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Fred Vettese is the chief actuary at Morneau Shepell, a human resources and actuarial consulting services firm.
Canadians are forgoing as much as $3-billion annually by not taking full advantage of employer matching contributions within their company defined contribution (DC) pension plans, according to a recent Sun Life Financial report. One has to wonder why employees would pass up free money when there are no strings attached.
Employees in most DC plans have the option of contributing extra, and if they do, the employer makes a matching contribution on their behalf. Sometimes it is a partial match, such as 50 cents for every dollar contributed by the employee, and sometimes it is a full match. Employers offer contribution matching to encourage employees to save more for retirement.
To gain some insight into why a significant percentage of DC participants balk at contributing more, I analyzed data from a number of DC pension plans for which Morneau Shepell does record-keeping. My investigation, which encompassed tens of thousands of employee records, turned up the following:
- About one third of participants in a given plan do not make an optional contribution, even if it is 100 per cent matched by the employer.
- Up to two thirds will not make an optional contribution if the basic required contribution they are already making is high, such as 4 per cent of pay or more.
- One would expect older employees to contribute more since they will get their hands on the employer’s money sooner. But it turns out the impact of age is quite minimal, especially if we correct for salary differences. In some groups, a fifth of the employees in their 50s do not make optional contributions.
- Salary level has a big impact on optional contribution rates but only up to the average national wage level - the low $50,000s. In one case, nearly half of employees in their mid-40s who were earning under $50,000 opted not to contribute versus only 18 per cent of employees in the same age group who were earning over $50,000.
- In plans where the range of optional contribution rates is limited, the employee’s decision is practically binary. The vast majority either contribute enough to earn the maximum employer matching or they contribute nothing. This suggests that deciding how much to contribute is not based on ability to pay or on perceived retirement income needs, but rather on whether or not one understands the idea behind the optional matching.
What is noteworthy is that many of the employees who elect not to make optional contributions to their DC plans still contribute to their own Registered Retirement Savings Plans (RRSPs). According to Statistics Canada data, over half of the participants in pension plans, including DC plans, also contribute to RRSPs. A rough estimate is that several hundred thousand DC plan participants are forgoing employer matching contributions in their DC plans and instead make personal RRSP contributions that are not matched.
The question is why are so many people not taking advantage of the matching contributions their employers are willing to make? There are some good reasons and some bad ones.
There are some good reasons. Some employees simply do not have the discretionary income to do so. This is especially true of younger workers who are earning less than the average national wage and are struggling to raise families and meet mortgage payments. It is easy for policy-makers to say such employees should be forced to contribute more for their own good but perhaps those policy-makers should spend a week in the worker's shoes first.
In addition, lower-paid workers could be better off contributing to a Tax Free Savings Account (TFSA) since, unlike the case with DC pensions, withdrawals from a TFSA will not reduce the Guaranteed Income Supplement in retirement.
As for the bad reasons, one is a lack of trust in one's employer. This was borne out by the fact that shorter-service employees were less likely to make an optional contribution. Where trust is an issue, DC participants should know that DC pension contributions go into a trust fund that is safe even if the employer goes bankrupt. They should also know that their salaries are not reduced in any way by the employer's matching DC contribution. To some people, especially new hires, the employer matching contribution might look to be too good to be true but honestly, there is no catch.
Another bad reason is that the employee doesn't like the investment options in the DC plan and thinks he or she can do better in a personal RRSP. If one takes the employer matching contribution into account, I can guarantee the DC plan will do better. That could be true even absent the matching employer contribution , since the management fee in DC plans are usually lower than in a retail product. By the way, the investment managers making the DC plan investments are often the same managers used for retail mutual funds.
A third reason not to make optional contributions is simply a preference for spending the money now instead of deferring it until retirement. I could be somewhat sympathetic to this position were it not for the fact that the employee is forgoing the employer matching contribution.
There is a tendency to want to correct a situation where workers are making poor decisions out of ignorance. The answer, in my opinion, is not more employee education, since I know how hard DC plan sponsors are already trying to communicate their plans and various employee options.
Perhaps nothing more needs to be done. After all, this is a private matter between the employer and the employees, those same employees can already count themselves among the "haves" since most workers in the private sector have no pension plan coverage at all, and the dynamics of the situation will change dramatically if the Ontario Retirement Pension Plan is launched or if the Canada Pension Plan is enhanced.