New Rules for Commuted Values (Pensions, QC)

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New Rules for Commuted Values (Pensions, QC)

Post by longinvest »

New rules for pensions came into effect on January 1st, 2016, a little over 2 year ago, in QC. I've alluded to them in another thread: http://www.financialwisdomforum.org/for ... 93#p609770

Here's an article about them on the Benefits Canada web site:
Quebec shakes up pension landscape with shift to going-concern funding

The new rules (allow to) reduce the commuted value according to the solvency ratio of a defined-benefit (DB) pension plan:
The new law also affects the minimum rights employees have when they leave their jobs and, therefore, their pension plans.

When employees leave the plan, they can choose to receive a lump sum reflecting the value they’ve accrued. Plan sponsors now have the option to pay the transfer value based on the solvency ratio of the plan. As a result, they no longer have to provide a 100% payout if the plan isn’t fully funded on a solvency basis, says Dickner. For example, if the plan is at 90% funding on a solvency basis, the employee will receive 90% of the commuted value.
At the same time, the new QC law removed the solvency requirement for the plan itself!
Bill 57, which took effect on Jan. 1, removes the requirement to fund private defined benefit pension plans on a solvency basis. A valuation on the basis of solvency assumes the plan folds suddenly and looks at whether or not it holds enough assets to pay out all obligations accumulated until that time immediately.
...
Under the new rules, employers will have to fund their plans on a going-concern basis. A going-concern valuation assumes the plan will exist indefinitely and therefore lessens the impact of short-term market fluctuations on its funded status.
In other words, the solvency ratio is now only used to reduce the commuted values of members quitting the plan.
Last edited by longinvest on 22 Feb 2018 02:01, edited 1 time in total.
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Re: New Rules for Commuted Values (Pensions, QC)

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Before the new law, I had been wondering, for a long time, if I should plan to quit my job, which I like, before reaching age 55, and take the commuted value due to the funding risks of non-government pensions in QC. I would surely not be able to buy as big an annuity with the money but, at least, I would get Assuris protection. There's no similar protection for pensions in QC. Mostly, I didn't want to take the risk of ending up like a Nortel retiree if things got bad in the future.

My employer has decided to take advantage of the new rules to reduce commuted values based on the solvency ratio of the pension plan. Taking the commuted value would be equivalent to taking a two-level haircut: (1) the haircut due to the higher cost of an equivalent annuity, and (2) the haircut due to the reduced commuted value based on solvency ratio.

As a consequence, I've decided to stop considering leaving my job before age 55 for fears of pension funding risks. I prefer to take my chances with the pension over accepting the certainty of a two-level haircut with a reduced commuted value.

But, as the Nortel-like risk remains, I've decided to plan for pension cuts in my retirement planning. Using hypothetical numbers, if the solvency ratio of my plan is 50% and I am promised a $100/month pension, I only count a (50% X $100) = $50/month pension in my planning spreadsheet. It's not perfect, because the solvency ratio can change in the future (going up or down), but it's the best I've found, so far, to sleep well at night.
Last edited by longinvest on 22 Feb 2018 01:23, edited 1 time in total.
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Re: New Rules for Commuted Values (Pensions, QC)

Post by Mordko »

Wonder what could be the objective of this law and what were they thinking in the provincial government.

On the face of it, they are deliberately incentivizing businesses with DB pensions to underfund and reward companies who brake their contractual commitments.

How does this make any sense???
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Re: New Rules for Commuted Values (Pensions, QC)

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Mordko wrote: 21 Feb 2018 23:06 Wonder what could be the objective of this law and what were they thinking in the provincial government.
Actually, it seems employers and unions were in agreement about it:

http://www.benefitscanada.com/pensions/ ... ding-77211
As a trade-off for eliminating the need for solvency funding, employers will have to put money in a reserve even when they’ve fully funded their plans on a going-concern basis. The requirement is the law’s so-called stabilization provision aimed at helping pension plans withstand financial shocks.
...
The size of the reserve will depend on each pension plan’s investment strategy. “The riskier your assets are, the larger the margin of the provision will be,” says Jason Malone, a Montreal-based partner at Aon Hewitt.
...
The stabilization provision was a response to union concerns, says Malone. “The bill was a collaboration between the unions and the employers. The employers did not want the solvency [requirement] anymore, but the unions wanted protection as well.”
Of course, that will only work if things go well:
Lower employer contributions do present potential risks, however. If the employer goes bankrupt for some reason, there could potentially be less money in the plan than there would have been under the old rules, says Gavin Benjamin, senior consulting actuary at Willis Towers Watson.

