What Is Your Workplace Pension Really Worth?, with Jason Heath
Welcome to The MapleMoney Show, the podcast that helps Canadians improve their personal finances to create lasting financial freedom. I’m your host, Tom Drake, the founder of MapleMoney, where I’ve been writing about all things related to personal finance since 2009.
If you contribute to a pension, do you know what type of plan you have? Do you even have a pension plan? Fewer and fewer private sector companies are providing pensions for their employees, making it harder than ever to plan for retirement.
My guest this week is Jason Heath, a fee-only financial planner and columnist for The Financial Post and MoneySense magazine. Jason joins me to discuss the current state of pension plans in Canada, and how the deterioration of employer pensions is impacting the retirement plans of Canadian workers.
In Canada, workplace pension plans come in two forms: defined benefit and defined contribution often referred to as a Group RRSP. While both types are designed to provide income for employees when they retire, one holds more value than the other. Unfortunately, defined benefit plans, long considered the gold standard for pensions, are quickly disappearing, due to their enormous cost to employers.
But while defined benefit plans are seemingly on the way out, Jason suggests that Canadian workers could benefit if the government were to introduce tax incentives to encourage more small businesses to introduce Group RRSP plans.
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- What exactly is a pension plan?
- The value of a defined benefit pension plan
- Why private companies are fleeing from defined benefit plans
- Drawbacks of a defined benefit pension plan
- How tax incentives could help boost pension plans
- The impact of procrastination on savings
If you contribute to a pension, do you know what type of plan you have? Do you even have a pension plan? Fewer and fewer private sector companies are providing pension plans for their employees, making it harder than ever to plan for retirement. My guest this week is Jason Heath, a fee-only, financial planner and columnist for the Financial Post, Money Sense and Retire Happy. Jason joins me to discuss the current state of pension plans in Canada and how the deterioration of employer pensions is impacting the retirement plans of Canadian workers. Welcome to the Maple Money Show, the podcast that helps Canadians improve their personal finances to create lasting financial freedom. This week’s episode is brought to you by EQ Bank. Did you know you can now transfer money abroad with Transfer Wise using EQ Bank’s Savings Plus account? Not only with you benefit from earning 2.4 or 2.5 percent interest on your savings but you’ll pay up to eight times less for international money transfers. While other banks have a habit of sneaking in mark-ups and extra charges that’s not something you have to worry about with the EQ bank. Visit maplemoney.com/eqbank today. Now, let’s chat with Jason…
Tom: Hi Jason, welcome to the Maple Money Show.
Jason: Thanks for having me, Tom.
Tom: Not too long ago you had written an article in the Financial Post which was interesting and I kind of wanted to spark a conversation around it. It was related to workplace pensions which is something we haven’t covered on the show. The most interesting stat was 37 percent of Canadian workers are covered by a pension plan which is very little. I’ve been in the private sector with my job 20 years and I have a defined contribution plan. And even at that I don’t feel all that lucky. Could we could go into start by starting at the beginning. Can you just explain what this stat means? What is this workplace pension compared to CPP or something like that?
Jason: I find that a lot of people I work with even have trouble with this, the difference between a defined benefit and defined contribution pension. Believe or not, I’ll ask people if they have a pension and they’ll say they do but they don’t know what kind of pension it is. They don’t know the terms of the pension. And the defined contribution pension you have is kind of like a group RSP. They buy mutual funds which go up and down. Hopefully, mostly up and eventually produces a retirement income. Defined benefit pension plans, the gold plated pension plans that everyone is jealous about are based on a formula of your earnings times your years of service times a certain percentage that pays you a monthly benefit forever. It’s predominantly that a defined benefit pension plan (this particular study from the Health Care of Ontario Pension Plan) is promoting how much more beneficial a defined benefit pension plan is. Their study, which is called, The Value of a Good Pension, suggests that for every dollar contributed to what they call a “Canada model pension plan” a retiree can expect to receive back $5.32 of retirement income. And that really doesn’t have a lot of context. But one thing the authors attempted to do was compare it to putting money in your RSP. What they found is that a typical individual who is saving in their RRSP might only be able to produce $1.70 of retirement income per dollar contributed. That’s almost triple the retirement income from a defined benefit pension plan compared to the old fashioned RSP.
