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DB vs. DC Pensions

72881 Views 183 Replies 37 Participants Last post by  Eclectic12
The series of articles in the Globe and Mail about the growing problem of underfunded public and private pensions has got me thinking.

Are DB really that good? I know from some of MDJ's posts that Federal Government Employees can get 70% of their average salary from their last few years of service, but I think that's rare. In my public pension plan, it appears that % of salary paid out are about 55%, 47%, 39% for 35yrs, 30yrs, and 25yrs of service respectively.

Given that my contribution rates keep going up (20% next year - half from employer), I was wondering whether I'd be better off with my employer simply giving me that money.

I made some preliminary models, and I'm actually finding it difficult to see an obvious benefit to the DB model. My rates of returns over the years of service were very modest (4-5%) - and considering many DB pension plans have severe penalties for early retirement, I'm starting to think I wish I had a DC plan (with similar rates of employer matching funds).

Taxes obviously play a major role, but lets assume all the money goes into an RRSP so is not taxed in either the pension, or in my own hands.

I'm I way off base here? Thoughts? :confused:
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I don't think there is anything magical about DB plans.
The magic is the longevity insurance, and in many cases, inflation insurance that it provides.
To replicate the kind of retirement income stream, longevity insurance and inflation indexing that gold-plated DB plans provides, a corresponding private sector worker with a SD RRSP in similar job would have to work much harder, longer, make much more gross income and have a higher % of savings put away each month.
For someone who begins working for the federal govt. in their mid-to-late 20s, is easily able to retire at 55 (or earlier, depending on when they started) with the full force of the govt. pension behind him/her.
The RRSPers are faced with very stiff risks (esp. equity market turmoil) that most RRSPers will not be able to overcome.
The best case scenario for them is hoping they have enough to buy an annuity.
I don't know the going rates of annuities, but I'd imagine that getting an annuity that has the inflation indexing and longevity insurance features of a DB pension at age 55 will be extremely expensive, esp. these days with low interest rates.
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As the teachers run their own fund, they are in a unique position to alter the plan as required.

Interesting that the HOOPP plan is similar in that the employees have representation on the pension board. They are 100% funded these days.
That is not a reflection of any superior management on the part of HOOPP vs. the OTPP.
It is simply a factor of the increasing size of the health care sector vs. the education sector.
Hiring of teachers has slowed down, class sizes are bigger, under grade 1 classes are consolidated in many schools now, teachers are starting late, retiring early, and so on.
OTOH, health care is receving more funding.
DB plans as MoneyGal said are done for private companies DC is the only way forward. No company today is going to take the risk
So what makes the public sector DBPs (in Canada) more sustainable?
Or are they not?
It must be the same set of factors and parameters that they are up against.
What makes them different?
the plans are paid for by the employee and employer, similar to many private-sector DB plans.
Ah, but the employer is the tax-payer.
There is no difference.
The tax payer is paying the employer portion of the DBP contribution.
In addition, the tax payer is guaranteeing the solvency of the fund as well.

It is not similar to private sector DBPs, at least the ones that don't come to the tax payers every 5 years with hat in hand to bail them out.
A true, sustainable, solvent private sector DBP is funded by the company's earnings, not tax payer subsidies like the auto and airline ones.
How many of such are still out there (if any at all), I do not know.
Like General Motors/Chrysler?..and we all know who bailed them out and we will be paying McGuinty's HST for many years to come for that.
Exactly...that was my point when I said above : at least the ones that don't come to the tax payers every 5 years with hat in hand to bail them out.
This is not the first time the govt. has rescued the auto makers, the airlines, etc.
This appears to be a 5 year ritual.

I think the era of DB plans are pretty much over. What they didn't count on was the number of retirees drawing from it and the length of time
each retiree lives.
It may be over, I agree, but someone forgot to tell the govt. this "news".
Apparently, we (the tax payers) are still paying for it, and probably will continue to do so for decades to comes.
I didn't feel particularly upset about it until recently when the government decided they had to increase the amount employees paid into their pension.
It was probably done to ensure solvency of the plan, given reducing real returns and increasing longevity, etc.