“In other words, [if] the employer isn’t there to fund the deficit, then you’re looking at members potentially receiving reduced benefits,” says Benjamin, something he admits is a remote possibility.
"Members potentially receiving reduced benefits" is only a "remote possibility". :?

On the good side of things, though, closing the 100% commuted value regardless of funding status loophole protects those remaining in the pension plan by letting those who take a commuted value assume their fair share of any funding deficit.
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Re: New Rules for Commuted Values (Pensions, QC)

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longinvest wrote: 21 Feb 2018 21:39 I've decided to plan for pension cuts in my retirement planning. Using hypothetical numbers, if the solvency ratio of my plan is 50% and I am promised a $100/month pension, I only count a (50% X $100) = $50/month pension in my planning spreadsheet.
Can I ask what the current solvency ratio of your plan is, roughly speaking?
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Re: New Rules for Commuted Values (Pensions, QC)

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Quebec wrote: 22 Feb 2018 19:22 Can I ask what the current solvency ratio of your plan is, roughly speaking?
Roughly speaking, it's lower than 100%, but higher than 50%. :wink:
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Re: New Rules for Commuted Values (Pensions, QC)

Post by Quebec »

I think you are overly pessimistic longinvest.

Shouldn't you account for the probability of the company going out of business, or the probability of you having to ask for the commuted value (e.g. you quit your job or are fired)? If those odds are 20% combined, then

. Your expected pension = 20% * reduced pension (due to bankruptcy, etc) + 80% * normal pension

(of course in real life you either get the full pension or the reduced pension, but your current thinking assumes a 100% chance of getting the reduced pension, which will likely lead you to save too much for retirement)
-----

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Re: New Rules for Commuted Values (Pensions, QC)

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Quebec,
Quebec wrote: 23 Feb 2018 18:59 Shouldn't you account for the probability of the company going out of business, or the probability of you having to ask for the commuted value (e.g. you quit your job or are fired)? If those odds are 20% combined, then

. Your expected pension = 20% * reduced pension (due to bankruptcy, etc) + 80% * normal pension
It took me a few seconds to understand the equation, then I got it: it multiplies the probabilities by the amounts to compute an "expected value".

Quebec wrote: 23 Feb 2018 18:59 of course in real life you either get the full pension or the reduced pension
Exactly.

I don't agree with the probabilistic approach because I'm not trying to optimize the outcome over a future 1000 lives; I've only got one life.

The probabilistic approach is an awesome tool to help insurance companies determine the price of their life annuities. But, in my opinion, it's useless to an individual who has a single shot at his retirement success.
Quebec wrote: 23 Feb 2018 18:59 your current thinking assumes a 100% chance of getting the reduced pension,
I see things differently. I don't like to build plans that require things to go as expected to work. I prefer to build robust plans which anticipate that adverse events could happen, and if they happen, that I'll have to pay the full cost, not only the probabilistic ratio of the cost. As a consequence, the probabilistic approach doesn't meet my robustness requirements.

I think that discounting my promised pension by the current solvency ratio is fair. It accounts for the current status of the pension plan. This status could improve in the future, or get worse. In some way, I'm already accounting for the probabilities, as the solvency ratio is itself a probabilistic measure of the plan's funding. Of course, people prefer to use the funding ratio on a going concern basis, which assumes future plan member and employer contributions could bail out any current and future deficit, but that's a pretty optimistic* assumption.

* I'm sure a Nortel retiree would agree.

As time goes, if the solvency ratio goes up, it will be reflected into my planning spreadsheet and will let me spend more. :wink: Of course, if it goes down, it will also be reflected and cause me to increase my savings at that point. The nice thing is that I'll be adapting gradually based on the solvency situation. I like flexible methods that adapt to the current reality.
Quebec wrote: 23 Feb 2018 18:59 which will likely lead you to save too much for retirement
I haven't found, yet, a method that will allow me save exactly as much as I need, but not a penny more, yet won't leave me in trouble if adverse events happen along the way.

