In my last blog posting, dated June 29, 2012, I commented on the issues I had with the way Defined Contribution (DC) Pension Plans are currently managed in Canada. In this follow-up post, I speculate on the evolution of DC plans in Canada over the next five years.

To overcome some of the drawbacks of current DC plan design, I think there are a few alternative plan designs to consider. I list them below in order of usefulness to plan members, with the most desirable first:

1. Switch DC Plan to a Target Benefit Plan (TBP) Design:

Of course I am biased, after spending most of my career managing Defined Benefit Pension Plans. Even after accounting for this bias, there are significant advantages of TBPs:

  • Predictable, stable retirement income for members.
  • Employers pay fixed contribution rates.
  • Employers do not have to worry about funding or accounting deficits.
  • The fixed pension benefits provide a strong retention tool for employers and can be a recruiting advantage over competitors offering DC plans.
  • Low administration costs if the plan design and investment structure are kept simple.

The potential downside is that benefits could fluctuate in the future. However, benefit fluctuations will be significantly reduced compared to DC plans if contribution rates are set at a level sufficient to fund the target pension benefit with some cushion to allow for future poor investment or demographic experience. Once employer concerns over short-term investment returns and valuation results are removed, target benefit plans can be managed for long-term sustainability.

2. DC Plan / TBP Combination:

To overcome the concern that TBPs do not serve short-service employees well, in particular for industries with high employee turnover, employers may look at a variation on option 1 above:

  • Provide a DC plan for all employees and allow employees to switch to a TBP once they have reached 10 years of service.

The extra cost and complexity of managing two plans should be weighed against the added benefits provided to short-service employees.

3. Simplified DC Plan Management:

A simpler, cheaper model for DC plan management could include:

  • No fund choice for plan members. Instead provide target date funds or asset allocation funds only. This would significantly simplify the member’s decision-making process.
  • Only provide members with fund choices if they sign a waiver and participate in a thorough education and advice program.
  • Compulsory plan membership.
  • Minimum required employee and employer contribution rates; this would have to be subject to affordability for both parties.
  • Contribution rates that increase significantly with employee service to aid with employee retention.
  • Provide suitable ways for retirees to remain in the plan (LIFs or RRIFs) or provide discounted annuity prices through group purchasing power.
  • A member education and advice program tailored to the stage of the employee’s career:
    • For early career employees: contribution rate adequacy
    • For mid-career employees: projections of desired and expected retirement income.
    • Pre-retirement: retirement choices and retirement planning.

4. Join a Pooled Registered Pension Plan (PRPP):

To date, only Quebec has provided details on their PRPP plan design rules (which are effective January 1, 2013), so it is too early to tell whether these plans will offer the key features needed to replace traditional DC Plans:

  • Compulsory plan membership.
  • Minimum contribution levels.
  • Lower fees.
  • A simplified investment structure for plan members.
  • Less fiduciary liability for plan sponsors (it looks unlikely that PRPPs will go as far as the “safe harbour” legislation provided in the U.S. for 401 (k) Plans).

Quebec’s framework includes some, but not all, of the above desired features.

I think any one of the above options would be preferable to the current DC pension plan model. Unfortunately we will only know how the current model will hold up when Gen X-ers start to retire in 20 years’ time. I would suggest that is too long to wait for action.