Tom: I haven’t looked in this before but there certainly seems to be a connection with defined benefit and public sector jobs still.
Jason: For sure.
Tom: Is that what we’re seeing? Are pensions decaying more in the private sector?
Jason: Absolutely. Yeah. Public sector pension coverage is far more than what you see in the private sector. Statistics Canada reports that about 87 percent of public sector employees were covered by a pension plan in 2017. That’s the last release of data that they had. Twenty years ago back in 1997, it was 88 percent. So basically over the last 20 years there’s been no change in public sector pension coverage. Private sector employees had 28 percent coverage 20 years ago. It’s down to 23 percent over the same period of time. So a pretty small fraction of private sector employees have a pension plan. And definitely the degradation of pensions is happening in the private sector. Not only coverage period but also the type of coverage. You’re seeing defined benefit pension plans that are converting to defined contribution pension plans. Or where former employees and existing employees have a defined benefit plan but new employees are only being offered a defined contribution pension plan. It’s tough because if I’m an employer, I understand a defined contribution pension plan where you just match contributions and the employee invests and the employer is done with that is a lot better from a business perspective. But employees, what they really want and what the hospital Health Care of Ontario Pension Plan studies suggests is that DB pensions are much better for employees and for people’s retirement income.
Tom: What can employees really do about this? Is it just a matter of looking into it when you’re applying? It’s not like this is a negotiable fact. You just take it or leave it?
Jason: You know, that’s a good question because I have clients who are very much motivated to find a job with a defined benefit pension plan, or if they’re in a defined benefit pension plan, I can think of a few clients who are hoping to transition into a new job or a new role but do not want to leave their DB pension coverage would never think of going to the private sector. Obviously, there’s a benefit to being in a defined benefit pension plan. But at the end of the day, I think if somebody can work for an employer where they’re all-in compensation where they can put a value on how much they’re getting every year from the pension plan, you can go work for an employer who has no benefits, no pension, pays you more and potentially be in a better position in the long run. Part of the problem with not having a defined benefit pension plan is you need to save on your own. And that’s where a lot of people have an issue. Defined benefit pension plan members are forced to save and end up with these lucrative pensions when they retire. And those who do not have DB pensions often complain about it. But at the end of the day, they may be paid more and just not save. It takes a lot of discipline if you don’t have a pension plan to be able to produce the same pension or retirement income that a pension plan member might receive.
Tom: Yes, that’s how it was explained to me at the time too before I got into this whole world of personal finance. I was starting a career and was told, “Yes, we’ve got this kind of pension. But don’t worry, in the private sector you’re going to get paid more,” which I’m still not sure is true. But there is this theory that you’ll make more money and to invest yourself. With the defined benefit, are there cons to this? You said you have to work a certain amount of time but aren’t people switching careers quite a bit? Or maybe they don’t as often in the public sector?
Jason: I couldn’t comment statistically, but I would have to guess that there is less transition within the public sector. A lot of times you can stay within the public sector for your whole career. In Ontario we’re seeing jobs that used to be guaranteed jobs, particularly in teaching, having cutbacks and changes. So you never really know. But I think there are a lot of people who have a defined benefit pension plan that can expect to work in the public sector for their whole career. Sometimes people will leave mid-career for a variety of reasons. More and more, actually. We’re seeing people who are given the opportunity to take a commuted value (pay out, lump sum payment) in lieu of their future monthly pension plan. They can take that money and put it into a locked in RSP, take a risk on their own and try to produce a higher retirement income. It’s tough though because right now interest rates are low. And when interest rates are low, the payouts from a defined benefit pension are high. Oftentimes people giving financial advice are those who would benefit from receiving the money to invest. So there are a lot of challenges there for people in these pensions who are transitioning between careers as well.
Tom: Another thing I believe I’ve heard—and hopefully I’m not wrong is, with defined benefit, have there been issues where companies go bankrupt? I seem to remember hearing about people missing their benefits because there’s just no money. Kind of like the CCP fears but within a company’s defined benefit plan.