I think that over-saving is unfortunately a requirement for financial stability. Those who always have just enough money for everything get into trouble as soon as an adverse event happens to them.

Maybe I'm wrong. Does a worker with an employer pension plan need to save money? Won't he have enough to retire at age 65, anyway?
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Re: New Rules for Commuted Values (Pensions, QC)

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longinvest wrote: 23 Feb 2018 20:52 The probabilistic approach is an awesome tool to help insurance companies determine the price of their life annuities. But, in my opinion, it's useless to an individual who has a single shot at his retirement success.
You should switch from a frequentist to a Bayesian interpretation of statistics, then :wink:

More seriously, I understand your concern, and share it to a large degree. But I can't plan for every contingency, or life will become impossible. So I set aside negative events with very high consequences but very low probabilities. For example, if I were to plan for a general breakdown of our society, I would be purchasing that place in the country, firearms, ammunition, and a year's supply of dried or tined food. But I don't. The expected loss in such a situation is high, but that combines a very large material impact with a very small probability. Too small for rational planning. And the cost of mitigation is relatively high.

So where do you put the cutoff as to things to worry about?
I'm sure a Nortel retiree would agree.
The final payout ratio for Nortel pensioners in Ontario, after all assets have been distributed, is above 90 per cent. Not too bad. Perhaps you should cite a different example of doom and gloom. :wink:
I like flexible methods that adapt to the current reality.
Yes, That is the strength of your various tools and approaches.
Maybe I'm wrong. Does a worker with an employer pension plan need to save money? Won't he have enough to retire at age 65, anyway?
Depends on an individual's risk aversion and discount rate, among other things. The fun thing about personal finance is that one size definitely doesn't fit all.

But I'm just nitpicking. Over all, I agree with you.

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Re: New Rules for Commuted Values (Pensions, QC)

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George,
ghariton wrote: 23 Feb 2018 21:30 I can't plan for every contingency, or life will become impossible. So I set aside negative events with very high consequences but very low probabilities. For example, if I were to plan for a general breakdown of our society, I would be purchasing that place in the country, firearms, ammunition, and a year's supply of dried or tined food. But I don't. The expected loss in such a situation is high, but that combines a very large material impact with a very small probability. Too small for rational planning. And the cost of mitigation is relatively high.

So where do you put the cutoff as to things to worry about?
It's a good question.

I would say that I'm aiming to enjoy life while minimizing regrets. The enjoyment is about both the present and the future. As for regrets, they can go both ways: regret of having been hurt after overly exposing myself to harm, and regret of having missed out because of over-caution.

Let's pick the society breakdown example. If society broke down and financial assets lost all of their value, I would have lots of regrets if I had overly deprived myself of spending and lived miserably to invest the money while society was still up and running. All the deprivation would have been for nothing. I could have, at least, used part of the money to buy things that nobody will ever be able to steal from me: joyful memories with people I love (which might have required spending), etc.

To me, a robust plan isn't a plan where I always get out of every situation unscathed. It's a plan that aims for good outcomes while mitigating unfavorable ones. In a catastrophic situation, the goal is to at least be able to get out alive even if I've sustained damages.

ghariton wrote: 23 Feb 2018 21:30 The final payout ratio for Nortel pensioners in Ontario, after all assets have been distributed, is above 90 per cent. Not too bad. Perhaps you should cite a different example of doom and gloom. :wink:
It would be interesting to know what the solvency ratio of the pension plan was before Nortel's bankruptcy. Would my proposed approach (e.g. multiply the pension promise by the current solvency ratio, in the planning spreadsheet) have really lead to significant over-saving?
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Re: New Rules for Commuted Values (Pensions, QC)

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Further erosion of commuted value pay-outs is on the cards across Canada: https://www.morneaushepell.com/ca-en/in ... ected-2018

The net outcome of all these changes is to force employees of companies with DB to stay whether they want to or not. Hardly a positive for the individuals or economy in general.
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Re: New Rules for Commuted Values (Pensions, QC)

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Employers offering DB pensions have been under siege obviously with the recent years of low interest rates. Kind of makes future pension/funding obligations a wild card with unpredictable boundaries. While new restrictions on commuted values will reduce the pressure, it seems to me this is just another reason for employers to freeze DB plans on a forward basis, and get rid of them when they can.

