The Danger in your Defined Benefit Pension

What is a Defined Benefit Pension Plan?

The defined benefit pension plan has often been considered the gold standard for pension plans in Canada over the last number of decades. These plans became the 'Cadillac' of pension plans as they promised to pay participants in their plans a set benefit amount beginning in their retirement. These plans were created to attract and retain top quality employees to organizations, and the plan worked! In what we now consider the old economy, employees would often stay at the same company for over 35 years.

So what could go wrong? These great companies were making money and providing great benefits as incentives. Well, apparently a lot could go wrong which is ultimately where we stand today on the precipice of what could potentially be a financial catastrophe for some retirees. When these plans were first introduced the average employee would work at the same company for 35 years and pension actuaries would make the assumption that male and female workers would retire by 65 years old, of which the majority would pass away by ages 68 and 72 respectively.

Plans Were Never Designed to Provide Long Term Benefits

Based on the fact that the pension plans only had to provide an income for 3-7 years the plans only required a minimum amount of funding to stay afloat and even if some employees lived longer the fact that most were dying just a few years after retirement ensured that there would be more than enough assets in the plan. The problem for these plans today? People are not dying! Or at least they are living much longer to the point now where actuaries are required to estimate life expectancy for males to be 91 years of age and 94 for females. The problem? The plans were never originally designed to provide benefits for 25+ years and thus have put major stress on the plans.

Pension Contribution Holidays from Overfunded Plans

Another contributor to pension plans being underfunded is the fact that companies were allowed to take pension contribution holidays if plans become overfunded. Some of my clients will be familiar with what I am about to say on this subject as I have often warned them about the ebbs and flows of market returns. During good times their financial plans will likely become overfunded in that if trends were to continue they would likely overshoot their goals. The problem? Things don't always stay good forever and those goods years are needed to make up for bad years.

Financial Stress Being Put on Companies

Unfortunately, many pension plans did not heed that same advice as they took contribution holidays in situations where pensions were overfunded. During good times many plans stopped contributing into their plans, especially in the late 90s prior to the tech bubble bursting. Unfortunately when the good times didn't last and markets retreated the pension plans became underfunded and in order for the plans to become solvent again would require significant investment from the company sponsoring the plan. This of course would put even more financial stress on companies especially coming out of a recession.

Another danger to consider is the quality of the company who is putting the money into the plan. Unfortunately for too many we have seen many examples in recent years where the sponsoring company goes under and the pension plans are left underfunded. Sears Canada is one of the most recent such examples where pension payments even stopped for pensioners while the companies insolvency proceedings were underway. To my knowledge there has been no final ruling on what reduction will be applied to all retired Sears employees who are part of the defined benefit plan. There are many other examples of this happening as well, especially after the 2008 financial crisis.

Being Comfortable with the Idea That a Company Will Be Financially Healthy

As mentioned above, statistics are showing that you are likely to live a long healthy retirement of 25+ years which means that you have to be comfortable with the idea that the company you worked for will be financial healthy for that long. As we have seen in the last 10 years, even companies which have been around for over 100 years can fail – Mercer, a pension administrator reported that in 2015 the average pension plan in Canada was only 83% funded, meaning that they were underfunded by 17%.

Understanding the Risks Related to Plans and Retirement

For any of you who are currently members of defined benefit pension plans it is important that you understand the risk related to these plans and your retirement. The common misconception is that the benefit they will provide is guaranteed but in actuality the benefits are only guaranteed as long as the pension is able to sustain them. If not, you may be facing the same fate that so many Sears Canada retirees are facing today which is reduced benefits which I'm sure I don't need to tell you could put significant financial stress on the retirement you had hoped for.

The Importance in Evaluating All Pension Options

This is why it is so important that when it comes to your retirement you evaluate all of your pension options and the pros and cons of each. Many defined benefit plans have become an extreme financial burden on the sponsor companies, I suspect that there will be many more companies in trouble in the future and just like the Sears Canada plan, will be forced to reduce benefits for all of their pensioners. Do what you can to protect yourself and your family, understand your options and make the best decision for you. For more information on your situation, please contact your Endeavour Wealth Management Investment Advisor.

- Grant White, CIM, CFP

Grant White is a Portfolio Manager/Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Grant White who is a Portfolio Manager for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Manager can open accounts only in the provinces in which they are registered.