DB Pension Plans, Old debate in Wealthy Boomer with ?

Preparing for life after work. RRSPs, RRIFs, TFSAs, annuities and meeting future financial and psychological needs.
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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by Flaccidsteele »

parvus wrote:Only from the American experience. What passes for capitalism in other places doesn't obey the same rules, nor cede to the same frauds, nor rely on the same legal & ethical culture, nor enrol individuals with the same motivations...
Of course. You are correct. I should have clarified that I was talking about North American investors.
Flaccidsteele wrote: North American investors, without fail, always think that crashes and threats to the economy are "different this time". Always. That there's supposedly new and devastating ways that society will collapse and leave the financial system in ruin. Guess what. It's never "different this time". Capitalism always recovers. Always. You would think that we would have figured that out by now. ;)
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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by ghariton »

Statistics Canada:
Membership in registered pension plans (RPPs) in Canada reached 6,185,000 in 2012, up 70,300 or 1.2% from the same date a year earlier.

Membership in public sector pension plans rose 0.6% to 3,179,300, while the number of members in private sector plans increased 1.7% to 3,005,700. The public sector accounted for 51.4% of total membership in RPPs.

<snip>

The pension coverage rate, the proportion of all employees covered by an RPP, was 38.4% in 2012, virtually unchanged from the previous year.

More than 4,422,800 employees were in defined benefit pension plans, down 1.2% from 2011. They accounted for 71.5% of employees with an RPP, compared with more than 84% a decade earlier.

Membership in defined contribution plans, the other most frequent type, increased 2.7% or 27,000 to 1,030,300. These plans accounted for 16.7% of all RPP membership. Nearly 86% of members in defined contribution plans work in the private sector.

Other plans, such as hybrids or composites, continued their upward trend. In 2012, over 731,800 employees belonged to these plans, up 15.5% from 2011.
So, yes, the shift away from DB plans is continuing, but it's happening slowly. Meanwhile, DC and hybrid plans are growing quickly enough to make up for this.

Are DC plans really that inferior to DC plans? At various times I've been a member of each. What mattered to me was the amount of the employer's contribution, not the way the risk was allocated.

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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by SQRT »

ghariton wrote:

Are DC plans really that inferior to DC plans? At various times I've been a member of each. What mattered to me was the amount of the employer's contribution, not the way the risk was allocated.

George
Yes, but for a comparable employer contribution, I would think less risk allocated to a retiree would be better. Taking too much risk in your pension arrangements would not seem to be desireable to me.
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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by kcowan »

ghariton wrote:Are DC plans really that inferior to DB plans?
I had a colleague who had chronic diabetes. He opted to convert to the DC plan. Five years later while still working, he died. His widow got the benefit of the DC portfolio rather than a rather small death benefit offered by the DB plan. He definitely made the right decision.
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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by Benchwarmer »

SQRT wrote:Yes, but for a comparable employer contribution, I would think less risk allocated to a retiree would be better. Taking too much risk in your pension arrangements would not seem to be desireable to me.
IMO the major advantage of a DB plan is the forced savings. If everyone saves 7% of their annual gross pay for their working years (as most civil servants are forced to do), into a couch potato 50-50 portfolio, they would probably all be millionaires. Not a lot by today's standards, but nothing to sneeze at either.

The other advantage, not outliving your money, probably is not a major cost to the DB plan itself. For one that lives to be 100, there are probably hundreds that die within a few years of retiring. But in return for that protection, a DB plan member gives up ownership. This implies a loss of capital for those that die early (as per the diabetes example above), and more importantly, it means it is subject to political manipulation, which is also a risk.

IMO a DB plan is fine for covering the necessities in retirement. After that point, I would prefer switching to a DC plan.
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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by SQRT »

Agree with recent comments. I am in the unusual position of collecting a very generous DB Pension. Not indexed. This pension represents about half my income. Rest is divs received from taxable portfolio. For me this is just about optimal as I have (mostly by chance) achieved a good asset mix without having to actually buy any FI. Obviously not typical but I am thankful for the pension.
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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by ghariton »

Benchwarmer wrote:IMO the major advantage of a DB plan is the forced savings.
There is no reason why a DC or hybrid plan could not also be a form of forced savings. In fact ISTR that in some countries iike Chile, contributions to DC plans were mandatory.