A question for Bruce or another expert. Assuming many private sector employers freeze DB plans and not offer them to new employees, eventually the DB plan winds down as annuitants die off. There must come a time when the remaining obligations of many such shrinking plans could/should be rolled into another aggregated DB plan managed by a third party. Does such an aggregator exist at this time?
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Re: New Rules for Commuted Values (Pensions, QC)

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Mordko wrote: 24 Feb 2018 11:39 The net outcome of all these changes is to force employees of companies with DB to stay whether they want to or not. Hardly a positive for the individuals or economy in general.
On the contrary, I think that it is positive for the majority of individuals who choose to stay in their DB plan. It stops the draining caused by those who escape with more than their fair share of the pension's current capital.

For those who wish to leave the plan, getting a commuted value reduced according to the solvency ratio allows them to get their fair share of the pension's capital. They shouldn't complain about the fact that private annuities, sold by insurance companies, are more expensive. If they want a DB pension, they can stay in their employer's plan which is cheaper than private annuities. If they want to manage their own portfolio, instead, they can commute and get their fair share.

The only individuals who won't be happy about it are those who wanted to take advantage of the artificially inflated commuted value assessed using low long-term bond yields in a pension managed using a diversified portfolio with a higher expected return*.

* Yes, you've just seen me write "expected return", because I think that pension funds should be managed using a probabilistic approach.
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Re: New Rules for Commuted Values (Pensions, QC)

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AltaRed wrote: 24 Feb 2018 11:45it seems to me this is just another reason for employers to freeze DB plans on a forward basis, and get rid of them when they can.
I disagree. I think that the new QC rules are a step forward to allow DB plans to survive; that closing the unfair drain caused of over-sized commuted values is a good thing. The added flexibility in adapting funding rules to the pension's internal composition, instead of using a formula arbitrarily based on the yield of long-term bonds, is also an improvement to stabilize employer and employee contributions.
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Re: New Rules for Commuted Values (Pensions, QC)

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You misread, or missed, the first part of that sentence
While new restrictions on commuted values will reduce the pressure,
where I agree the pressure on DB pensions are reduced.... The logic of the second part is that if rules have to intervene for DB plan survivability, then WTF are we (corporate executives) still doing supporting DB plans? IOW, as an executive, I would see the intervention of regulatory support as just another example of the 'badness' of DB plans and to 'get out from under them' while the getting is good.
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Re: New Rules for Commuted Values (Pensions, QC)

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longinvest wrote: 23 Feb 2018 20:52 Does a worker with an employer pension plan need to save money? Won't he have enough to retire at age 65, anyway?
Who plans to work til age 65? Most people don't like their jobs enough for that. And even if they do, they should save for retirement anyway, because:
- their pension may not be indexed
- they might stop liking their job so much
- their health might deteriorate
- etc.
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Re: New Rules for Commuted Values (Pensions, QC)

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longinvest wrote: 23 Feb 2018 20:52
I haven't found, yet, a method that will allow me save exactly as much as I need, but not a penny more, yet won't leave me in trouble if adverse events happen along the way.

I think that over-saving is unfortunately a requirement for financial stability.
I agree with that. I'm saving aggressively, probably too much. Enough for a comfortable early retirement, just in case I don't want to work until age 63 or 65. If somehow the pension promises get cut, or there is a terrible bear market at the wrong time slashing my personal portfolio, then I can likely continue working a few more years. If not, I should have enough for a decent (but less comfortable) early retirement.

So I have two layers of safety: (1) plan to retire early; (2) plan to spend quite a bit during retirement. You are adding a third layer of safety. I'm just questioning if you need that 3rd layer.
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Re: New Rules for Commuted Values (Pensions, QC)

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AltaRed wrote: 24 Feb 2018 14:44 You misread, or missed, the first part of that sentence
While new restrictions on commuted values will reduce the pressure,
where I agree the pressure on DB pensions are reduced.... The logic of the second part is that if rules have to intervene for DB plan survivability, then WTF are we (corporate executives) still doing supporting DB plans? IOW, as an executive, I would see the intervention of regulatory support as just another example of the 'badness' of DB plans and to 'get out from under them' while the getting is good.
OK. I see. But, if the decision was left to employers alone, everyone should be forced by law to work for them with just enough salary to eat and stay in good shape to work until they could be replaced by a younger worker or a machine, and, most importantly, no pension. Wouldn't that be great for stocks?

