they want to.

For example, a prominent manufacturing company once took $1 billion from its company pension. Three years later, the same company reported its pension plan was underfunded by… $1 billion.

Where did it go? Bonuses to less than 100 employees to buy shares in the company – just before it was sold!

Here’s an exception to the DB “You-Can’t-Take-It-All-Out-at-Once Rule:”

  • If the pension is wound down (closed)

or

  • The employee leaves the company before age 55

The employee may transfer the commuted value of his or her pension to a Locked-in Retirement Account (LIRA). Some provinces call this a Locked in RRSP.

The thing to remember is, if a Defined Benefit plan is underfunded, employees will receive less than the promised amount.

In some jurisdictions, the government provides a guaranteed minimum income to retirees.  For example, in Ontario, the Pension Benefits Guarantee Fund insures pensions of up to $1000 per month.

Because of the cost, liability and the financial crisis of 2008, the number of DBPPs have been on the decline.

Employers are moving away from traditional Defined Benefit Pension Plans and into Defined Contribution Pension Plans because of cost, funding liabilities and the increased complexity of the pension regulation.

However, the move to Defined Contribution Pension Plans has created three new problems for members and some related concerns for employers.

Defined Contribution Member Concerns:

1) Making Investment Decisions:

Members now have to make their own investment decisions and learn to manage their own portfolios define their risk tolerance and manage accordingly.

2) Determining the Amount of Retirement Benefits:

In the past, DB plans provided a Benefit Statement annually that gave its members the dollar amount of what they could plan for at retirement. With DC plans, the end result is uncertain. The predictability of the DBPP created more certainty and security for planning retirement income needs.

Now, the DC asset values are constantly changing and as a result there is little or no direction as to what kind of income can be expected at retirement.

3) Self-Discipline to Save Additional Funds:

Members of DB pension plans, especially the gold-plated public sector plans like the Teacher’s Pension Plan, have little or no incentive to save additional funds for retirement. Members are guaranteed substantially more than private sector plans offer. Plus DB plans have mandatory participation and contribution levels which are adjusted on a regular basis to reflect funding for the benefit.

With Defined Contribution Plans, it’s much more important for individuals to set additional retirement savings aside and be self-disciplined enough to increase this amount as they progress through their working career. Canadians in their pre-retirement phase of life should know that it’s important to start saving 10 percent of their gross pay annually with their very first pay cheque.