Jason: Yeah, absolutely. Nortel, Sears and some of the big bankruptcies you’ve seen in the United States, pension plans have funding ratios where (depending on where you live in Canada or elsewhere) pension regulators attempt to ensure that a company has sufficient money in a pension plan to pay out future benefits to employees. Pension plans can have deficiencies for a variety of reasons. Back in 2008, 2009 those deficiencies were because of market conditions; the financial crisis causing pension plans to lose money. But we’re also seeing situations where employers just fall short on their contributions because they’re running into financial difficulty. People are living longer and the actuarial calculations used to determine how much money needed to be there (for those living longer) is insufficient. Low interest rates as well make it tough to earn the same rates of return. With the private sector, depending on your employer, Nortel, Sears—I mean, there have been big companies that have had difficulties with their pension plans. Had you asked somebody 20 years ago, you never would have expected the amount of retirees that potentially would be impacted by these sort of pension issues. So when you work in the private sector, that’s one drawback with a defined benefit pension plan. You need to trust that your employer is going to be there to continue to make those payments. Pension plan payments are as guaranteed as one might expect they would be.
Tom: Yes, that’s a good point because it’s kind of double-dipping on risk a little. It’s the same reason I wouldn’t want to invest in my employer as a stock. If they fall through all of a sudden you’re without a job in your retirement.
Jason: There are options as well to take your money as a payout, as a as a commuted value and transfer it into a locked in RSP that I think would be that much more desirable if your employer is in a risky part of the private sector. There can be options as well to take money out of a pension plan and use it to buy an annuity. That way you’re shifting all the risk to an insurance company that may be more reliable and less risky than your private sector employer. But yeah, it’s tough. I think there’s pros and cons to pensions, RSPs and to having control of your own money and investment decisions. There’s no right or wrong or better or worse option. In my own opinion, because I’m comfortable making my own investments for a lot of Canadians, DB Pension plans are definitely better and as it’s been suggested, much more lucrative.
Tom: Now also in this article, you mention how tax incentives might start to improve the odds of an employer getting into this. What kind of tax incentives do you think would work here? What would get things moving?
Jason: Tax incentives tend to have a positive effect on encouraging people or businesses to do things. A couple of things I suggested in the Financial Post article I wrote was potentially introducing a tax incentive to employers, to businesses, to introduce or maintain a pension plan. I run a small business. I have employees. The time and effort involved in doing anything new, including introducing a pension plan, even if it were a simple defined contribution pension plan, takes time. It costs money to do that. A lot of other businesses are in a similar situation. So if the government would introduce a tax incentive that would encourage small businesses to introduce even just a simple group RSP, defined contribution pension plan… It doesn’t even need to be a big elaborate defined benefit pension plan. I think that could be a great way to enable more employees to have coverage. Beyond that, one of the other things I had suggested was introducing some sort of a tax incentive; something like an introductory tax credit for an employee who signs up for a defined contribution pension plan, a defined benefit pension plan or a group RSP so they were able to receive an extra tax deduction or a special tax credit to encourage them to get in, because oftentimes I will come across people who have these great route plans at work—even just a savings plan where there is a company match on contributions, and they just don’t sign up. Sometimes it’s because they don’t have the cash flow. Sometimes it’s because they’ve got an adviser already. And if the advisor was advising them properly, they should be asking about their group benefits saying, “Wow, there is a 50 percent matching contribution on your group plan at work. That’s really where you should be putting your money instead of into what RSP with me.” But there are conflicts of interest that exist where advisors sometimes don’t like to take money out of their own pocket, even if it’s the right thing to do for the client or investor.
Tom: Well, that’s a great point you brought up. If there’s employer match in any of this, 50 percent, 100 percent (I’ve heard of more, but I’ve never seen it) what a great return. No matter what you think of the portfolio they use and future growth, if you’re getting, say, a 100 percent dollar-for-dollar match, that’s a pretty good start right off the bat.
