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Pension Debate
May 10th, 2007 by 
investoid
David Dodge has gone on record to suggest that companies should be offering defined benefit pension plans over defined contribution plans. Mr. Dodge is suggesting several changes to the private pension plan structure to improve their efficiency and ensure that employees of smaller companies can also benefit from employer-sponsored retirement plans.
While I agree with Mr. Dodge’s specific recommendations, I do not intrinsically believe in defined benefit plans. Ostensibly, defined benefit plans are the ideal for employees, since they provide peace of mind for them in retirement. This is definitely an alluring proposition for employees - all they have to do is have $x automatically removed per month and when they retire they will receive $y in return, sometimes until they die.
However, defined benefit plans are not without their issues. For instance, when employees leave an employer, they are faced with having ‘orphan’ retirement funds. Some companies will pay out these amounts, depending on how long you’ve been there, while others will actually pay you small amounts at retirement. It would be to the employees benefit if these funds could travel with them, at the very least to reduce administrative overhead in retirement.
Secondly, employees still face risks associated with their return on investment, although these plans simply shift the risk. Your contributions are not only dependent on your retirement picture, but also the overall picture of all past and current employees. As a result, when defined benefit plans fall into trouble, current employees pay the price while retired ones do not. This can be especially tough on younger employees, who potentially face many years of additional premiums that are doing nothing for their retirement.
Thirdly, the expenses involved with such plans can be opaque, yet quite costly. Defined benefit plans require sophisticated financial engineering to remain solvent, and are based on continually changing estimates of lifespan, employee retirement rates, the overall economy, wage inflation, etc. Not only do the costs of managing a portfolio come into play, but the actuarial expenses are something that you would otherwise not have to account for.
Philosophically, I do not believe in defined benefit plans. Each individual should be responsible for all aspects of their life, retirement included. I do not expect everyone to manage their own retirement finances, but I think they should have the privilege and responsibility of deciding who manages their funds and how.
Personally, I would like to see employer-sponsored personal retirement accounts that are mobile with the individual over time. Employers would provide matching funds up to some amount, and individuals can choose to put in more money if they wish. The individual can choose to direct the investments themselves, have a company or advisor manage the funds, and pool them with other employees and even companies to be able to improve their diversification and asset mix. In the worst case I could seeing this being another opportunity for the financial services industry to rip off retail investors, charging high fees for such services. But at least the person would have the choice to determine how his funds will be managed.
Of course, this type of solution only works with transparency in fees, hopefully more options for retail investors, etc. I would hope that if our country set up the right structure and reasonable cost services would emerge, but you never know.
The shift towards defined contribution plans is a step in the right direction, but I would like to see employees more empowered with their plans.
Posted in News Comments | 
May 10th, 2007 at 4:30 pm
I think I would have to disagree on this one. Defined contribution is cheaper for employers - that’s why they like it. It is true that for employees who move around from job to job or those early in their careers DC may also be better. But for what you pay and what you get, DB has all the advantages. Most importantly it is shared risk - basically group insurance. With DB you can guarantee that no one gets left behind, which DC can never do.
Also keep in mind that DC is a relatively new invention. I think that once the first batch of DC pensioners run out of money before they die we will start to see some attitudes shift on this topic. However, the feedback loop on pension plan design is too long to ever be useful.
Just my 0.02…
MD:)
May 10th, 2007 at 5:01 pm
MD - thanks for your comments.
I am not sure if it’s actually cheaper for employers, but even if it is I don’t think that’s why they were providing them before. Historically, they were the most attractive option to employees viewed as the gold standard, thus a mandatory perk to attract top talent.
The fact that DB is like insurance is why I don’t like it - nothing is guaranteed in life (besides the cliches) and I don’t want to have to guarantee other people’s future (or their current retirement lifestyle) with my money. I would rather be responsible for my own destiny. Another issue is that it doesn’t guarantee that you will get your benefits in retirement - in the worst case the fund falls apart and everyone gets nothing.
I don’t doubt that some DC funds will fail - they are still typically group policies that are not necessarily properly set up for a high probability of desired retirement benefits for its clients. But that doesn’t mean that setting up RRSP style group policies would not be a better alternative. The key is to let you choose which group(s) you allocate your money to (like you can with your RRSP) instead of throwing in your lot with people who happen to work or have worked in the company you do.
Lastly, most employees do not expect to stay with the same company for more than 5-10 years (based on the 3 career lifetime rule), so I don’t see how defined benefit plans can reasonably continue in their current state.
May 11th, 2007 at 8:50 pm
*smile*
I could get into this topic a bit too strongly to be appropriate so we will have to agree to differ. Am I weird to have major opinions about something as esoteric as DB vs. DC pensions?
MD:)
May 12th, 2007 at 7:57 am
I don’t think so - I’d rather see someone believe strongly in something than have no conviction about anything.
May 16th, 2007 at 2:07 am
You too sound like an old married couple discussing your pensions! I found this article interesting since my current employer is giving me a pension choice in the next few months. I can either stick with the current DB and 3.5% DC match or go to a straight DC 7% match plus they kick in 4% for a total of 18%. Yes on paper Money Diva is correct because my Pension Adjustment reflects a higher amount for DB than DC so i have no RRSP room in the blend but some in the DC only. Since we can all agree here than we enjoy or seem to enjoy managing our money a DC plan is not a bad thing for us. I find that if you leave a company, or its bought out, goes into recievership, etc, a DB plan always gives you less! Unless you stay till the fat lady sings i would choose DC everytime. I took 2 coworkers as examples because they left 100% DB plans to work here and both took big hits. We did the math on paper and putting in only 11% of gross salary/yr with 4% annual returns solidly beat the DB amount they recieved! I just look at the current job market and can’t see myself at the same job for 20-25 years… I think most people are lucky to make 15years with the same employer? However as is stated above only time will tell if DC is good or bad, but i bet Stelco and Air Canada employees wish they had a choice?
Derek