Not to pick on anyone in particular - don't get me wrong - but what, may I ask, is wrong with increasing the employee contribution?
The rest of the workers do that (i.e. majority of private sector employed folks without pension plans).
They make a RRSP contribution and get a corresponding tax deduction.
Contributions to a pension plan have a similar effect.

I see no reason for the employer (i.e. tax-payer) to keep paying an ever increasing share of the pension burden for a sub-section of the working population.

When CPP had started running into issues, both the employee and employer contributions were increased.

Regarding the argument around pension being a part of the total compensation, salaries and benefits in the public sector are in line with private sector salaries and benefits these days for similar types of job functions -in fact, if anything, they are quite a bit more generous than what typical small or medium scale organizations can afford for their employees.

Barring a very, very small top pyramid of salaries and benefits (such as bank executives, technology firm partners, etc.) I'd say the public sector is at no particular disadvantage.

Therefore, once you factor in employer DBP contributions and future pension entitlements, that total compensation package becomes behemothly out of whack compared to private sector compensation.

Just think about what it would take for a given 65-yr. old retiree (esp. female) to puchase a guaranteed, inflation indexed income stream (annuity) equal to 70% of the average of the previous 5 best years' salary.
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Thanks for your perspective, Karen.
I agree the govt. dipping into a protected pension plan and using it as an ATM machine is totally wrong.
We are seeing this scenario play out in Europe these days.
All of the following governments - Spain, Italy, Greece (of course), Portugal - are dipping into the public sector pension plans to withdraw money because of huge deficits.

The difference of course is that those plans in Europe were never in surplus to begin with.

And yes, the 70% is only for a full 35 year term of service.
But it's a flat 2% for each year anyway, so it's proportional.
I thought of bringing up this thread when I read the following news:

Royal Bank joins wave by abandoning defined benefit pensions for new hires

They are just the latest in a series of large, mega-cap corporations switching from DBP to DCP (Manulife and some utilities being the other recent ones I can think of).

Of course, they don't have any choice but to.

DBPs are becoming more and more unsustainable because of a variety of factors.

The only "organization" that is able to "afford" it are the governments and the quasi-govt. public sector - purely due to the full might and unlimited taxing capacity of the govt.

While corporations, that are answerable to shareholders and need to preserve fiscal sanity, are complelled to make this change, the public sector is going about its merry way - borrowing from the future and bankrupting the present.
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Corporations don't have debt problems...........governments do.

Corporations are sitting on mountains of cash.
If they were deploying the cash creating new jobs, investing to increase productivity, or investing in research and development, I might agree with the premise...........but they aren't.
Corporations are answerable to shareholders for profitability.
Governments aren't, as is evident all across the world.

The reason why corporations are "sitting on mountains of cash", as you say, is simple - we are facing the prospects of a huge and debilitating global recession.
It is only natural for companies to not invest during such times.
Governments cannot force private businesses to increase production and capacity during recessions, that's the way it has always worked and has nothing whatsoever to do with pensions.

The elimination of DB pension plans is the transfer of employee obligations from corporations to the government of the future, and therefore future taxpayers.
Agreed, yes.
However, here is how I think this will play out : with increasing longevity, fiscal austerity, etc. governments are simply going to claw back social programs.
We are already seeing this with CPP.
The spread between the penalty for taking CPP before 65, and the "reward" for taking it later is widening.
This will keep increasing in the future.
Several countries are now surreptitiously increasing the "retirement" age to 66 or 67.
This will keep going up and within a couple of decades might be rounded off to 70 across the entire developed world.

OAS clawbacks etc. will be increased.

In short, the present generations are paying into a black hole.
They will get much less return on their contributions than the previous generations are getting.

Our tax dollars already support people who didn't have a DB pension plan.
Private sector tax dollars are supporting those that have public sector pensions.

