Thursday, February 8, 2018

Who Can You Trust with Your Retirement Income?

Retirement Planning in Canada for the Road Ahead Pension

You keep your commitment. You show up for work with the expectation that in return you will one day receive a comfortable retirement benefit.  You hold up your end of the deal.  But something goes wrong…figuratively (and financially) speaking. Nothing you did caused this.

Types of Pension Plans

People who are fortunate to work for a company that offers a pension plan generally have either a Defined Benefit Plan (DBP) or Defined Contribution Plan (DCP).  The Defined Benefit Plan comes with a promise to pay a retirement income for life based on a specific formula based on a percentage of your income and years of employment.  A Defined Contribution Plan, also referred to as a money purchase plan, is one in which contributions made by both an employer and employee are invested into a pension plan in a similar way investments are made to a personal RRSP (Registered Retirement Savings Plan).   What you see is what you will get at the end of your working years.
Quite often people know they have a pension plan but they are uncertain about the plan’s details. If they do open their annual pension statement, they usually glance only at the breakdown of pension benefit. 

When your pension statement is dropped on your desk or arrives in your mailbox, it’s imperative to look at your statement to understand what you are entitled to receive upon retirement.  You may get to the end of your career only to discover you are not as “rich as you think you are”.

Retirement Planning for the Road Ahead Pension

Are all pension plans equal?

One of the biggest news stories lately has been the financial welfare of defined benefit pension plans.  A Defined Benefit Pension Plan (DBP) promises retirees a lifetime benefit.  They are depending on this steady stream of income in the years when they are no longer able to work.

We don’t often talk about the solvency ratios of pension plans.  When you don’t understand something you assume that if something is wrong, “they” will fix it. 

Here’s the simplified version. The financial terminology for “solvency” is the ability for one to pay their debts.  It is not complicated. If you were to stop doing what you are today, do you have enough cash to pay all your debts?  If you were no longer in business today, would you be able to meet all your debt obligations?  The formula is straightforward:

Assets – Liabilities = Surplus or Deficit

The expectation for Defined Benefit Pension Plans is their ability or inability to fulfill their commitment to pay the promised retirement benefit.  The most overlooked section on a pension statement is the section, Plan Funding, which addresses the financial health of a pension fund.

The Pitfalls Associated with Pension Plans

I read a recent pension statement that didn’t provide the specific details about its solvency ratio.  However, the statement clearly indicated that the plan’s assets would not have been sufficient to cover its liabilities if the plan had been wound up on the last valuation date.

This particular pension plan is a Public Defined Pension Plan. Any shortfall in these types of pension plans has the backing of the government and will be picked up by the taxpayers.  On the other hand, Private Defined Pension Plans do not have this kind of luxury.  If there is a deficiency in their pension plan, no one picks up the pieces to replenish the plan to fund 100% of the promised benefits.  When a business goes bankrupt, the assets are liquidated and are distributed firstly to secured creditors.    Unfortunately, retirees are like an unsecured creditor; they come at the end of the line.  Whatever amount of cash is held in the pension pool is theirs to be divvied up.

The deficiencies (shortfalls) in pension plans have analysts scrutinizing the demise of Sears Canada.  Because their case is recent and unexpected, many want to know what went wrong. The greatest discovery was the extravagant amount of money doled out to the shareholders rather than directed to the pension plan’s deficit. Where do the obligations reside?  Who has a greater entitlement to the company’s retained earnings:  the shareholders who made a sizable investment into the company or the employees who worked for the company to create the profits?

An insightful observation into the status of Defined Benefit Plans is outlined in the report, The Lions Share, Pension Deficient and shareholder payments among Canada’s largest companies. Cole Eisen, David Macdonald, and Chris Roberts identify the need for policy reform to protect the beneficiaries of defined benefit pension plans.   

Their research included this alarming observation:

The recent news that Sears Canada will shutter all remaining stores as a result of its insolvency leaves its DB pension plan with a $267 million funding shortfall on a wind-up basis.  Since 2010, Sears Canada paid back $1.5 billion to shareholders in dividends and share buybacks.  In other words, Sears Canada paid back five-and-a-half times more to its shareholders than it would have cost to entirely erase the deficit in its DB pension plan. As Sears proceeds to liquidate its entire Canadian operations, it will be Canadian retirees who are left to deal with that decision.  Regulators, policymakers, and Canadians will quite rightly ask whether this disaster could have been avoided.  

Equally alarming are comments made by Sears retiree, Ken Eady.   In the Money Sense’s article, What Sears retirees can do about the reduced DB pension, employees were aware of the events that were transpiring in the company.  

Mr. Eady shared, “They sold the assets, took the capital and did not make any meaningful investment in the business, including the pension plan. They let the company drift into a very bad spot and stripped it of many revenue-generating assets. If they had invested in the company, built a new online sales platform or other revenue-generating enterprises, Sears would still be operating and we wouldn’t be talking about this.”

My hearts goes out to these retirees or near-retirees. For many, the clock has run out on their working years.  These veteran employees trusted their employer. They trusted the pension regulators, The Office of the Superintendent of Financial Institutions (OSFI), to watch over their pension funds.  Who failed them?  Knowing there is a deficiency in the pension plan and providing too much leeway to make up the difference are the makings of a disaster. Someone made an incorrect assumption, claiming the company needed time to restructure and then they would rebound. 

I also questioned the role and responsibility of the actuaries.  They advise trustees and companies on the management of their pension schemes. Pension actuaries are on the scene to purposely check the financial health of the Defined Benefit Plan and ensure its viability to withstand the test of time to meet its obligations to plan members.  Their valuation is reported annually or triennially to the Office of the Superintendent of Financial Institutions (OSFI) who supervises federally regulated pension plans.   

With so many checks and balances in place, one would expect an alarm to be sounded during this rigorous process. But obviously, the rules around best practices haven’t been firmly established. The potential problem has been compounded with lower-than-ever-expected interest rates and the longevity of retired employees. The pension fund may have been depleting more rapidly than anticipated.

Looking After Your Retirement Income

The take-away from this unfortunate circumstance is that promises can be broken.  Things can and do go wrong with the financial operations of any business.  If the business has a pension plan, like Sears Canada and others did, there can be detrimental effects to people’s retirement income.  There is minimal comfort in knowing a benefit, even if it is 19% less than originally anticipated, will be forthcoming.  Any reduction will be a severe blow to a retiree living on a fixed income while inflation affects the cost of living expenses. 

If you are relying too heavily on your pension plan to provide income in your retirement, the simple answer is “Don’t”.  In CBC’s news article, Sears Case Shows the Risk of DBP for Employees, personal financial experts say there is a risk with this kind of dependency.  I couldn’t agree more. 

Retirement Planning for the Road Ahead Pension

The outcome is your lack of control over your future.  You are allowing someone else to drive your destiny. When your pension statement appears, make the time to understand your pension plan and its projections. If necessary, speak to a CERTIFIED FINANCIAL PLANNER® professional to make sense of your retirement plans.  What you see on paper today might not be what you get in a pension benefit tomorrow. 

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