2023-06-04 06:02:23
Defined benefit pension plans, which fix the pension until death, have always been the holy grail for employees.
The situation
A Holy Grail all the more precious as it tends to disappear. This is what happened with Geneviève*’s employer.
“Last year, they changed the pension plan from defined benefits to defined contributions,” she says.
Aged 33, she has been with this company since 2020.
“I have been participating in the defined benefit plan ever since. My employer offers me the option of continuing with this plan or joining the new defined contribution plan. »
She wonders. Should she set aside the Holy Grail and drink from the defined contribution cup?
“The goal isn’t to save less, it’s just to save differently, to get more return for my dollars,” she explains.
“I wanted to see if it was worth it for me, because I don’t know if I’m going to make my career there. »
The defined benefit plan “has less value if [elle] don’t stay all [sa] career in the company,” she says.
But is this a fair perception?
She currently estimates her savings capacity at $8,700 per year. She has two children with her husband, who is regarding the same age as her. They are equal owners of a house with net assets of around $700,000.
The benefits option
His defined benefit plan will provide him with a life annuity equivalent to 1.7% of the average of the five consecutive years with the best earnings, multiplied by the number of years of participation.
The pension is not indexed during retirement.
Geneviève must make a compulsory contribution of 5% of her salary. The normal retirement age is 65. She can take early retirement from the age of 55, with a penalty of 5% per year.
The contribution option
If she opts for the defined contribution plan, Geneviève plans to pay the maximum contribution of 6% of her salary, or $5,460 per year. Her employer’s contribution is 6.4% of her salary, plus a supplement equivalent to 25% of Geneviève’s contribution.
And here is the dilemma: “Which diet should I opt for?” »
Numbers
Genevieve, 33 years old
Salary: $91,000
Random annual bonus of approximately $25,000, invested in TFSA or RRSP
Defined benefit pension plan (for now)
Locked-in RRSP: $22,499
FAMILY: 51 945 $
RETURN : 31 135 $
Property
Net worth of around $700,000
Held equally with spouse
The answer
“At first, without having put anything in the machine, I expected to see a glaring difference between the two plans,” says financial planner Émile Khayat, senior regional manager at TD Wealth Management.
He believed from the outset that the defined benefit plan would justify its reputation as a golden pension plan.
However, “the more I advanced, the more I saw that it was relatively similar in terms of results,” he says.
He developed six retirement scenarios to reach this conclusion.
Their common point is to maintain until age 95 a train of current expenditure roughly equivalent to that of today, that is to say some $60,000 in constant dollars of 2023.
PHOTO ALAIN ROBERGE, LA PRESSE ARCHIVES
Émile Khayat, Senior Regional Manager at TD Wealth Management
For the first 15 years of retirement, our planner added a margin of $9,000, to take Geneviève’s plans into account. He assumes that her salary will increase at 2% per year and that she will maintain her current savings discipline until retirement.
Scenario 1
First scenario: Geneviève keeps her defined benefit plan until she retires at age 57. According to current projection standards for a balanced growth profile, he applies a rate of return of 4.38% (following management fees) on his retirement savings plan (RRSP) and his voluntary savings account. tax (TFSA). Result: “objective not achieved”, notes Émile Khayat. The projection reveals an income shortfall of 37% at age 80.
Scenario 2
Second scenario: Geneviève immediately switches to a defined contribution plan (RCD). With this same return of 4.38% applied to the RCD, the RRSP and the TFSA, Geneviève falls into an income deficit at the age of 71!
Scenario 3
Third scenario: she keeps her defined benefit plan (DBP), but the return on RRSPs and TFSAs, with a more daring investor profile, is increased to 5.38%. This time, the objective has been achieved, “with the advantage of reducing the risk, because a portion of the retirement income, that of the RPD, is guaranteed for life and is not dependent on the markets and returns”, comments our planner.
Scenario 4
In a fourth projection, this ambitious return of 5.38% is applied to the scenario of the defined contribution plan as well as to RRSPs and TFSAs. Good news, the plan holds up to 95 years.
“On the other hand, the risk is higher, because it will be up to Geneviève to generate this same high return each year. »
Scenarios 5 and 6
Can we reduce this risk? By reducing the yield to 4.38%, this is achieved if retirement is deferred to age 60 with defined benefits, and to age 61 with defined contributions.
If Geneviève wants to retire comfortably from the age of 57, whether with an RPD or an RCD, “she will have to assume a higher risk than the average on her investments in order to generate more returns”, underlines Émile Khayat.
Of course, many things can happen between now and the results of the projections will vary depending on whether other parameters are used – a slightly more modest spending package or promotions that would lead to larger salary increases, for example. However, the comparison between the two plans would give similar results: “In the end, the difference is rather negligible, notes our adviser. Either choice can be good. »
Job change
Geneviève is not wrong to think that her defined benefit plan is no longer as advantageous if she does not stay with her current employer until her retirement. Even if “DBPs remain the best plans for employees who plan to have a stable career in a specific field, explains Émile Khayat, Geneviève is right in considering that DBPs give more flexibility in terms of the choice of investments and potential returns”.
On the other hand, “they transfer the risk to the employee, who must ensure that the expected returns are generated. For DPPs, the return risk rests with the employer and fund managers should exercise caution in their investment choices”.
It is this caution, coupled with a more modest return, that explains why when you leave an employer by cashing in the commuted value of your pension plan, “the check is often going to be higher with a defined contribution plan than ‘with a defined benefit plan,’ he argues.
Which choice ?
Does this mean that Geneviève would be well advised to opt for the defined contribution plan offered by her employer?
She seems confident in her abilities, she has good financial knowledge and she maintains a strong savings discipline, discerns our planner.
This suggests that in the fourth scenario, which combines a defined contribution plan and a more aggressive investment strategy, she would be able to outperform a DBP and achieve her retirement goals. .
“Depending on her career aspirations, if she is thinking of changing employers one day, she might favor the flexibility of the defined contribution plan and the greater potential cash value when changing employers,” he explains.
Geneviève will then have to be as determined as her contributions, in her financial as well as budgetary discipline.
* Although the case highlighted in this section is real, the first names used are fictitious.
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