Defined-benefit plans are great: We already knew that

From the blindingly obvious file today comes a study conducted by the Boston Consulting Group that finds defined-benefit pensions provide major benefits to the economy and that DB recipients are far less likely to need Ottawa’s Guaranteed Income Supplement (GIS).

The group says only 10 to 15% of DB beneficiaries collect the GIS, compared with almost half (45 to 50%) of other Canadian retirees. Well, that should be obvious: as a supplement to Old Age Security, the GIS goes mostly to the poorest of Canada’s seniors. Anyone with a significant amount of Canada Pension Plan income and a DB plan is unlikely to collect much if any GIS. In fact, I’m surprised that even 10 to 15% do. Not for nothing do some quip that “a consultant is someone who borrows your watch and then tells you what time it is.”

Small towns especially benefit

In most cases, DB pension income means losing GIS income. The study finds DB pensions reduce the annual payout of GIS by $2 to $3 billion a year, which is a savings for Ottawa. In addition, the added spending power coming to DB plan recipients contributes between $14 billion and $16 billion a year in tax revenue to various levels of government, via additional income tax ($7 billion to $9 billion), sales tax ($4 billion) and property taxes ($3 billion).

Naturally, DB plan recipients also put their after-tax income to good use, thereby boosting the economy: in 2011 and 2012, DB beneficiaries  spent between $56 billion and $63 billion each year on durable and consumer goods. Their spending is especially important to small towns, where DB pensions account for 9% of total earnings, versus just 6% for larger cities.

Ontario benefits in particular, with $6 billion in tax generated from DB plans and $27 billion in spending. Of course, the study was commissioned by OMERS (the Ontario Municipal Employees Retirement System), the Ontario Teachers Pension Plan and HOOPP (the Healthcare of Ontario Pension Plan). Canada wide, the top 10 pension funds have invested about $400 billion, including $100 billion in real estate, infrastructure and private equity.

All of which makes the ongoing decline of DB plans seem more regrettable. While DB plans are still widespread for workers in the public sector (including the above pensions), they are much rarer in the private sector and becoming rarer as time goes on as major employers attempt to replace DB plans with defined-contribution plans. DC plans, like self-directed RRSPs, put more investment risk on the shoulders of retirees and less on employers. The study also analyzed the four plans that commissioned it and found that up to 80 cents of every pension dollar comes from investment returns.

Pooling longevity risk and asset risk

The study notes that two big advantages of DB plans are their ability to pool longevity risk and to pool asset risk. The larger plans also tend to have much lower investment management costs, certainly compared to DC plans or to RRSPs consisting mostly of mutual funds.

The press release ends with quotes from the presidents of the pension plans who funded the study.  Teachers’ president and CEO Jim Leech even refers to the financial independence that DB plans provide—thereby making DB plan retirees less reliant on government social assistance in retirement, which in turn frees up government funds for other programs or priorities. HOOPP president Jim Keohane says Canadians should look at how the DB plan “success story” can be replicated for those who lack adequate workplace pensions.

So will private sector rediscover DB plans? Not likely!

Those who lack DB pensions are in and will increasingly be in the private sector, of course. And however attractive the benefits of DB plans are for employees and future retirees, many employers seem to have decided they don’t wish to bear the costs and risks of DB plans. It’s not clear how that trend can be reversed. The study makes no mention that I could discern of Ottawa’s Pooled Registered Pension Plans (PRPPs).

About Jonathan Chevreau

As MoneySense’s Investing-Editor-at-Large, he is also author of Findependence Day and co-author of Victory Lap Retirement. Reach him at [email protected], where he is the founder of Financial Independence Hub.

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