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Pension plan and problem-free?

Defined-benefit pensions are among the best retirement savings deals going

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If Wynn Sweatman -- a Winnipeg-based certified financial planner with Sweatman Insurance and Retirement Services -- could say one thing to someone with a defined benefit pension, it would be: "Thank heavens for your guaranteed income."

Praise the pension plan indeed.

The defined-benefit pension may not be the Cadillac of retirement-savings vehicles (unless you're a member of Parliament). They're more like a Toyota: not luxurious, but dependable and built to last.

At one time DBs, as they're often called, were standard with good employers. You worked for a company for decades and received a guaranteed retirement-income stream for life based on years of service and average salary.

Today, DB plans certainly aren't uncommon, but in the private sector, they're like the bison -- nearly extinct.

Only a few companies offer these plans now, like Canadian Pacific Railway and CN. Many firms have switched to defined-contribution plans, says Dave Ablett, director of tax and retirement planning at Investors Group.

"From an employer standpoint, the one thing about a defined-contribution plan is they have certainty about cost because the employer is only obligated to contribute what the plan stipulates they have to contribute each year," he says.

Once the obligation is met, the company has no liability -- unlike defined-benefit plans.

"Under a defined-benefit plan, the employer is responsible to fund the difference between the ultimate cost of the benefit and the value of the contributions that the plan members have made," he says.

"It's, in effect, an open-ended commitment."

Despite the costs, defined-benefit plans are likely to hang around. They are still the most common pension plans in Canada. Of the approximately six million plan members, almost 4.5 million are defined-benefit members, Statistics Canada's latest data (2011) indicates.

But the number is declining mostly because private-sector plan membership is decreasing by about 100,000 a year while public sector membership is rising slightly, slowing the erosion.

(Overall, however, most Canadian workers -- about 11 million, or 60 per cent of the workforce -- have no plan at all, a 2012 report by the Canadian Association of Retired Persons found.)

Ablett says many private-sector plans -- including Investors Group and RBC -- have moved to hybrid plans in which existing members belong to the defined-benefit plan while new hires are members of a defined-contribution plan.

"What is happening, of course, is the membership of the DB plan will gradually decrease, and then at some point, the company will only have a defined contribution plan," he says.

Even in the public sector, defined-benefit pension plans may not be in the future what they are today because governments -- which are often on the hook for meeting pension shortfalls -- are facing ongoing deficits and declining revenues.

Ablett says DBs will likely continue to be the norm in the public sector, but probably with a few adjustments.

"What we will see is employees will be required to contribute higher amounts."

Limits may also be imposed on certain aspects of the plans, such as inflation indexation.

At the moment, most defined-benefit plans provide some protection against inflation. The measuring stick is the Consumer Price Index (CPI), an aggregate number representing a basket of commonly purchased consumer goods. If the index increases two per cent from the previous year, a pensioner's annual benefit will increase by two per cent.

Any plan which has investment managers worth their salary can keep pace with this modest increase, but if we have a return to the high inflation of the 1970s and early 1980s when it ranged from as low as about seven per cent a year to as high 12.5 per cent, it's very likely plans without inflation-indexing limits in place will create them in a hurry.

No indexing for pensioners would make retirement very difficult in a high-inflation environment. A monthly income of $1,500 would be more like $700 if we went through a decade like 1972 to 1982, when the average annual rate of inflation was more than nine per cent.

For that reason and many more, defined-benefit pension-plan members should carefully consider the many options available to enhance their guaranteed incomes in retirement. Among the choices to mull over is the joint to last survivor benefit, which guarantees after a pensioner dies a percentage of pension income will be paid to his or her spouse. In Manitoba, like many other provinces, law requires this coverage be in place unless the spouse signs a waiver.

The "normal coverage" for most plans is two-thirds of the pensioner's benefit, Sweatman says.

But a pension-plan member can choose to increase the coverage to 100 per cent.

Doug Nelson, a Winnipeg-based planner and author of Master Your Retirement, says determining the level of coverage varies by individual situation.

"The answer to that question depends on other sources of income, the size of this pension as it relates to these other sources of income and the income risks to the survivor."

The amount of pension income at stake can be substantial, so detailed retirement planning is required.

As an example, if a monthly pension is $3,000 and the pensioner dies early, the benefit paid the surviving spouse is reduced by a third. The the loss of income over 30 years would be about $300,000, Sweatman says.

By comparison, with 100 per cent coverage, the pensioner's monthly benefit would be reduced to about $2,625, but the loss of income over 30 years if the pensioner dies early would only be about $130,000.

A similar option is a guaranteed payout, Ablett says.

"Even if you have a joint to last survivor pension, unfortunately, you could have a situation where both parties are killed in a car accident two years later and no payments would be further made."

A minimum guarantee would ensure payments continue to be paid out to a beneficiary, generally for about a decade after the pensioner starts receiving benefits.

"The nice thing about the minimum guarantee, based on what we've seen, is that it's only just a few dollars per month in cost difference to have it in place."

Another option is integration, which provides a higher benefit upon early retirement in exchange for a reduced payment once CPP and OAS commence.

"It would be useful to somebody who felt that they did need a larger amount of a level benefit until the date those kick in."

Ablett adds pensioners likely can't choose all the guarantees. They'd reduce the actual monthly payment too much.

"What normally happens is the actuary determines the cost for each one of the benefit upgrades and most people simply couldn't afford all of the upgrades, but you could likely afford two of them."

giganticsmile@gmail.com

Republished from the Winnipeg Free Press print edition June 1, 2013 B8

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