It may not be the CPP enhancement Ontario has been hoping for… but it’s a start. The federal government has announced new target-benefit pension plans, considered a hybrid of existing defined benefit and defined contribution pension plans.
With a retirement crisis looming, will these new plans solve Canada’s retirement woes, or is it just another pension scheme to add to the already overcrowded alphabet soup of retirement plans?
Defined Benefit vs. Defined Contribution Models
Just how many Canadians are fortunate enough to have a pension plan at work? According to Statistics Canada, six million Canadians are covered by registered pension plans. Of those covered, 73.2 per cent are in a defined benefit plan, 16.4 per cent are in a defined contribution plan, and 10.4 per cent are in other types of plans. While the majority of Canadians with pensions are covered by defined benefit pension plans, it’s a trend that’s been changing for decades.
With defined benefit plans, it’s the employer who shoulders the risk. If investments perform poorly and Canadians continue to live longer than expected, it can leave the pension in deficit. Just ask private sector employers like Air Canada who have been struggling with pension deficits for years.
Employers looking to de-risk have been switching to defined contribution plans in droves. With defined contribution plans employees bear the investment risk. Unlike defined benefit, employees won’t know in advance what their pension will be in retirement; it depends on how the investments perform.
The Risk Factor
A major flaw of both models is that they leave employers and employees susceptible to economic risk. Defined benefit plans were hit especially hard by the prime mortgage fiasco in 2008, which left many in the red for years. Although pension funding is improving – about 36 per cent are fully funded, compared to just three per cent a year ago – another downturn in the markets could quickly change that.
How the Shared Risk Model Works
Target-benefit pensions are seen as the middle ground between defined benefit and defined contribution. They will allow employees to receive a steady stream of income in their golden years, sharing investment risk with employers.
Here’s how target benefit plans would work: benefits and contributions adjust over time based on the financial performance of the plan when on agreed upon targets. In times of surplus, workers could see their benefits enhanced, while in times of financial crisis, they could see their benefits reduced.
The shared risk model is especially attractive to employers looking to shift away from defined benefit plans. Unlike defined contribution plans, retirees would benefit from the pooling of longevity risk shared between employers and employees.
Coming Up Short
Target-benefit pensions are seen as coming up short by provinces like Ontario, Manitoba and Prince Edward Island, which favour CPP expansion. The federal government has so far refused to budge on its stance, citing that enhancing CPP is a payroll tax and businesses simply cannot afford it. Ontario differs, viewing it as way to help solve the looming retirement crisis. Although the details aren’t known yet, Ontario said it’s prepared to go on its own and create its own pension plan.
The Impact on Existing Pensions
The major criticism of target-benefit pensions is that they will transform existing pensions instead of creating new ones. They are seen as a solution for the federal government to solve underfunded pension public sector plans by shifting risk from employer to employee. With taxpayer-funded crown corporations like Canada Post with massive pension deficits in the billions, changes need to be made to ensure these pension plans remain sustainable.
Target-benefit pensions will only be available to the minority. The so-called third option will only be available for crown corporations and federally-regulated workers in the transportation, banking and telecommunications sectors. The majority private sector pension plans are provincially-regulated. It will be up to each province to enact its own legislation for target-benefit pension to be available for workers. The federal government already tried a similar plan with Pooled Registered Pension Plan (PRPP) without much success, so I wouldn’t hold my breath if you’re covered by a provincially pension plan.