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 BenefitsExperts agree, Defined Benefit pensions are best (March 2008) By Lionel Railton, CEB, PPAC, Administrator The news media has been full of stories related to sub-prime mortgages, credit crunch, asset-backed securities, stock market melt down, etc. What does it all mean and what impact has this crazy time had on the Operating Engineers’ Pension Plan? I am happy to report that your pension plan has no exposure to these securities or the markets that are affecting so many. It is important to reaffirm that the investment strategy engaged by your Board of Trustees in 2002 was specifically designed to protect the plan from such events. Some questioned the logic of avoiding investments in equities, particularly during the recent run-up of the markets, but it is important to understand that our plan is a mature plan and our risk tolerances are very low; consequently, our investment strategy is reflective of this risk profile. What factors could affect our Plan? • A major and prolonged downturn in the economies of the U.S. and Canada—Thankfully, Canada, and in particular western Canada, seems to be better insulated against a number of the issues that are affecting our neighbours to the south, however, a slow down in the U.S. would clearly lead to less demand for the resources and materials that we sell to them and the world. • A lack of growth of new members in the plan. “Organize or die”—you hear it time and again. We are all responsible for keeping our plan healthy. As Brother Gary Kroeker has repeatedly emphasized, expansion of market share, and the employers that come with it, are vital to the continued growth of your plan and its well-being. • Stagnant pension contributions—We must support our negotiators when they are at the bargaining table to ensure the ongoing health of the plan. • Lower long-term interest rates—Although we are at historically low long-term interest rates, a further decline would place additional pressure on financing future benefits as we go forward. These are but a small number of factors that could impact the plan. However, it is important to know that your pension trustees have taken all steps within their control to ensure the ongoing health of the plan and your pension benefits that flow from it. Your Board of Trustees continually monitors the performance of the assets and liabilities of the plan and those professionals we have engaged to help us with the process. Retirement planning Towers Perrin, in a recent article entitled The 21st Century Pension System: A Retirement Reality Check, describes current trends and states that if they continue “the majority of Canadians will face a substantial reduction in lifestyle when they retire.” The full article can be found at www.towersperrin.com. “Society will face the strains of a gulf between those with employer-sponsored plans and those without.” The article looks at the impact of the do it yourself world when it comes to retirement planning coupled with employers’ reluctance to establish or maintain pension plans for their employees. Towers points to the growing use of Defined Contribution (DC) Plans or Registered Retirement Savings Plans (RRSP) where “the residents of this world will be largely responsible for providing their own retirement income. But evidence to date suggests they are: not saving enough on their own, not effectively managing their investments or are handicapped by relatively high fees that erode their investment returns.” He goes on to say that, “There is a widespread view that the biggest pension trend of the last 15 years is that employers have been shifting from Defined Benefit (DB) pension plans to Defined Contribution (DC) pension plans. This is misleading. By far the strongest growth has been in the number of employees with no pension plan at all. “DB pension plans covered 44% of the workforce in 1992, but just 34% in 2005. Conventional wisdom attributes most of this slippage to corporate conversions from DB to DC structures. Indeed, while DB participation did fall 2.3%, DC membership soared 94%, but, because the DC membership base was so low, this gain made little impact on the overall picture. DC & Registered Pension Plans (RPPs) covered 4% of the workforce in 1992 and just 7% in 2005. Again, by far, the strongest growth has been among those with no RRP at all.” The article reveals that only 28% of private sector employees (you and I) are now covered by a pension plan. “The bottom line: fewer employees are covered by Defined Benefit pension plans, especially in the private sector. Defined Contribution pension plans cover somewhat more employees, but not a sizable portion. Many more employees have no RPP coverage at all and rely entirely on RRSPs.” How much will you need to provide a lifetime income? Towers looked at someone earning $70,000 in the final year of employment. “Retirement eliminates certain job-related expenses and also, arguably, the need to contribute to retirement savings. As a result, this person likely needs to replace 80% of employment income to be able to retire without changing his or her pre-retirement lifestyle. That’s $56,000. Of this, $16,000 would be expected from the Canada/Quebec Pension Plan and Old Age Security if the person qualifies for maximum benefits. That leaves $40,000 to come from workplace pensions and personal savings. “An employee retiring at 65 would need almost $650,000 to generate $40,000 of annual income fully indexed for inflation. This would require annual savings of more than 15% of pay spanning 40 years from age 25 to 65. If the employer makes the median contribution of 5%, the individual would still have to save more than 10%. That’s well above the level of contributions Canadians actually make. Without indexing, the capital requirement would fall to roughly $550,000 and the annual contribution rate would be 12% of pay. “If these targets are beyond the employee’s grasp, he or she might consider postponing retirement—a reasonable alternative in an environment of labour shortages and longer life expectancy. A five-year delay to age 70 would reduce the capital requirement to somewhere between $450,000 and $550,000 depending on the level of inflation protection desired. The annual savings—now spanning 45 years instead of 40—would fall to somewhere between 9% and 11% of pay. “But...will a generation raised on ‘Freedom 55’ be ready or able to work until 70, or later? Or, will it simply settle for much less in retirement income, perhaps supplementing it with part-time work? “Second, how relevant is an average annual savings rate, no matter how manageable? There is abundant evidence that Canadians typically do not sock away meaningful amounts of retirement money every year unless this discipline is imposed by pension plans. Consider the trailing edge boomer who has just turned 40 and has little or nothing saved after coping with student loans, insecure employment, family formation expenses and a high level of lifestyle spending common in our society. This person has already lost a third or more of his or her capital formation years. Past experience suggests these late savers will start to rapidly increase their RRSP contributions after age 50, but will they really be able to muster the resources for catch-ups when there are still loans to service and, in many households, grown children and/or elderly parents to support? “Canadians commonly joke about ‘Freedom 95’ but thus far have shown little or no serious interest in the not unlikely prospect of ‘Freedom 70.’” The article concludes with an in-depth review of personal retirement savings rates of Canadians and the challenge of those within a DC plan to achieve their retirement goals. The following excerpt really stood out in my mind: “Someone who works for the same employer for 30 years would receive roughly twice the benefit from a DB plan than the DC plan. But conventional wisdom suggests the DC design better accommodates the frequent job changes common in today’s workplace. So, we revised our projection to divide the 30-year career into three 10-year periods of employment. The BD pension was still 50% larger than the amount available from the DC plan.” Clearly, Tower’s and similar research re-emphasizes the need for pension plans and the benefits that flow from them, and how privileged we are to have the Operating Engineers’ Pension Plan to support our retirement goals. As always, my best wishes. |
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