Pension de-risking can take many forms. As a plan sponsor, you can introduce minor changes like switching to a less generous plan formula (final average earnings to career average earnings), or more drastic measure like closing the plan to new entrants or switching to a defined contribution pension plan. Recently introduced by the federal government, Target Benefit Plans (TBPs) offers some middle ground, falling somewhere in between defined benefit and defined contribution pension plans.
What is a Target Benefit Pension Plan?
Unveiled as the third pension option for plan sponsors, TBPs adopt a shared risk model. With traditional defined benefit plans, plan sponsors bear the investment risk. In times of economic trouble, plan sponsors can be on the hook for massive pension deficits.
Not surprisingly, plan sponsors have been trending away from defined benefit and towards defined contribution plans in recent years. With defined contribution plans, employees bear the investment risk, as their retirement income depends solely on how their investments perform over their career.
TBP fall in between – they allow for risk sharing between plan sponsors and employees, while providing employees with some income predictability in their golden years.
Who is Eligible to Participate in Target Benefit Pension Plans?
Similar to Pooled Registered Pension Plans (PRPP), TBPs will only be available to a handful of employers. At first, TBPs will only be available to federally-regulated pension plans in the transportation, banking and telecommunications sectors, and crown corporations. It will be up to each provinces to adopt legislation for provincially-regulated pension plans to offer TBPs.
What are the Advantages of a Target Benefit Pension Plan?
The shared risk model can be beneficial for plan sponsors and employees by offering predictability. Not only is investment risk equally shared between employers and employees, retirement and contributions change over time based on the performance of the plan vis-à-vis set targets. In times of prosperity when the plan has a surplus, members could see their benefits increased, while in tough economic times, they could see their benefits clawed back.
TBPs offer many advantages similar to defined benefit plans. Employees can expect a higher benefit in most cases compared to a defined contribution plan over time. TBPs also make retirement planning a lot easier, since employees will have a better idea about their monthly pension in retirement.
Unlike defined contribution plans where employees bear the majority of the risk, TBPs offer the opportunity for pooling longevity risk. With retirees living longer with each passing generation, this is an important advantage.
Is Switching to a Target Benefit Plan a Good Move?
The shared risk model is more appealing to some plan sponsors more than others. You should consider switching to a TBP if:
- You offer a generous form of pension like best average earnings or you offer perks like indexing in retirement.
- You would rather have predictability in contributions over contribution holidays.
- You’re funding a large pension deficit and/or facing solving fund requirements.
- You have an unchanging or growing labour force.
- You haven’t already de-risked your pension plan by switching from defined benefit to defined contribution.
If you’re thinking about switching to a TBP, it’s important to open a dialogue with your workforce. Bear in mind that switching to TBP requires member consent. If you can show members how it’s a win-win situation for everyone involved, you’ll face much less of an uphill battle.