Canadians who belong to good pension plans at work may believe their retirement income is secure. But more and more employers with good defined-benefit pension plans — in which pensions related to earnings and years of service are guaranteed — are making changes to their plans.

Some have closed DB plans, switching employees to defined-contribution plans or group RRSPs, in which the retirement pension depends on investment returns and no particular benefit amount is guaranteed.

Bernard Mercier, a principal in the Vancouver office of benefits consultants Towers Perrin, says the first wave of such conversions took place six or seven years ago, when pension plans were in surplus. With stock markets booming, employees wanted a chance to manage their own retirement funds and put pressure on plan sponsors. Now, with many pension plans facing deficits, plan sponsors are looking for ways to cut costs — although the wave of conversions from DB to DC is much stronger in the U.S. than in Canada, Mercier says.

Colin Ripsman, head of the DC consulting group at Mercer Human Resources Consulting in Toronto, says a large number of DB plans in Canada are now converting to DC plans for future service and/or new employees. But, unlike in the U.S., he says, a lot of Canadian employers are allowing existing employees — especially long-time employees — to stay in the DB plan and are not forcing them to convert.

What advice can you give clients facing such a situation? Ripsman says employers typically provide employees with a range of pension projections comparing the value of the DB plan with the range of potential values under the DC plan. But, he believes, many employees have difficulty making the choice. “On the one hand, they are looking at converting a huge amount of money and they may not have a good sense of what this translates into, in terms of purchasing a pension,” he says. “Others may be overwhelmed by the dollar value they’re seeing.”

Generally, those who switch to the DC plan would retain the benefits accrued in the DB plan. When they retire, they would receive a pension based on those accrued benefits, along with anything they generate from the DC plan.

In this type of conversion, new employees may be directed to the DC plan, creating a two-tier pension set-up, in which younger employees don’t have the option of the guaranteed benefits the DB plan offers.

Other plan conversions may involve “more modern designs,” Mercier says, or hybrid plans, with elements of both DB and DC plans.

In some cases, the DB plan may be wound up completely and employees may have to transfer the commuted value of their accrued pension in a lump sum into a DC arrangement or locked-in account. In other cases, the employees simply may be given the option of transferring a lump sum, equivalent to the accrued benefits, out of the DB plan and into the DC plan.

“People, in general, appreciate the value of their defined-benefit plans,” Ripsman says. “Those who don’t take a lot of time to read the materials provided by the employer may have a bias toward defined-contribution plans.”

As well, he suggests, “There may be a tendency for financial advisors to recommend taking the commuted value of the pension because it provides a huge lump sum of assets for them to manage.”

Advisors need to alert clients to the impact pension plan changes can have on their replacement income at retirement, says Ripsman: “It’s very difficult to match the value of the DB accrual under a DC plan.

“It’s probably not possible to make some of that up,” he adds. “Plan members must be prepared to look at alternative sources of savings or adjust their cost-of-living expectations.”

As well, says Ripsman, employees who switch from a DB to a DC plan need to determine when they will need to draw on their funds and how significantly they will need to draw on them. For a client who starts drawing a pension around age 60, he suggests, the asset mix should reflect the fact that the funds will have to remain invested and earning a return for a considerable time. In other words, funds can’t be invested 100% in fixed-income securities.

AGE MAKES A DIFFERENCE

@page_break@For individual employees, says Mazen Shakeel, a principal with benefit consultants Hewitt Associates in Toronto, deciding whether to stay in the DB plan or switch to the new arrangement generally comes down to whether the client expects to stay with the particular employer until retirement. That, in turn, may depend on age. For employees aged 50 and more, says Shakeel, it’s generally better to stay with the DB plan.

“If you’re forced out of a DB plan at age 50,” he says, “it’s probably too late to adjust your savings and investment behaviour.” One option, he suggests, may be to continue working.

Choosing between the DB plan and the DC option is a very difficult choice for many employees, Mercier adds — particularly as it is a one-time, irrevocable choice. In other words, as Shakeel points out, an employee who decides to move out of the DB plan will not be able to reverse that choice later on. Shakeel also notes the “choice window” is typically short. Employees may be given four to six weeks to make a decision, although the changes to the pension plan may be phased in over a period of several years.

Information provided by the employer may be confusing, says Shakeel, especially for someone who doesn’t know much about pensions and may not understand how to use the results of a modelling exercise. A good financial advisor can help interpret the results of the modelling tools, he adds.

The advisor should help the client to understand what the options are, to weigh the financial consequences of those options and to see what has to be done to make up the gap — if there is a gap.

But it’s not purely a financial decision, he says. The big question is: how comfortable is the client in dealing with risk? Even if the economics lead to a decision in favour of a DC plan, he adds, if that decision is based on unrealistic expectations about investment returns, the decision may be flawed. IE



Monica Townson is the author of Growing Older, Working Longer: The new face of retirement, written for the Canadian Centre for Policy Alternatives.