Defined Contribution plans can be better for people who change jobs a lot, especially early in their careerALEX SEREBRYAKOV/Getty Images/iStockphoto
Millennials may be slowly taking over the work force, but they are lacking a key employment perk many of their parents got: a guaranteed pension.
Instead, those in the newest working generation are more likely to be presented with what is widely considered an inferior pension plan that is riskier and puts more onus on the employee to save enough for retirement. That is, if they receive a pension at all. Statistics Canada data show about 38 per cent of Canadian workers are covered by any type of workplace pension, down from about 42 per cent in the late 1990s. About a quarter of workers in the private sector today have a pension plan.
"It's an advantage to have a pension plan, period," says Janice Holman, Toronto-based principal and defined-contribution practice leader at consulting and actuarial firm Eckler Ltd.
While the newer defined-contribution (DC) plans may not be as secure as the traditional defined-benefit (DB) plans, they have benefits, Ms. Holman says.
DC plans – where both the employee and employer make contributions to the pension and the final lump sum at retirement is based on investment returns – can be better for people who change jobs a lot, especially early in their career. That's because the existing balance in a DC plan can be easily transferred from one employer to another, or to a personal locked-in retirement account, and keep growing, Ms. Holman says.
Outside the public sector, most DB pension plans won't accept the credits from another pension plan. "It won't continue to grow with salary increases and will lose purchasing power by retirement," Ms. Holman says. "It is also hard to keep track of multiple deferred DB benefits and much easier to keep moving your accumulated DC balance to a new employee."
DC plans on the rise
Among Canadian employees with a registered pension plan today, about 17 per cent have at DC plan, which is about double the number from 30 years ago, according to Statistics Canada. About 86 per cent of DC plan members work in the private sector. Among those with workplace pensions, the number covered by DB plans has fallen to about 71 per cent, compared with more than 90 per cent in the mid-1980s.
Employers are eager to shift to DC plans because they don't have the same responsibility, as in a DB plan, to come up with a certain sum of money for workers in retirement. Instead, in a DC plan, employees take on the risk by putting their pension money into market funds and hoping for higher returns in the long run. The added risk is that the markets could be down when it's time to withdraw the funds.
DC plans need attention
Employees with DC plans need to be more engaged in their investments, including making decisions about which funds to buy, and keeping track of market movements and management fees, Ms. Holman says.
"The main thing they need to know in a DC pension plan is that with all of this flexibility comes responsibility," says Ms. Holman. "In the DB world, you were just given this guaranteed benefit without paying the fees, without having to take on the investment risk or management of the plan."
The biggest mistakes employees make are not signing up for the company pension plan as soon as they're eligible and not matching the employer's contribution, which Ms. Holman says is usually 5 per cent at many Canadian corporations offering DC plans.
"We see a lot of plans where employees are leaving free money on the table because they aren't making the maximum contribution to receive the maximum match," Ms. Holman says.
New models needed
While most DC plans are in the private sector, there is growing pressure for the public sector to make the switch. The argument is that it will take pressure off cash-strapped governments, especially at a time when people are living longer and, in turn, drawing pensions for a longer period.
In his study, Shifting Public Sector DB Plans to DC – The Experience so far and Implications for Canada, co-author and pension expert Robert Brown argues the move increases both costs and required contribution rates – a negative for both employers and employees.
Instead, Mr. Brown argues for a plan that's a mix of both DB and DC plans, where pensions are shared among industries into large asset pools, to help mitigate risk.
"You can't provide real, solid retirement income security on an individual-account basis," says Mr. Brown.
Keith Ambachtsheer, pension expert and founder of KPA Advisory Services, argues the flaw in DC plans is their design, which gives employees too much investment choice. He advocates for default investments, based on an employee's risk tolerance.
"The basic design shouldn't require employees to make investment decisions," he says.
Another problem with DC plans, according to Mr. Ambachtsheer, is that they only accumulate investments and don't have a method to distribute them over a set period, which happens with DB plans. "What do you do with your lump sum if you don't know how long it has to last?" he says, citing "longevity risk."
"The insurance industry [which offers DC plans] needs to fix it," Mr. Ambachtsheer says. "There are better solutions and they're being advocated. It just takes time to get there."