We are heading in the wrong direction on pension issues
If by this you mean we need more DBP plans, then I'm with you.
We need stable, sustainable DBP plans across the board - for private sector and public sector.
Right now there is a huge imbalance and it's getting worse every day.
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The adjustments are actuarially sound. If people are living longer (which they are), then short of an increase in contributions the payouts must decrease. Over the average lifetime, the payout levels are the same - 25% of an average salary, with a cap, based on 40 years of payments in.
I am sure the changes are actuarially sound, and were even necessary.
My point, however, is that there is a reason that large, stable financial institutions like RBC and Manulife are moving away from DBP to DCP, and it is not that they don't care about the welfare of their employees.
It is the various levels of government that have adamantly stuck their necks in the sand - refusing to raise employee contributions rates, reduce payouts, increase minimum eligibility age, reduce indexation, etc.

They only reason they are able to do so is because they can, while private businesses like RBC and MFC can't.
I see no reason whatsoever that public sector employers are matching employee contributions $-for-$, in some cases up to nearly 20% of gross annual pay.
Where is that slush fund hidden, I'd like to know too.

A related issue is creating a society of pension haves and have-nots.

If anyone thinks that right now tax payers are carrying those that didn't have DB pensions during their working years (as sags said above), the coming decades are going to be much worse, given the state of market returns.

sags said:
If employers are not interested in these types of plans, the government should move forward plans to greatly enhance the CPP plan and let the CPPIB administer the plan.
I agree completely 101%
Unfortunately, the current administration is moving in a different direction with these private sector RPPPs.
A most unfortunate turn of events for those without pensions.
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The federal and provincial governments should be setting contribution rates, etc. on private pension plans - that isn't what you are saying, is it?
Apologies for my ramblings lol :eek:
No, what I was trying to say is that (IMHO, of course) the various levels of governments are creating a society of haves and have-nots by refusing to moderate the generousity of the govt. sponsored DB plans.

That is what has created (and will create to a much larger extent in the future), a large section of welfare dependent retired folks (by welfare I mean OAS + GIS).

There are various parameters in the govt sponsored DB plans that are outrageously generous, and the matching of up to 22% (I believe is the max rate) is just one of them.

If a private corporation (answerable to shareholders w.r.t profitability) decides to match 22% of gross salary as employer contribution into DB plans - that's fine as long as they don't come cap in hand to the tax payers for bailout like the auto companies did.

However, for various govt. agencies, corporations and pure administrative departments to do so is outrageous.
At the end of the day, it is one set of workers funding the retirement of another (smaller) set of workers.
The irony arises because majority of workers in the first set don't have access to the very same benefits that they are funding for the rest.

sags said:
Benefits that are too high, or employee contributions that are too low, are the result of poor negotiations by the employer (government), rather than a DB plan design fault.
I agree with you, sags.
I think you and I are saying the same thing from different angles.
Benefits are too high and employee contributions are too low for sure.
And yes absolutely, this is because of poor "negotiations" by the employer (the tax-payer and not the govt.)

This is simply because the fox is in charge of the hen house.
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Well, I'm not sure I would argue that the various levels of government should moderate the existing pension plans. Those are legal contracts and the employees and employers entered into them in good faith.
Oh no, I would never suggest/desire that either.
The last thing we need is more tax payer $$ be wasted on lawsuits between workers and govt.
But I think (all else being equal), the various levels of govt. ought to be doing what we are seeing in the private sector i.e. reducing DB benefits or switching to DC for new employees.
There may be existing union contracts that prevent the employer from switching to DB for new employees, and if so, such contracts need to be modified during the next cycle of negotiations.

I would suggest, though, that public service compensation be described in more transparent terms. The value of DB pensions is pretty enormous and I don't think this value is necessarily portrayed fully or accurately in discussions of public sector compensation (or understood by public sector workers themselves).

The flat markets in the last decade, together with close-to-zero interest rates and new funding requirements for pensions are a triple-whammy for pension administrators and employers. It's no surprise that employers continue to dump DB pensions.
+ 101%
It is also a triple-whammy for those that are not part of the public sector DB pension system, primarily private sector and self-employed workers.
Because their tax $$ are left footing the bill for these increased costs.
The reality is that the current RRSP limits are enough to fund a decent retirement, and most Canadians don't come close to maxing out their contribution room as it is.
While that is true, we are comparing two different things.
Regardless of the contribution room (you can make it $1M and it won't change a thing), the real issues are the guarantee, the inflation protection and the longevity protection that a non DBP plan (RRSP or DCP) can never claim to fully achieve.
Esp. in these days of volatile markets and erratic asset returns.

