Garry Marr: The revenge of the defined contribution pension plan

Tell a 60-year-old Canadian with a $4,200 per month defined benefit pension that they are sitting on an asset worth close to $1 million, and they might shrug it off as an abstraction.

Offer that same person that lump sum up front, and it’s a different story, says Jeremy Phillips, president and chief executive of Regina-based Plannera Pension and Benefits, which administers Saskatchewan’s Public Employees Pension Plan, the largest defined contribution (DC) plan in Canada.

“I heard someone say one time when they were offering their plan members (the opportunity) to take the cash balance … 90 per cent chose the money and would rather manage it for themselves,” he said of the popularity of commuting, or taking a pension’s value up front.

Defined-benefit (DB) plans have become revered as gold-plated pension perks, something reserved for the likes of public servants and a shrinking number of lucky private sector workers. But as stock market returns have soared in recent years, DC pensions have been staging a comeback .

Phillips said that when you start out with no money a defined benefit plan looks great for its security and predictability. But once balances start to grow, he finds that his members love defined-contribution plans and would be loathe to change.

Frothy stock markets will do that. The S&P/TSX composite index rose 28 per cent last year and is up almost nine per cent year to date. The performance of major public pension plans, which pursue more conservative asset mixes, is nowhere near these gains.

While most DB plans today are in the public sector, Phillips said it’s an interesting question as to whether the rest of the country, with employer matches, might prefer a DC plan.

Ana Nunes, an actuary and investment professional, said a rule of thumb is that a pension taken at 60 can be worth 18 to 20 times the monthly amount you will get for life, so for $50,000, those payments indexed or partially indexed to inflation could be worth $1 million today.

“The DB plans tend to favour people who stay in their jobs for a long time,” Nunes said, adding that people like them because “you really don’t have to lift a finger.”

Phillips noted that DC plans are evolving, and can offer structures that recreate aspects of that security, such as through Variable Payment Life Annuities (VPLAs), which create at DB-like structure within a DC plan and can ensure retirees don’t outlive their savings.

“We will give you a pension for the rest of your life and guarantee you don’t run out of money,” said Phillips.

Bernadette Chik, the leader of the defined contribution advisory business at Mercer Canada, a business of Marsh & McLennan Cos. Inc., said a top concern for employees remains covering monthly expenses.

“The construction of investments has changed, and they are increasingly including alternatives in their asset mix,” said Chik, about defined benefits, adding that exposure to investments such asprivate markets is allowing participants to retire earlier by achieving higher returns.

She said VPLAs are just starting to emerge, with Quebec finalizing legislation allowing them. Ontario is looking at the same thing.

“Basically, they allow for longevity pooling within a DC plan and to convert a portion of savings into a stable income,” she said, adding that the key difference is that the outcome is still not a promised benefit like a defined benefit.

Nunes, a fellow and director of the Canadian Institute of Actuaries, said the while the predictability of DB plans drives demand, the features matter, with a key issue being whether payments are indexed to inflation.

“A good time to be in a defined benefit plan was when interest rates were low, and markets were not performing well. Think about the tech bust in 2000 or 2001,” said Nunes, noting those people managing their own money lost a massive chunk of their retirement overnight. “Historically, when there is a big correction, things recover. But if you were at a point in time where you wanted to retire, your plans got kiboshed. You have to withstand some ups and downs.”

In the 1990s, she noted employees “put up their hands” for defined contribution because they didn’t want to be in defined benefits plans where the employer kept the money if the plan was overfunded.

Typically, defined contribution plans offer less generous employer matches. Nunes said in a government-operated defined benefit plan, the employer might be putting in something equal to eight per cent or nine per cent of pay to match the employee contributions. Defined contributions are more typical at five per cent match, said Nunes.

“The value of your defined benefit could be worth more than your house,” said Nunes, adding a caveat of those plans is how much can be transferred to a spouse if you die early. “Other people argue I would rather have my (retirement account) where I can see $1 million and leave it to my spouse or children.”

Kevin Cork, a Calgary-based certified financial planner with Investia Financial Services Inc., said he recommends a defined contribution plan for those under 30 because a defined benefit is conservative in its investing strategy.

“This is provided they are investing properly,” said Cork, who will sometimes deal with people in their 60s who have done nothing with their DC accounts for decades and end up with little appreciation. “They will have it sitting in a savings account option for 20 years.”

Even with better employer contributions, Cork said he believes defined contribution can create more money if people are properly invested, but that means having the stomach for the market, which can be a roller coaster at times.

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“Human nature is the stumbling block. If they don’t have someone holding their hand, they will bail the next time the markets go down,” said Cork. A panic sale during the COVID-19 panic looks pretty ugly, with the S&P/TSX composite index almost three times its low from 2020.

“We haven’t had a multi-year bear market for a long time,” said Cork, noting it’s easier to talk people into investing when markets are up. “I like to tell people about (events like) 1987. But for something like a global financial crisis, they have to know they can survive that test. Historically, stocks make the most money, but you have to handle the volatility.”

Cork said the shift from corporate responsibility in a DB plan to greater individual responsibility in a defined contribution plan is unlikely to go away. “They’ll give a seminar on how to invest it, but in the end, it’s your choice,” he said.

Sure, it looks cushy to have a better-funded, likely government-backed, defined-benefit plan. Not everyone will embrace defined contribution, but it’s an opportunity to create your own wealth.

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