Defined Benefit Pension Plans are a thing of the past

Can you imagine turning down a job because they have a pension plan?

Recently I was working on the annual contributor report for a Defined Benefit Pension Plan. While the corporate world has traded these in favour of Defined Contribution Pension Plans to no longer deal with the headache and liability, there are many reasons why employees should want conversion as well.

For those who are unsure of the difference: Defined contribution plans are where the employee and employer each make a contribution to a plan such as a Registered Retirement Savings Plan (RRSP) in Canada. The contribution is defined, for example 9% : 9 % of your salary, it is your fund to manage as you wish and is yours regardless of where you work. A Defined Benefit plan is similar in that you each contribute a portion, but the plan belongs to the employer, the terms dictate what your payment will be when you retire which is typically calculated based on age and years of service; these typically work fine when you stay with the same company for 35 years and you do not leave until you are 65 years of age, but drastically erode otherwise therefore no longer reflecting our current world of work.

Let’s say your Defined Benefit is 2% per year of your average best 5 years to a maximum of 35 years.  At the simplest level, if you worked for 35 years and your average best 5 was $100,000 per year, you might see a $70,000 per year pension.

But with most plans, when you die your spouse receives 50%, and when they die your adult children receive zero. Also, if you married after you started drawing your pension, your spouse gets zero let alone your children or grandchildren.  

Now consider Defined Contribution Plans where your employer matches you 1:1 of 9% and 9% of your wages similar to a Defined Benefit Plan contribution rate, and it all goes into your Registered Retirement Savings Plan (RRSP in Canada). If you die, your spouse gets it all even if married at a later time, if they die your children get it all, and if they die, your grandchildren will inherit the balance.

If you think you receive a medical plan with your pension, you pay for it, and can often get a better plan outside. For those who do have a Defined Benefit Pension Plan in Canada, you do not get much more than what publicly funded medical gives you. For the USA residents, you receive Medicare when you draw Social Security.

Can it get worse? Sure. How about the plan where the 2% per year will be penalized 5% per year for every year you are short 35 years service? If you had 30 years service you would not get 60% (2%X30) you would lose 25% of that (5X25%) due to not achieving 35 years. Another scenario is you lose 5% per year for every year you are short from age 65; If you had 30 years but started at age 25 therefore you are 55, you could lose 50% for not achieving age 65. In this scenario where you thought you were getting 60% of your salary (30 years X 2%) you could be getting less than half of that unless you wait ten years to draw the pension in some cases. There are many types of penalty calculations such as rules of 80, 85, and 90 depending on the plan. If you think I am mistaken, do your homework and note how your plan works, or the one you are considering.

Now imagine you work in an industry where some companies are in Defined Benefit Plans where others are not, and you move around as part of your advancement. You now have a mixed bag of pension funds some of which may be so watered down due to age and years of service penalties, you and your employer’s contribution has just become a donation. If you were on match to RRSP, you would lose nothing. 

Can it get worse? Yes it can. With most plans once the employer enters into it, everyone must participate. For those of us who do not want to be in a Defined Benefit Pension Plan, our employment opportunity window is narrowed unless we want to make the donation. At 56 years old and managing my own affairs, when I took a job for four years to bring me to retirement, the 18% match per year has just become a donation to the pension fund.

Defined Benefit Pensions are archaic and do not reflect the current world of work; even for the likes of military and public safety. Work for ten years then move on and your contribution becomes almost worthless. Change employers every 5-10 years moving in and out of organizations in the plan and you end up with the same result.

What other negative consequences can occur? There are situations where individuals are no longer happy with their employment for other reasons but stay because of the plan and become pension prisoners; this does not benefit anyone as the employee becomes minimally productive at best, the environment becomes toxic, and no one is happy.

While these plans still exist in union environments, many organizations are convincing bargaining agents to turn to defined contribution also called ‘matched RRSP’ in Canada. In these cases, an actuarial assessment of each persons plan is performed, then the funds moved into the individuals locked in RRSP (LIRA) which is now theirs to manage, and the employer now contributes along with the employee. From here, you are free to move about the industry, and the best part in my opinion, is when you die, your spouse gets all not half, and when they die, your children get all versus nothing.

Know the plans including asking the questions at interview time, know your options, and choose wisely. If you are union and in negotiations, this is the time to consider making the switch.