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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by Benchwarmer »

ghariton wrote:
Benchwarmer wrote:IMO the major advantage of a DB plan is the forced savings.
There is no reason why a DC or hybrid plan could not also be a form of forced savings. In fact ISTR that in some countries iike Chile, contributions to DC plans were mandatory.
I didn't realize that - in Canada can you make contribution to a DC plan (the employee's portion) a condition of employment? Isn't that similar to saying you must have an RRSP in order to work here - in both cases, they belong entirely to the employee.
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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by Shine »

It might be worth remembering that during the 1970's and 1980's one had no choice other than to participate in a DB plan whether one worked in large private sector companies or in municipal, provincial, or federal public service. In those days one could neither opt out of the pension plan nor union dues. Everything was prescribed and part of one's employment contract.
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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by parvus »

Benchwarmer wrote:
ghariton wrote:
Benchwarmer wrote:IMO the major advantage of a DB plan is the forced savings.
There is no reason why a DC or hybrid plan could not also be a form of forced savings. In fact ISTR that in some countries iike Chile, contributions to DC plans were mandatory.
I didn't realize that - in Canada can you make contribution to a DC plan (the employee's portion) a condition of employment? Isn't that similar to saying you must have an RRSP in order to work here - in both cases, they belong entirely to the employee.
Yes, in Australia, workplace DC schemes are mandatory.
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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by izzy »

parvus wrote: Yes, in Australia, workplace DC schemes are mandatory.
But not fully tax deferred. If I remember correctly it's a hybrid,their system was more like leaving retained earnings (which have been already taxed at a lower rate) in a corporation but with restrictions similar in some ways to our RRSP/RRIF system and some added wrinkles concerning maximum accumulation etc ! And of course ,since it's government regulated, there are constant changes so it may well have changed in the last few years since I was interested enough to look into it.
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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by CROCKD »

Known by all Australians as "Super."

Superannuation in Australia
Eligibility for access to preserved benefits in superannuation depends on a worker's preservation age.
(Since 1997 55+ and will be 60 by 2025)
Income earned in the fund is also taxed at 15%, depending on circumstances.

Income retrieved from the fund after preservation age is generally tax free
Edit: From an article in the Melbourne Age Aug.26
Only a fraction of Australia's ­half-a-million self-managed super­annuation funds pay any income tax, experts say, because of generous super concessions and franking credits that are undermining the federal budget.
Australia and New Zealand are now the only two developed countries that have full imputation of dividends.
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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by brucecohen »

From Benefits and Pension Monitor:
Converting large public sector defined benefit pension plans to defined contribution arrangements is not a financial panacea. Instead, it would create higher costs, inefficiencies, and increased risks for employers, taxpayers, and members, says a research paper by Robert L. Brown, retired professor from the University of Waterloo and president of the International Actuarial Association, and Craig McInnes, a journalist and writer. ‘Shifting Public Sector DB Plans to DC – The Experience so far and Implications for Canada’ studied the experience of other jurisdictions including Australia, Michigan, Nebraska, New York City, Saskatchewan, and Texas and applying those lessons here. After examining the literature on the experience in other jurisdictions and modelling what the ramifications would be in converting a large Canadian DB plan to DC, the paper concludes that none of the stakeholders, including taxpayers, would ultimately be better off. “The perceived advantages to closing DB pension plans in the private sector do not translate directly into the public sector,” says Brown. “Our modelling has shown us that for an efficient $10 billion DB plan, converting to individual-account DC arrangements to provide the same value of pension benefit would increase the ongoing cost of the plan by about 77 per cent and increase the required contribution rates accordingly,” say Brown and McInnes. The authors add that even with the use of pooled DC pension arrangements, ongoing costs would still increase by 26 per cent.
The paper is available here.
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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by kcowan »

brucecohen wrote:“Our modelling has shown us that for an efficient $10 billion DB plan, converting to individual-account DC arrangements to provide the same value of pension benefit would increase the ongoing cost of the plan by about 77 per cent and increase the required contribution rates accordingly,” say Brown and McInnes.
I think most conversions are about shifting risk from the plan sponsor for the a given contribution, not providing the same benefit. Everyone acknowledges that for most workers, it is a takeaway. Only the exceptional ondividual investor would end up ahead.
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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by adrian2 »

