By Ryan Goldsman
Special to the Financial Independence Hub
When times change but our pension options don’t, we are quick to point the finger. “You made a promise, now I’m going to hold you to it. Even though it will be paralyzing for you to keep this promise, that’s ok – you will keep this promise.”
“Oh and by the way, the next generation is entitled to the same promise.”
It makes no sense, but last summer we’ve seen a few major employers — Canada Post and GM (General Motors) to name a few — go into the wee hours to get a deal done, both arguing over pension benefits. It’s been a major sticking point for a number of employers and their employees over the years and will only continue to increase in frequency.
The reality is the DB (Defined Benefit) Pension Plan — which was a very good idea a generation ago — is no longer readily offered to employees today. Effectively, gone are the days of the gold watch and the even more valuable promise of income for life: “You don’t have to worry, we’re your employer, we will worry for you.”
In the past, an employee gave the very large majority if not 100% of their working years to one employer; in return he or she was offered the benefit of income until death and it was the employer who would pay up if needed. It was a wonderful deal for employees who lived to an average age of under 70. Employers were also able to hire the best employees and make them this promise. It made sense. With contributions made over 30 working years and a payout not usually exceeding 10 or even 15 years in the worst case, employers had a fair amount of money in the employee pension plan, allowing everyone to sleep well at night.
Many pensions today underfunded
Fast forward to 2016, and we learn the reality is most employee pension plans are either underfunded or the assumptions made on the rate of returns are unrealistic; which means they will be underfunded. As has been discussed in previous articles appearing on findependencehub.com, the benefit for every year of working (as an employee) is an annuity from retirement (age 65) until death of 2% of your final salary. Sometimes the average is used, sometimes it’s lifetime. It depends on each plan. Effectively, that’s $1,000 per year if you earn a salary of $50,000. If you work somewhere for 30 years, you will get $30,000 annually.
The problem younger workers are having today is that employers no longer want to make the promise of lifetime income. First, a lifetime is significantly longer today than it was for someone born 100 years ago. Secondly, the contributions made over an employee’s lifetime have to be significantly greater since the average rate of return has declined significantly in the past 30 years. The shortfall is borne by the employer, not the employee.
Translation: the taxpayer will pay the difference for all government workers currently enrolled into this plan. We are holding the risk.
In Canada, we have something called the CPP (Canada Pension Plan) which is government run and is mandatory for everyone who is employed in Canada. This should be the only DB pension plan which taxpayers are on the hook for.
Employees at Canada Post: Get back to work.
Essentially, the union and older workers should be recognized for fighting for the benefits of newer, younger workers, but in many cases (like GM), the end result will simply be a shortfall in the employees’ pension once they are too old to make it up themselves. Essentially, the pension fund will run out of money before everyone dies.
The solution: do away with all Defined Benefit pension plans except the CPP. The CPP is for all working Canadians with the risk being borne by all working Canadians. As for the others, may it by private or public employees, the promise of a pension from an employer is not a promise that should be made in this day and age. Letting employees get back to work, the alternative known as a Defined Contribution (DC) pension plan or money purchase pension plan is the best way to go.
The contributions are made on an annual basis, allowing each and every employee the choice of which asset allocation is right for them, and giving them control over their investment selection. Gone will be the days of wondering “is the man going to uphold his side of the bargain.” The “man” has already written you a cheque for your portion: in fact, every single year the contribution is made to your pension account that you control.
If only the mail were always delivered rain, shine or strike, we would all have copies of our pension statements.
Ryan Goldsman is a bilingual Toronto-based Certified Financial Planner and author of the eBook: Financial Myths, available on Amazon.