How Defined Benefit Plans Contribute To Retirement Security?

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Retirement Security

There is a perception out there that defined benefit plans are more costly than defined contribution plans, and in fact, that’s not true and in fact, the reverse is true, I mean it’s much more costly to run a defined contribution plan than a defined benefit plan. So a defined contribution plan, the employer simply makes a payment into a plan and then it’s up to you to figure out how to invest it, and what you get in retirement is completely dependent on how you did on your investment returns. But defined benefit plan, on the other hand, is based on a formula so the employer and employee make a contribution into the plan, and then when you retire there’s a formula that defines what your income’s going to be, and it’s typically about two-thirds of your working career income.

The issue really is around risk transfer, and so then essentially if an employer is sponsoring a defined benefit plan they accept some of the risks of future under funding. So by shifting from a defined benefit plan to a defined contribution plan effectively what happens is that risk gets a shift from the employer to the employee and ultimately to the social welfare system. The risk doesn’t go away. It just gets shifted to somebody else. So a defined benefit plan is low cost to the environment. We can run our defined benefit plan for about 30 basis points per year, which includes all investment and administrative costs and then you move into a defined contribution plan and that cost goes up to about 2% per year. As a result, you end up with less money, in the end, so because it’s higher cost to administer and run the plan over time, you actually end up with less money.

Defined contribution plans

So I mean by shifting from defined benefit plans to defined contribution plans, when you look at it from a societal point of view, you’re actually making things worse, not better. One of the important things to understand is that in a pension fund like ours, most of the pension payment you receive comes from investment returns. For every dollar, we pay out in pensions only about 20 cents comes from the employer and the employee contributions. The other 80 cents comes directly from investment returns accumulated over the life of the plan. So if the money doesn’t go you’re not going to have much of a retirement income. So investing money well is really critically important to the long-term outcome. We spent a lot of effort the last few years at least trying to get the correct facts out there.

You know I mean the correct facts are that it’s actually, it’s less costly to run a defined benefit plan than a defined contribution plan, and particularly to policymakers, so members of Parliament and members of Provincial Legislation, because people that get elected to those offices generally aren’t pension experts, I mean there are some, but generally speaking that’s not what they are. So you know, we need to provide them with correct information so they can make good decisions. If you change people’s opinions at a grassroots level, I mean that’s really where you can be effective.

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