At least, in the USSR, I think that they had pensions. I'm not sure, but it would make sense...
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Re: New Rules for Commuted Values (Pensions, QC)

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longinvest wrote: 24 Feb 2018 14:20
Mordko wrote: 24 Feb 2018 11:39 The net outcome of all these changes is to force employees of companies with DB to stay whether they want to or not. Hardly a positive for the individuals or economy in general.
On the contrary, I think that it is positive for the majority of individuals who choose to stay in their DB plan. It stops the draining caused by those who escape with more than their fair share of the pension's current capital.

For those who wish to leave the plan, getting a commuted value reduced according to the solvency ratio allows them to get their fair share of the pension's capital. They shouldn't complain about the fact that private annuities, sold by insurance companies, are more expensive. If they want a DB pension, they can stay in their employer's plan which is cheaper than private annuities. If they want to manage their own portfolio, instead, they can commute and get their fair share.

The only individuals who won't be happy about it are those who wanted to take advantage of the artificially inflated commuted value assessed using low long-term bond yields in a pension managed using a diversified portfolio with a higher expected return*.

* Yes, you've just seen me write "expected return", because I think that pension funds should be managed using a probabilistic approach.
1. Full disclosure: I took commuted value ~1 year ago. Pension fund was 57% funded; the unfunded part is being paid over a period of 5 years.

2. Having been through the process, I am opposed to all DB pensions due to lack of transparency. The government ones represent an unfair subsidy from private sector employees to the government ones. The private ones lead workers to believe that there is a guarantee and a contract, which apparently isn't worth all that much.

3. When commuted value is being withdrawn, this isn't "traitors sneaking away faithful employees' money". This is the company fulfilling contractual obligations, which it owes to the individuals who are leaving and the ones who are staying. Arbitrarily reducing the payout does not seem right, rewarding companies who underfund pensions does not seem fair.

4. Not only do the governments change payout amounts out of the blue; they also impose >50% tax (Ontario) on the non-LIRA portion of the commuted value of the pension savings.

In summary, I support winding down of all DB pensions. Sure, there is risk with DC but at least its transparent and you know exactly how much the company is chipping in; nor can the government grab a huge chunk of it right away.
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Re: New Rules for Commuted Values (Pensions, QC)

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longinvest wrote: 24 Feb 2018 16:50
AltaRed wrote: 24 Feb 2018 14:44 You misread, or missed, the first part of that sentence
While new restrictions on commuted values will reduce the pressure,
where I agree the pressure on DB pensions are reduced.... The logic of the second part is that if rules have to intervene for DB plan survivability, then WTF are we (corporate executives) still doing supporting DB plans? IOW, as an executive, I would see the intervention of regulatory support as just another example of the 'badness' of DB plans and to 'get out from under them' while the getting is good.
OK. I see. But, if the decision was left to employers alone, everyone should be forced by law to work for them with just enough salary to eat and stay in good shape to work until they could be replaced by a younger worker or a machine, and, most importantly, no pension. Wouldn't that be great for stocks?

At least, in the USSR, I think that they had pensions. I'm not sure, but it would make sense...
They did have pensions, also 100% at the mercy of the government, which also arbitrarily reduced most of them.

Shares of companies that pay just enough to eat would dive right away. See, all qualified workers would leave. How do you think it would reflect on earnings? Now... If the workers were to lose a large chunk of their pension if they leave, because of arbitrary decisions like what we are discussing - that would change the equation and incentivize paying the minimum one can get away with. Essentially, workers would be slaves and why would you pay a slave more than he needs to stay alive?
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Re: New Rules for Commuted Values (Pensions, QC)

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Mordko wrote: 24 Feb 2018 16:50 2. Having been through the process, I am opposed to all DB pensions due to lack of transparency. The government ones represent an unfair subsidy from private sector employees to the government ones. The private ones lead workers to believe that there is a guarantee and a contract, which apparently isn't worth all that much.
Every year, I get a fully detailed pension plan annual report. It's at least as transparent as any stock annual report I've seen.