kcowan wrote:
brucecohen wrote:“Our modelling has shown us that for an efficient $10 billion DB plan, converting to individual-account DC arrangements to provide the same value of pension benefit would increase the ongoing cost of the plan by about 77 per cent and increase the required contribution rates accordingly,” say Brown and McInnes.
I think most conversions are about shifting risk from the plan sponsor for the a given contribution, not providing the same benefit.
I agree with Keith. That's why one type is called defined benefit and the other defined contribution. If one tries to build a defined contribution plan which must provide a defined benefit eventually, we end up with heads I win (the public employee), tails you lose (the taxpayer).
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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by ghariton »

brucecohen wrote:From Benefits and Pension Monitor:
An advocacy piece, and as such, biased in its selection of facts and arguments. (Funded by a group representing present and future public pensioners.)

While the paper visits all sorts of arguments in favour of maintaining public DB plans, and not converting them to DC, at the heart of its reasoning are three claims:

(1) Governments can obtain better financial returns via a DB plan than individual investors via DC plans

(2) Government pensions have a social welfare aspect to them, preventing retired public services from resorting to GIS, etc.

(3) Governments can better bear risk than can individual investors

Governments are better investors than individuals

I'm ambivalent about this claim. It's true that many investors are terrible at finance. But I reject the assumption that the only way an individual investor can get a decent return is by hiring a financial adviser at 3% per annum fees. I also reject the conclusion that individual RRSPs are poor vehicles for building a retirement. (For example, I've done better in my LIRA than Bell Canada has done in its pension plan.)

I note that public sector pension plans are subject to political interference. Although federal pensions have done well in this regard in recent decades, if we go back to the 1970s, financing provincial government spending was a major objective of federal plans. As well, under Paul Martin, the government appropriated the surplus of the federal public servants' pension plan, to the tune of $26 billion if I recall correctly. Such expropriation is less likely under a DC plan, not least because it is harder to define a surplus under such a plan.

Nevertheless, suppose that the authors are right, and that the government can do a better investing job. In that case, why not create a government-administered fund, open to all Canadians on a voluntary basis, that would invest their savings for them? This would spread the benefits of centralized investing to all Canadians, not just those who are public sector employees. People would naturally flock to this plan. (Isn't Saskatchewan trying that model? How is that working?)

A subtheme is that a DB is desirable because it is a form of forced savings. But as discussed upthread, there is no reason why a DC shouldn't be a form of forced savings as well.

Government DB plans are a partial substitute for welfare

The idea here is that, if governments do not provide proper (read DB) pensions for employees, these will do such a poor job of saving and investing that some might end up collecting GIS or other forms of welfare.

I find the proposed link between pensions and welfare surprising. Although the two can have some connection, it seems at best tenuous. In any case, I have always believed that public sector pensions are best seen as an element in a compensation package, not a social safety net.

In any case, if one of the objectives of public pensions is to keep people off welfare, why should that be limited to public servants? Why should that not be extended to the entire Canadian population? If the problem is than individuals are lousy investors, set up a voluntary government investment body, to invest for them. If the problem is that they are spendthrifts, make it compulsory to save a certain proportion of one's income. If the problem is that people become disabled and cannot earn enough to save, improve disability benefits. And so on.

Using public sector pensions as a welfare program that helps those who are already advantaged just seems wrong.

Governments can better bear risks than individual investors

This is getting closer to an intellectually respectable argument. Even here, though, we need to consider some issues that the authors skip over.

First we need to distinguish the different types of risk. For example, market (or investment) risk comes in two flavours, systematic and idiosyncratic. I believe (along with the textbooks) that a well-diversified portfolio can pool away idiosyncratic risk. You don't need to be a government to be big enough to do so. All you have to do is buy units of an ETF such as VT. (In passing, I note that CALPERS has been quite disappointed by the performance of alternative investments; maybe missing out on these doesn't disadvantage individual investors.)

Diversification won't get rid of systematic risk. That's true for the individual investor. But it's also true for a government. Switching from a BC to a DC plan doesn't increase market risk, it merely shifts it from the employer to the employee.

