Defined benefit pension plans, which fix the pension until death, have always been the holy grail for employees.
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 benefit to defined contribution,” she says.
She is 33 years old and has been with this company since 2020.
“I’ve been 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 [she] doesn’t stay [her] entire career with 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 about the same age as her. They are equal owners of a house with net assets of around $700,000.
His defined benefit plan will provide him with a life annuity equal to 1.7% of the average of the five highest-earning consecutive years, multiplied by the number of years of membership.
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 age 55, with a penalty of 5% per year.
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 go for?” »
Salary: $91,000Random annual bonus of approximately $25,000, invested in TFSA or RRSPDefined benefit pension plan (for now)Locked-in RRSP: $22,499RRSP: $51,945TFSA: $31,135
Net worth of approximately $700,000 Owned equally with spouse
“At first, without having put anything in the machine, I expected to see a stark 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 further I went, 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 expenses roughly equivalent to that of today, or about $60,000 in constant 2023 dollars.
For the first 15 years of retirement, our planner added a margin of $9,000, to account for Genevieve’s plans. He assumes that her salary will increase at 2% per year and that she will maintain her current savings discipline until retirement.
Scenario One: Genevieve 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% (after 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.
Second scenario: Geneviève switches to a defined contribution plan (DCP) now. 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!
Third scenario: she keeps her defined benefit plan (DB), but the return of RRSPs and TFSAs, with a more aggressive investor profile, is increased to 5.38%. This time, the objective is achieved, “with the advantage of reducing 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.
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 for up to 95 years.
“On the other hand, the risk is higher, because it will be up to Genevieve to generate this same high return each year. »
Can this risk be reduced? By reducing the yield to 4.38%, we achieve this if we postpone retirement to age 60 with defined benefits, and to 61 with defined contributions.
If Geneviève wants to retire comfortably at age 57, whether with an RPD or an RCD, “she will have to assume a higher than average risk on her investments in order to generate more returns”, emphasizes Émile Khayat.
Of course, a lot 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 yield similar results: “At the end of the day, the difference is rather negligible,” notes our adviser. Either choice can be good. »
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 expect 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 cashing in the cash value of their pension plan, “the check is often going to be bigger with a defined contribution plan than ‘with a defined benefit plan,’ he argues.
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 higher 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.
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