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by Daniel Gloade on May 20, 2014

When family lawyers think of pensions, they usually classify them as either Defined Benefit or Defined Contribution plan.

A Defined Benefit Plan is mostly used by public employees.  Using a formula, the retired employee gets a fixed benefit per month for as long as he or she lives.  The disadvantage for employees is that there is less flexibility when changing jobs.  The plan’s sponsors are disadvantaged because they absorb all of the risk if they miscalculate the present value of the future benefits.  Of particular concern is the frequent underestimation of people’s longevity.

A Defined Contribution Plan is used mostly in the private sector.  It is like a bank account.  The employer and employee invest the money.  Your retirement benefit consists of what is left at the time you retire. The advantage is that it gives the employee more freedom to change jobs (just transfer the money),  The disadvantage is the risk of the stock market crash, especially at or around the time you retire.  Also, when it is time to cash out  a pension the pension holder must estimate his or her lifespan.   Miscalculations, however, have serious negative consequences for the pension holder.

The federal government is proposing a Target Benefit Plan.  It is a type of Defined Contribution Plan.  The difference is that an actuary sets a target for the amount of the monthly benefit payments you should receive.  The actuary then resets the pension contribution amount annually so that the employee will reach that target.  Although pension plan sponsor still assumes the risk if the plan has insufficient funds to reach the target at least a professional, and not a layperson, makes the calculations to reach the goal.

To reduce the risk even further, perhaps if would be best to expand the the Pension Benefits Guarantee Fund.  This fund is a government-run insurance policy. If a company goes bankrupt then the government will reimburse the beneficiaries of the single employer pension fund.  I suggest that this program is be expanded to users of Target Benefit Pension Plans.  Benefits are paid to ensure that a pensioner’s monthly income does not fall below a certain amount.

Beneficiaries benefit because they know that they will have money available if the retire in spite of a market crash.  The insurance premium amount is constantly adjusted by actuaries so that the program can be close to revenue neutral.  The government even benefits because it makes it less likely that retirees need to access social services if they retire during a recession.

Perhaps a Target Benefit Plan with an expanded Pension Benefits Guarantee Fund is the best compromise for Canadians.

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