As a bonus, I also get a personal report, telling me about my accrued pension rights, a commuted value estimate, and a pension projection if I work until age 65.

I don't see a transparency problem in my pension plan.
Mordko wrote: 24 Feb 2018 16:50 In summary, I support winding down of all DB pensions. Sure, there is risk with DC but at least its transparent and you know exactly how much the company is chipping in; nor can the government grab a huge chunk of it right away.
It's up to every person to choose to work at a place with a DB pension, a DC pension, or no pension (giving maximal RRSP contribution room).

If employees and unions didn't want DB pensions, employers and governments would stop offering them.

DB plans are financially much cheaper, for their members, than private annuities bought individually from insurance companies. They have the huge advantage, over private annuities, of avoiding adverse selection. All workers, regardless of their habits and family longevity history, are forced to participate. This significantly lowers costs.

Of course, financial advisers and heirs dislike DB plans. It's also probable stock holders of insurance companies would also prefer for DB pensions to disappear to increase the size of the annuity market.

The QC government has taken the initiative of relaxing funding rules for private DB plans, rules which were already relaxed for public pensions, and fixing the calculation of commuted values to make them fairer.

The best course of action, for those who dislike DB pensions, is to never get into one and never buy the stock of a company that offers one. As for avoiding to pay the employer part of public DB pensions through taxes, I don't see much alternatives to voting for a party who promises to abolish them or move to a country where there are no public DB pensions.
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Re: New Rules for Commuted Values (Pensions, QC)

Post by AltaRed »

Fair enough, but DB plans, at least in the private sector, are on their way out. Public plans will have to be reined in substantially someday too, to avoid 'figurative' bankruptcy of provincial and municipal governments....as has happened in the USA.
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Re: New Rules for Commuted Values (Pensions, QC)

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Quebec,
Quebec wrote: 24 Feb 2018 16:07 So I have two layers of safety: (1) plan to retire early; (2) plan to spend quite a bit during retirement. You are adding a third layer of safety. I'm just questioning if you need that 3rd layer.
I understand, now. It's a good question. I'll have to think about it.
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longinvest
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Re: New Rules for Commuted Values (Pensions, QC)

Post by longinvest »

AltaRed wrote: 24 Feb 2018 17:55 Fair enough, but DB plans, at least in the private sector, are on their way out. Public plans will have to be reined in substantially someday too, to avoid 'figurative' bankruptcy of provincial and municipal governments....as has happened in the USA.
The QC government has also changed the laws and rules governing public pensions. I think that now pension funding (including deficits) are at the charge of both the employer and employees 50/50.
Variable Percentage Withdrawal (finiki.org/wiki/VPW) | One-Fund Portfolio (VBAL in all accounts)
fireseeker
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Re: New Rules for Commuted Values (Pensions, QC)

Post by fireseeker »

This pessimism about the future and the value of DB plans ... is it misplaced?
Fifty years ago, DB plans were common -- a good way of retaining employees and sharing the risk of post-employment income among a large group.
Today, we're at the end of a multi-decade collapse in interest rates. I'm no actuary, but isn't that the culprit making DB plans look so undesirable right now?
Rates appear to have finally bottomed. If so (and, yes, there are no guarantees), we're at the time of maximum pessimism -- the point at which John Templeton said we should be buying.
IOW, DB plans may not be so onerous for sponsors going forward. In fact, insurance companies are starting to take pension obligations off the hands of corporations. Why? Because the business looks profitable.
Prudential aims to earn a 12% to 13% long-term return on the capital tied up in pension-risk deals, it has told investors.

https://www.wsj.com/articles/that-pensi ... 1489342032

Maybe it's time for corporate executives and government regulators to stop worrying about DB plans. Maybe they don't need to look for the nearest exit. There is so much pessimism, maybe it's time to be contrarian. Maybe it's time to re-embrace DB plans.
If the plans start to show surpluses, corporate sponsors could do very well indeed.
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