Unfortunately, there is currently a huge problem with most public sector pension plans. As pointed out by Malcolm Hamilton in two publications for the C D Howe Institute earlier this year, governments bear the market risk, but the contributions charged to pensioners don't recognize this. Rather, they are based on an assumption that there is no market risk. (One way this manifests itself is to simultaneously use a government bond rate to discount future benefits, on the grounds that they are "safe", and a market rate of return for investments. Who is out of pocket if the market investments do badly?)

So if DB plans are to be retained, contributions have to be adjusted upward. The alternative is to keep the present contribution rates, but to shift market risk to pensioners, i.e. to convert to a DC pension.

There are other risks of course, the primary one being longevity risk. It is true that this can be a much bigger burden for individual investors than for governments. I agree with the authors that annuities are an imperfect substitute, given the present state of the annuity market in Canada. But it seems to me that this is a problem for all Canadians. The DB plan solution helps only members of the DB plans. Wouldn't it be better to work on solutions that would help all Canadians, e.g. government offering annuities in competition with insurance companies, or perhaps organizing tontines (which apparently are coming back).

So no, I didn't like the paper.

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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by ghariton »

The Dutch pension system:
The Dutch system rests on the idea that each generation should pay its own costs — and that the costs must be measured accurately if that is to happen. After the financial collapse of 2008, workers and retirees in the Netherlands took the bitter medicine needed to rebuild their collective nest eggs quickly, with higher contributions from workers and benefit cuts for pensioners.

The Dutch approach bears little resemblance to the American practice of shielding the current generation of workers, retirees and taxpayers while pushing costs and risks into the future, where they can metastasize unseen.

<snip>

The Dutch central bank also imposed a rigorous method for measuring the current value of all pensions due in the future. Pensions are not supposed to be risky, so the Dutch measure them the same way the market prices very safe bonds, like Treasuries — that is, by discounting the future payments to today’s dollars with a very low interest rate. This method shows that a stable lifelong benefit is very valuable, and therefore very expensive to fund.

Notably, the Dutch central bank prohibited the measurement method that virtually all American states and cities use, which is based on the hope that strong market gains on pension investments will make the benefits cheaper. A significant downside to this method is that it lets pension systems take advantage of market gains today, but pushes the risk of losses into the future, for others to cope with. “We had lengthy discussions about this in the Netherlands,” said Theo Kocken, an economist who teaches at the Free University in Amsterdam and is the founder of Cardano, a risk analysis firm. “But all economists now agree. The expected-return approach is a huge economic offense, hurting younger generations.”

He explained that in the Netherlands, regulators believe that basing the cost of benefits today on possible investment gains tomorrow is the same as robbing tomorrow’s workers to pay for today’s excesses.

<snip>

But most of the time, when someone in the United States calls for Dutch-style measurements, pension officials suspect a ploy to show public pensions in the worst possible light, to make them easier to abolish.

“They want to create a false report, to create a crisis,” said Barry Kasinitz, director of government affairs for the International Association of Fire Fighters, after members of Congress introduced a bill to require the Dutch method.
Interesting that the New York Times, generally a leftie newspaper, in illustrating opposition to pension reform, quotes a union official.

I suspect that, more generally, when it comes to a range of issues, unions line up with older workers, against the interests of the young.

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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by newguy »

ghariton wrote:The Dutch pension system:
The Dutch system rests on the idea that each generation should pay its own costs — and that the costs must be measured accurately if that is to happen. After the financial collapse of 2008, workers and retirees in the Netherlands took the bitter medicine needed to rebuild their collective nest eggs quickly, with higher contributions from workers and benefit cuts for pensioners.
They're talking about work pensions which are the same as DC plans I guess. I thought they were govt plans so I looked up how it was implemented.
In the pay-as-you-go system in the first pillar, the AOW is financed by contributions levied on earnings at a rate that is statutorily limited to a maximum of 18.25 percent. Once this contribution is no longer adequate to cover costs as a result of the ageing population, the deficit will be met from the public purse. All taxpayers contribute to this system, including retirees who do not pay any AOW contribution.
So the taxpayer is on the hook there as well, and for a much bigger chunk of the pie compared to our C/QPP at ~10%.

http://euracs.eu/summaries/summary-the-netherlands/

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Re: DB Pension Plans, Old debate in Wealthy Boomer with ?

Post by SQRT »

Ghariton: your post of Oct 8 was excellent. Well thought through and objective. You must spend a lot of time in these intellectual exercises, and we are the beneficiaries. Thank you.
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