Pension plans that download costs to the employee may provide short-term benefits, but the long-term consequences indicate they are not worth the cost.
Around the globe, pension plans for public-sector workers – like those for workers in the private sector – are under attack.
Most of the public-sector plans are “defined benefit” (DB) pensions, meaning that the payouts are based on a member’s earnings and years of service. In order to pay out the promised benefit, the plan’s sponsor must successfully invest member and employer contributions over a long term. In recent years, turbulent markets have eroded investments, creating a technical shortfall for some single-employer plans. As a result, critics are saying that all such plans are unsustainable. And, they ask, why should public servants get a better plan than the rest of us?
What they don’t seem to realize is that “the rest of us,” meaning private-sector workers, are increasingly not provided with pensions at all. As Moshe Milevsky and Alexandra Macqueen point out in their book Pensionize Your Nest Egg , Statistics Canada figures from 2008 show that 72 per cent of private-sector workers have no registered pension-plan coverage.
And despite the fact that multi-employer DB plans can operate successfully without running into funding problems – the Healthcare of Ontario Pension Plan (HOOPP), which I lead, being a prime example of that – the single-payer DB pension plan is starting to disappear from the pension landscape. That’s because private companies want to spend less on pensions for their employees, and critics of public-sector compensation feel their pension benefits should align with those of the private sector.
Where DB plans have been eradicated, alternatives, such as defined-contribution (DC) savings plans, have been introduced in their place. But is DC a viable alternative? Does it provide an adequate retirement income? With a DC plan, all that’s “defined” is the money that is put in – what comes out, in the form of a retirement income, depends on how well the money is invested, and how much the annual investment fees are.
Australia provides a cautionary tale of what can happen when pension reform focuses on cutting employer costs rather than on benefit outcomes. Only a couple of DB plans still exist Down Under, with most of the population dependent on DC plans. A study by the Melbourne Institute shows that 50 per cent of all seniors are living below the poverty line. The Australian Investment Institute points out that the average male Australian has only $130,000 in his DC “super” plan at retirement, and that the average female has just $45,000. Using the industry rule of thumb that you need $20 of savings for every $1 of retirement income, those “super” totals aren’t that super after all – our retired Australian man is living on $6,500 a year, while our retired Australian woman will receive just $2,250 per year.
It’s worth noting that when DC supers were introduced in Australia, employers contributed three per cent. This amount was subsequently increased to a nine-per-cent contribution, and legislation has recently been introduced to increase it to 12 per cent. Australia has realized that in order for DC to work, employers need to put a lot more money into it.
The DB model is the most efficient pension-paying machine that exists. In 2010, the average starting HOOPP pension was just over $18,400 per year – and while HOOPP retirees will not retire rich, they can rest assured that they will be paid their monthly income for as long as they live in retirement.
In this system, members and employers contribute money, which HOOPP’s professional team then invests. Since HOOPP manages the fund in house, 80 cents of every pension dollar we pay out comes from investments – the rest comes from contributions. Fees are minimal – HOOPP’s cost to invest the money is just 26 basis points, which is a fraction of the 150 to 250 basis points that most retail mutual funds charge. And with an investment strategy that aligns to the income needs of members, DB plans can succeed over the long-term. HOOPP was 101 per cent funded as of the end of 2010, meaning there is enough money to pay our members the pensions they are owed.
When there is a shortfall, DB plans – unlike their poorer DC cousins – have the time to make adjustments to contributions and benefits in order to turn things around. DC does not have that wiggle room: Ask anyone who retired in early 2009 with a DC pension, or using their RRSPs, if the markets had any impact on the benefits they received. The answer will surely be yes. By comparison, no HOOPP pensioner was short a penny of pension benefits during the same period.
A DC plan is no real plan at all – it just downloads retirement responsibility onto the employee’s shoulders. And if tomorrow’s seniors have inadequate income, our next generations of workers will have to shoulder the increased cost of funding tax-assisted old-age support programs.
Only 35 per cent of Australians have any money left in their DC supers by the time they turn 75 – a terrifying prospect given that more and more Australians are living into their 80s. If we continue the race to the bottom by reducing pensions for Canadian workers, we are inviting those same problems here in the not-too-distant future.
With Canadian federal and provincial elections now settled, we need to ask our governments where they stand on workplace pensions. Are they interested in working together to ensure that retirees have adequate income in retirement? Or are they in favour of downloading the responsibility for retirement onto the shoulders of individual workers?
We need to start telling politicians of all stripes that the national pension debate should be not only about coverage, but also about adequacy, and about preserving and expanding workplace pensions. Cutting costs on pensions for short-term savings will bring negative, long-term consequences for all of us – we will replace an effective and efficient system with one that offers inadequate coverage and creates dependency upon government social programs.
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