Thursday, May 14, 2015

Another reason to move back to Defined Benefit Pensions

There has been much discussion over the the merits of moving Canadians towards Defined Contribution Plans and away from Defined Benefits Plans. Here is a study that shows how important Defined Benefit Plans are to Economic security and business success.

 A recent study by The Boston Consulting Group (BCG) provides some thought-provoking information about Canadian retirees with defined benefit (DB) pensions. The most compelling fact from the survey is that DB retirees receive the Guaranteed Income Supplement (GIS) 10–15% of the time, compared with 45–50% for other retirees. That represents $2–$3 billion a year in savings to the federal government.

The study was sponsored by four Ontario pension funds, including Teachers’. A recent Angus Reid poll shows a troubling situation regarding saving for retirement in Canada. The poll shows that those with household income of $50,000 or less save 7% of their income for retirement, rising to 9% for those in the $50,000-$99,000 group. In contrast, DB retirees contribute 10-14% of their income to their pension plans. So part of the reason that payouts from DB plans are generous is that DB members simply save more for retirement.

Two other responses from the Angus Reid survey are alarming: only 26% of Canadians believe that they are saving enough for retirement; and 15% of Canadians are saving nothing for retirement.

Yet much of the recent conversation about retirement savings has revolved around the perceived need to convert DB pensions to defined contribution (DC) plans.

Former President and CEO of Teachers’, Jim Leech, and Senior Writer at the Globe & Mail, Jacquie McNish, in their book The Third Rail: Confronting our pension failures, argue that while DB pensions need to evolve to deal with demographic challenges, getting rid of DB pensions would be a large mistake.

The BCG study, plus a study from earlier in 2013, show the many benefits of DB pensions, including:  
  • a very low cost of investing;
  • investment expertise that allows them to generate up to 80% of a fund’s assets
  • through investment returns;
  • shared longevity risk; and
  • the ability to invest in areas that the average person simply can’t access, such as real estate, private equity, hedge funds and infrastructure.

Longevity risk is a big deal. If you are a retired with a Defined Benefit Plan you aren’t concerned about how long your retirement lasts because you know that you will receive your pension at a given level for as long as you live.

People with DC plans know how much money they have when retirement begins. Since they do not know how long they will live, they do not know how much money they can afford to spend each year in retirement.

The BCG study indicates that DB retirees are able to spend at a higher rate because they have a pre-determined steady and stable income throughout their retirement. This makes sense if your income is reliable and secure, you are able to spend freely. So instead of pitting the public sector against the private sector and DB vs DC, perhaps the conversation should be:

“Let’s fix what is broken and ensure that all Canadians have access to reliable and secure retirement income.”
Key Findings

  • Defined benefit retirees spend $56–$63 billion  on goods and services each year.
  • DB retirees pay $14–$16 billion in income, property and  sales taxes each year.
  • DB retirees take the GIS 10–15% of the time, compared with 45–50% for other retirees, reducing the GIS payout by $2–$3 billion each year.
  • The smaller the community, the greater the benefits from DB pensions. In small Ontario towns, DB pension benefits represent nearly 12% of total earnings. 75–80% of DB pension benefits are paid from investment returns. 

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