Op-ed Try a Hybrid Pension Model

November 12, 2011

Daily Gleaner, Telegraph-Journal

August 2, 2011

Pensions were originally designed to prevent retired workers from the possibility of living in poverty in retirement. This is an admirable goal for society, and one that should be adhered to for pension plans. Most Canadians do not need a pension plan to be lifted from poverty, with the combination of seniors income support plans that Canada has in place. Specifically, we are speaking of the Old Age Security (OAS), Guaranteed Income Supplement (GIS) and Canada Pension Plan (CPP) programs.

The public sector, on the other hand, has been provided the same base, and its pensions have lifted retired workers far above poverty. The pension plans have been heavily funded by Canadian taxpayers and provide a seamless level of income support for public-sector employees from working into retirement. In fact, many retirees from public-sector plans have higher levels of disposable income in retirement than they did during their working years. These retirement years start early for government workers, and the City of Montreal recently disclosed its police officers retire on average starting at age 53 with a pension of $59,000 per year.

Today, any future shortfalls in pension plans fall upon taxpayers and future employees. Employees who retire after having made insufficient contributions are no longer participating by making contributions into the plan, but are guaranteed the pension income for life. They do not share in any of the responsibility for contributions that are too low, investments that don’t achieve estimated rates of return or increases in the longevity of plan members.

It is unfair for taxpayers to be on the hook for these liabilities.

The city of Saint John has been tinkering around with its pension problem for almost a decade. Real changes are required to make the city’s employee pension plan sustainable.

Change the retirement age.

The most immediate change that needs to be made is to realign the retirement age of the public sector with that of private-sector Canadians. It is acutely unfair that working in the private sector Canadians must pay for the early retirement benefits of the protected class of public-sector employees, especially at a time when governments around the world are waking up to the new reality of changing demographics. We recommend public-sector pensions use the normal CPP age (currently 65) as the basis for determining the retirement age for the public sector.

Eliminate the CPP Bridge Benefit.

This is a special arrangement that allows the public sector to collect full CPP benefits during early retirement, prior to age 65. It is paid for through the pension plan and subsidized by taxpayers. The University of Guelph recently estimated that the early retirement provisions in its pension plans cost 30 per cent of the value of the pension liability. Public-sector retirees should be subject to the same CPP regulations as all other contributors.

Change to Career Average Earnings.

Current public-sector pensions boost payouts by allowing members to use their highest three-year or five-year incomes as a base for pension benefit calculations. In the private sector, the few defined-benefit pensions that still exist generally, use a career average formula.

The average Canadian is collecting a CPP benefit of about $6,100 per year, and city employees, when fully qualified, collect a pension worth 70 per cent of their salary. Any extra savings that a taxpayer has for their retirement is on a defined-contribution basis, usually a RRSP. That is, the amount of money in their pot determines how much income they will have.

One of the problems with today’s public-sector pensions is that any future shortfalls in the plan will fall onto the shoulders of taxpayers and future employees.

A recent innovation in pensions has been the hybrid pension plan. It offers employee the same annual contribution into their pension plans, but would allow for taxpayers to be removed from a major portion of future liabilities and shortfalls.

The city pension plan offers a defined benefit with an accrual rate of two per cent of salary for every year worked. So an employee at the end of 35 years gets 70 per cent of their average working salary (two per cent times 35 equals 70 per cent). Employees contribute equally into the pension plan, along with the employer (taxpayer). Currently, employees and the city pay 8.5 per cent of their salary into the pension plan.

A hybrid pension plan keeps the contributions the same. The only difference is, the employees’ portion goes into a defined-contribution plan and the employer’s goes into the defined-benefit portion. The accrual rate is split, one per cent per year, for each portion. So in this scenario, the city receives one per cent for each year of service (35 per cent), and the employees get whatever the value of the defined-contribution plan is.

For an employee earning, say, $46,000 a year, the pension value would still be estimated at $32,000 (70 per cent of $46,000). The city would guarantee $16,000 of this, and the employee gets the value of his direct contribution portion the same way most taxpayers do. If stock markets perform the way they have been calculated in the current defined-benefit plan, the employee would end up with the same income, and even more if the markets do better. On the other hand, the taxpayer is responsible for only 50 per cent of any future shortfalls. Currently, taxpayers are responsible for all future shortfalls.

The best and fairest option for taxpayers is to convert the city plan into a full defined-contribution pension. However, we feel this is a middle of the road approach that will work well for both taxpayers and employees.

Bill Tufts of Hamilton, Ontario is the founder of “Fair Pensions for All” and is currently co-writing a book, to be published this fall, titled Pension Ponzi.



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