IMHO, the issue does not lie on the RRSP side.
The RRSP rooms are adequate, more or less.
The issue lies on the pension side, esp. the govt. backed public sector pensions.
The only way to fix the imbalance between the Haves and HaveNots is to make DBP pensions more accessible to everyone, not this useless half-hearted attempt with RPPPs that they announced last year.
^ w.r.t. the above, the Sep/Oct issue of Money Sense had an article titled A civil servant's sweet payoff or something similarly worded.

A quick look at two facts highlights the futility of comparing public sector DBPs vis-a-vis private sector salaries + RRSP:
- the value of their pensions upon retirement
- the % contributions made by the employer (i.e. tax payers) vs. employee contribution

As they say on the Lang O'Leary show : it is off the charts
They *are* saying that two high income earners, one in the private sector, one in the public sector, get very different benefits from the *tax system* and that allowing people to accumulate much more RRSP room would be one way around this (for that small class of people).
I disagree with their solution.
You could give everybody $1M RRSP room every year and that wouldn't change the fact that RRSP is not a DB pension.
The only way (for the private sector workers) is to increase accessibility to DB pension plans.
Either by expanding CPP or through a new system.
The RPPPs are useless in that regard as well.

I know MG you are not a fan of CPP expansion but I don't see what else would solve this particular issue.

"Just buy an annuity" is often suggested as a simplistic solution but consider : how many $$$$ would someone need to accumulate in their RRSP to even come close to purchasing an annuity that has the same features and same payout as their public sector DBP cohorts are getting.
the public sector employee pension is subsidized by the government.
^ Exactly
Actually, by the other tax payers.

In theory, the private sector employee should have a higher wage :rolleyes: which would allow them to save enough to purchase an equivalent pension.
So we agree...I think we were saying the same things from different angles.

Conversely, average public sector compensation should be lower to offset this huge gap, since the govt. can't force the private sector to pay more wages but has full control over its compensation structure.

Another alternative is accessibility to a public DBP for the private sector workers, such as CPP expansion or a DB version of the RPPPs.
I don't know why so many (including the CD Howe institute) are opposed to expansion of the CPP.
Seriously - one drawback of expanded CPP would be increased employer premiums which might not be great for the economy or jobs.
But what about the employer premiums that we are all paying for the public sector DBPs - that's a drag for the economy too since it is funded out of tax revenues.
I might understand a successful and profitable private corporation paying generous contributions into its pension plans, but the govt. is neither.

I'd be more in favour of increasing the CPP, but leaving the employer premiums alone and just increase the employee premiums.
Yeah, I'd totally be ok with that.
Keep the current level of pensionable earnings for CPP and add a second tier of contributions funded entirely by employees themselves, which equates to the current average pension plan contributions in the public sector plans.
I'd sign up for that.
Originally Posted by Eclectic12
True ... but then again, the same is true for those with private DB plans, as well as those with DC plans or RRSPs where the employers contribute.
No, there is a difference - a big difference.
A private corporation can do whatever the heck they want.
As long as they are successful and profitable, they can pay $1M to a bellboy, who cares.
Just don't keep coming back to the tax payers with cap in hand begging for money every 10 years.

The govt. on the other hand is a very different thing.
Right now, govt. contributions and DB plans are the most generous around - by a wide margin.
IMO, that is a huge imbalance - made possible not by virtue of profitability but simply by virtue of a ruthless and unrelenting taxing capacity.
Excellent discussion on the Lang O'Leary Exchange this evening called The Pension Ponzi - How the Public Sector is Bankrupting Canada's Health Care, Education and Your Retirement'Leary_Exchange/1308689786/ID=2165811814

I have ordered the book as well.

The authors arguments are compelling and something we have discussed here several times.
You are referring to that new book?
I mentioned it on that DB vs DC thread under Retirement section.
Maybe you can post your comments there.
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