One is the risk of uncertain investment performance (let’s call it market risk), leading to uncertain level and duration of payout for retirement. This is a continuous risk – you expect it to vary with a bell curve like shape (possibly with fatter tails). In a DC scheme, the retiree bears all of this risk. In a DB scheme, the employer bears the bulk of this risk, though as mentioned above, if the whole plan gets too much out of whack, contributions may need to be adjusted.

The second is the catastrophic risk of an event wiping out (or significantly devaluing) the pension. This is a form of counterparty risk. In a DC plan with reasonable asset allocation, this is only the risk of a complete financial system failure – possible, but unlikely, and its impact is somewhat under the control over the retiree by what they do. In a DB plan, the retiree is significantly exposed to the risk of collapse of his/her employer and devaluation of the pension.

So in DC, recipient has lots of market risk but minimal counterparty risk. Employer has none of either, so prefers it. In DB, employer bears the bulk of the market risk, but recipient has a ton of counterparty risk – financial health of the employer.

The main benefit of DC plans that I see is that if you manage your withdrawals carefully, you could leave a nice inheritance to your heirs. With DB plans however once you are gone, your pension is gone as well

The bias towards those retiring is precisely one of the main reasons I’m hesitant to believe in DB plans – contribution rates have been leaping ahead for younger workers in order to fund the people retiring now.

@GTP – interesting case example. I wonder if this scenario (of the DC employee working longer to make up the difference) is common. Since I’m on a DB, perhaps we’ll just have one spouse in each type of pension plan and take the average.

you are correct about solvency company and impact on DC vs DB plan. there’s no impact on DC other than maybe future contributions. for DB there is some risk you won’t get all of your retirement benefit. the guarantee funds will kick in at this point, however i think they are biased to protect people already retired over those still working toward retirement.

Also, I really like how my current pension plan is set up:
0-10 years working: DC-Employee 4% salary, Employer 10% Salary
10 years to retirement: DC Employer 4%, DB 1.5% x Salary

The choice of plans was completely removed, but I think this is a great way to give the benefits of both plans and mitigate the risks discussed about both plans…

My wife’s company offers both – and employees select which to enroll into. They have one opportunity while at the company to switch – my wife’s will be in 2 years I believe.

As a DIY’er – I’m sorta pro defined contribution – we can hopefully build balanced (in our eyes) portfolios. However, I think it’d take some kind of growth (in the DCP) to get 70% of her final year’s income.

On the otherhand – if she doesn’t stay with the company long enough to get 50-70% – then I believe the DCP might be better.

You provided some great information and good points.

However, I don’t see that a DCP is related to a DBP in terms of risk to the plan holder. From what I understand, when a company allows you to contribute to your DCP (with possible supplementation by the company, e.g matching contributions) for all intents and purposes that money is yours as it is held “in trust” by another firm. If there is a vesting period, then that comes into play, but my feeling is that the solvency of the company does not affect the DCP holdings. (Excuse me if I’m using the wrong financial/legal terms.)

Now, if the company is faltering they may decide to reduce or stop matching contributions which may be where you were heading.

I wish our company was using low MER funds – our choices are limited and for the most part seem to be copies of other funds – with the commensurate and additional management fees by our investment provider, Standard Life.

FT – when designing a DB pension plan, the employer has the option of deciding which forms of benefit to offer. These are usually determined on an actuarially equivalent basis. I think most jurisdictions require the minimum to be Joint & Survivor 60%. That is once you die your spouse will continue receiving 60% of your benefit. This seems fair since your family will have roughly half the expenditures cut from their retirement expenses when you pass on. What may not be fair is when your employer does not off the J&S 60% as the normal form of payment, and you have to take a reduction in your pension to receive the legislated form of payment.

Scott – you will receive the same retirement income regardless of market performance, but you and the employer both have an obligation to contributing to your pension to get you there. As a taxpayer it is unfair for us to pick up your pension deficit without you having to contribute a dime. It is up to individual employers to determine whether or not their employees should share in the cost.

AndrewP – this is a perception that many DC plan members have. It seems really generous that the company would just double up your money, but in fact this is a lot less generous than a DB plan where the employer will put in everything, bear the investment risk, bear the inflation risk, bear the mortality risk….and you would put in nothing.

Its a very interesting time to be a pension consultant right now….

i think all registered pension plans are covered by the pension benefit guarantee fund. there such things as non-registered plans, but these are usually top-up plans for senior executives and are not really to be compared with RRSP, DCP.

I’ve never heard of the pension benefits guarantee fund. Does the GM employee pension have this?

Yes, DC plans do have lower rates. I was looking at the government of NL DC plan for part time employees, and they use PH&N funds with an average MER of 0.80%.

Thanks for pointing out some more of the differences between DC and RRSP, good to know.

you are correct. the pension adjustment for DB plans is

(annual benefit accured x 9) – 600
benefit accrued is plan specific but would something like:
salary x accrual rate (eg 50k x 1.5%)
pension adjustment would be 50k x 1.5% x 9 – 600 = 6150

the calc may have changed but this is what it looked like as recently as 2002 or so.

factor of 9 is supposed to be an average deferred annuity factor (starting at 65) over one’s working lifetime

the PA for DC plans is just the contribution.
PA’s reduce your RRSP room for next year.

If the fund decreases in value by 4% over a year, my portfolio is still worth about 92% more than what I put in (compounding aside). You can’t go wrong with that!

I think things have improved on this front with “target date” funds being offered pretty broadly. it used to be that if you didn’t go in and choose your specific fund line-up, the employer wasn’t allowed to default you into anything but a money market fund (they can’t choose your risk profile for you). now a lot of plans will default people into a target date fund based on when they would turn 65.

- another advantage of DC plans is the lower MERs offered. depending on how large your employer is, you can get some relatively low rates compared with the average mutual fund out there (though not much better than TD e-series).

– regarding “Another disadvantage is that some DBP’s only allow a portion of the pension to be transferred to a spouse if the beneficiary passes away. Whereas an RRSP is more flexible where all assets can be transferred.” I think this is false. At retirement you are usually provided with an benefit option form which provides an array of options: payments for life, payments for life with a 5 or 10 year guarantee, payments for life with a % continuing to a surviving spouse. For each of these options, the benefit payment is reduced/increased accordingly so that they are actuarially equivalent (eg $1 per month for life might be equivalent to $0.90 cents for life with 50% continuing to spouse upon death).

- regarding “Employer matched RRSP is pretty much the same thing as DCP” – be careful about this. There are a few key differences one should know. RRSP contributions are limited based on last year’s income. DC plan contributions reduce next year’s contribution room. Can make a difference if income is volatile. Also, and more importantly, RRSP contributions can be withdrawn whenever you want (pre-retirement, post retirement, lump sums) where as pension plan contributions are locked-in. You can’t withdraw them pre-retirement, and even in retirement you can only withdraw within specific upper and lower limits (i don’t know them off hand).

- also, there’s a pension benefits guarantee fund, which plan pay premiums into in the case of a pension insolvency. this reduces the risk of your plan defaulting if you’re a corporate db plan. i don’t agree with the point that DB plans are “arguably” riskier than DC for the employee. if the DB plan were to default and you only get 50 cents on the dollar, chances are a DC plan wouldnt’ have faired all that well either.