Pensions in Canada: Defined Benefit vs Defined Contribution
I’m sitting in the garden patio at Langdon Hall in Cambrdge, Ontario with my brain spinning with new ideas because of listening to a line up of great speakers. One of the themes today was a number of presentations and discussions about pension reform and the shifting pension landscape from Defined Benefit pensions to Defined Contribution pensions.
Defined Benefit plans are dying
There is clear shift world wide from Defined Benefit (DB) plans to Defined Contribution )DC) plans. In 2000, 65% of pensions were Defined Benefit plans but by 2010 only 56% of all pensions were Defined Benefit. In the US, DB plans were about 51% of all pensions in 2000. Ten years later, than number dropped to 43%. The most dramatic change comes in the UK where they started with Defined Benefit plans making up 97% of all pensions. In 2010 that number fell to 60%.
The data in Canada is not as clear and dramatic. Although there is a clear trend where there is more money in DC plans over DB plans, we still have one of the strongest DB exposure because of the public sector.
Why are Defined Benefit Plans becoming extinct?
While this statement may be a little strong, there is a movement from employers to move away from DB plans because of the costs, funding liabilities and increased complexity of the pension rules. Although it is easy to understand why employers may want to move away from DB plans to DC plans, the DC plans have created three new problems for members.
Three new problems for members
- Investment decisions. From a members or investors perspective, DC plans have shifted the investment decisions from the employer and the fund managers to the members. If you think about it, with DB plans, the members never had to make any investment decisions. DC plans put members right into the drivers seat when it comes to selecting investments and managing portfolios.
- Planning with uncertainty. In DB plans, every time a member got a pension statement, they were told how much monthly income they would get at retirement. This predictability was great for planning and created security and comfort. Now with DC plan statements, they are given an asset values which is constantly changing and with little to no direction of how much income this asset will provide at retirement.
- Self discipline in savings. With a DB plan, not only was participation mandatory but contribution increases were also mandatory. Because DB plans required regular actuarial calculations determining if the pension was properly funded, contribution amounts were adjusted accordingly to reflect funding for the benefit. With a DC plan, this funding calculation is up to the member and increases are mostly up to the member. History has shown that most people do not have the discipline or awareness to make this happen.
This shift from DB to DC is real and despite these problems, the trend is likely to continue. What’s important is that we help members in DC plans (with eduction and advice) to address these three very real and important problems to help ensure they will have a secure retirement and financial future.