Almost as though to prove my point about the fact that individuals need to stop counting on others, whether the government or their employer, to ensure their financial future, and to take charge themselves, the federal government announced that same day that they were introducing a new variation on the two standard pension options available, and introduced the Target Benefit pension plan. It is worth noting that this new type of pension plan will only be available for, “crown corporations and federally-regulated industries, such as transportation, banking and telecommunication”. For now. (Author’s snide comment.)
Defined benefit, defined contribution, and target benefit models
By way of a brief review, a Defined Benefit (DB) plan is a plan where the benefits are, in theory at least, guaranteed. The strength of the guarantee depends on who is making it. It is not uncommon for companies to have unfunded pension liabilities. If circumstances conspire, it is possible that the money simply won’t be there when it’s needed. The one exception to this is governments, who always (OK, usually) have the option to tax the population to meet their obligations.
A Defined Contribution model means that is it the contribution, rather than the benefit that is defined. In other words, the input is set in stone, but the results are not. Workers and employers contribute to the plan, and whatever is available to pensioners is what is paid out. Benefits can be adjusted either up or down, depending on circumstances.
The new, third, option is Target Benefit. In this model, introduced by the Federal Government 24 April, 2014, both the contributions and benefits are adjustable, depending on the situation. This is being presented as a “shared risk” model; the implication being that there is no more free lunch for those in DB plans. Critics are calling in a “shifted risk” model; from the company or government to the individual.
While it would be easy to bang on about the little guy getting screwed (again), that would serve little purpose. This is, I believe, the wave of the future. The days of 40-year positions, gold watches, and guaranteed pension plans are over. They have already taken a beating in the private sector, and I’m quite sure that the government’s end-game is to eventually impose TB plans on all its employees as well.
And, as much as change is almost always uncomfortable, it doesn’t mean the end of the world, either. Although we aren’t used to thinking of it this way, the CPP, to my mind, is essentially a TB plan. Let me explain. When the CPP was first introduced by Pearson in 1965, contribution rates were set at 1.8% of an employee’s gross income. For quite a while, this was fine, and the plan chugged along, with required contributions slowly rising. Then, in the 90’s, changing circumstances dictated that a major re-think was in order. (Fun Fact: It was estimated that if things continued as they were, the reserve fund would be empty by 2015.) The major changes were that contribution limits were raised significantly (to almost 10%, when counting both employer and employee contributions), and the CPP Investment Board was established.
As a result of these changes, the CPP is the envy of much of the world. It has posted a 10-year return of 7.4%, which is pretty impressive if you consider the size of the fund and the economic climate over the last decade. The CCPIB states that it must earn an annualized 4% real return to sustain the CPP.
The point is that the government saw that things were not going to end well if they didn’t change course. The news that workers and employers were going to have to pony up more for CPP was not met with a lot of enthusiasm, but the changes were necessary, and so they were implemented.
The challenge for target benefit pension plans
While the CPP may be seen as a success story, it is important to realize that this outcome was by no means inevitable. The government at the time had the sense to listen to the actuaries, and the intestinal fortitude to act. As a result, we are all better off. Don’t forget, though, that a government and a Board of Directors have different agendas. It isn’t hard to imagine a situation where a BoD makes decisions based on short-term profit, rather than the long-term interests of the employees.
As with so many things in life, target benefit plans are neither good nor bad; how they are run will determine their effectiveness for the people involved.
Here is the danger with a target benefit pension plan
When companies (or governments) ran defined benefit plans, it was in their interest to ensure that the pension liabilities were covered because the company (or government) was on the hook for any shortfalls. With target benefit pensions, it is the employee who will feel the pinch when contribution levels over the past, say, 20 years, are found to have been inadequate. The company can simply shrug its shoulders and say, “Well, there was never any guarantee that this was going to work. The payouts are based on the contributions that were made, and the market returns that the fund was able to generate. Don’t look at us.”
The problem is that it is in the company’s interest to reduce its contributions to pension plans, and by the time that employees realize the importance of these things, they’ve often got 20 years of insufficient contributions behind them; it’s too painful to try to catch up starting at age 40, which is when things like pensions come into clearer focus for a lot of us.
I come now to the same conclusion as I did last week: Individuals need to make a shift in their thinking. Nobody is as concerned with your future as you are. I think it’s fair to say that you, dear reader, by virtue of having found this article, and read it to its conclusion, have probably already made this realization. I just hope the rest of population sees this philosophical sea-change before it’s too late for them.