Jason: Yes, I wouldn’t say no to it. And frankly, more often than not, the investment options are at least decent and sometimes good. And the fees as well. They’re usually decent, sometimes good. I do see plans where there’s tons of different mutual funds and fees are actually fairly high. That’s when you sort of shake your head and knowing the employer is not really doing their employees a favor. But getting a 50 percent return (free money) from your employer, I think it’s very difficult to say no, even if you can find a little bit of extra cash flow. The only situations where I would say no would be if you have really high interest rate debt, credit card debt. Even if somebody had a mortgage they wanted to pay down aggressively, in the long run they’re going to be much better off. In the short run, it may not feel like it if you have a big mortgage, but in the long run you’d be a lot better off taking advantage of employer matching contributions.
Tom: Yeah, it’s similar when I say to people if they’re looking at paying off their credit card; should they pay it off or invest? If they’re paying 20 percent interest on their credit card, that’s worse. But in this case, possibly doubling your money kind of beats every other possibility.
Jason: You got it.
Tom: As a financial planner, just speaking generalities, what things have you seen around pensions? Are people doing better with the defined benefit? How is this affecting people in a complete picture?
Jason: One thing that I often notice and share with people is, when I look at the clients I have who are the most comfortable in retirement—If you remove the outliners who’ve just been very successful in accumulating a lot of savings, I come across a lot of retired, defined benefit pension plan people who have had modest incomes during their working years with such lucrative pensions, that in retirement they’re saving. I can think of couple of clients I have that are married teachers that are saving in retirement who said back when we were working, raising our kids and paying off our mortgage, we didn’t feel like we had extra money. We didn’t really travel. But if you work for 30 years for defined benefit pension plan where there’s a 2 percent per year of service pension, 30 years of service is going to get you 60 percent salary replacement at the end of your career when you’re hopefully done paying off your mortgage and the kids are off the payroll. When you add in your CPP and Old Age Security pension, a little bit of savings, an inheritance or a downsize—oftentimes people are better off in retirement and they expect. I think that for me, it even reinforces the benefit of a defined benefit pension plan. It just makes it really easy in retirement for people. And it’s not to say that it is the be-all and end-all where we should be pushing hard to introduce these because there’s a lot of people who like the flexibility of doing their own savings. But, it brings a lot of peace of mind for people, especially those who are not well versed with their money and their finances and investments.
Tom: I’ve seen a lot of people that don’t think about their pension at all so I can see why private sectors are dropping them. It’s not the selling point of the job. It’s, “What’s my salary now? How much vacation do I get now?” They’re not asking about the pension plan. I doubt many job interviews are going in that direction.
Jason: It’s interesting, though. One of the things that came out of that study—and I actually don’t recall how random the people surveyed were. But they found that eight out of ten Canadians said they would forego a salary increase for a better pension or just for any pension. Period. That blew my mind because I thought people would rather have cash today. They’d rather have more money in their pocket; be able to pay down debt, go on a vacation. I think it would change depending on the demographic of the people you were asking. As people get a little bit older and to the midpoint or late-point of their career, I think people tend to look back and say, “Should of, would of, could of, saved more.” A lot of young people these days that just need a little bit of extra cash flow to make ends meet, come up with a down payment or have first and last month’s rent—it’s challenging. There are pros and cons to being paid less than having a better pension, for sure.
Tom: I think that’s kind of what I was saying. Once you’re in the job you’re looking at things like that. You’re probably not looking at it, originally though. I think my pension was literally me signing a form saying it was okay to take the money out. At the time I probably barely knew what I was signing. It was just part of the paperwork.
Jason: You think back to going to school and going out and getting your first job and I don’t remember thinking that it was important to get a pension. You’re not thinking about stuff like that back then. There was a study that was done by Vanguard in the US called, How America Saves. What they found is that pension plan members, when they joined a pension plan, if it was voluntary enrolment where somebody had to actually go out of their way to sign up, the sign up rate was about 60 percent. But when employers introduced a pension plan where you had to opt out because by default, you were signed up, 91 percent of people joined the pension plan. It’s interesting that people, I guess, are inherently lazy and would choose the easiest option. It just goes to some of the behavioural finance side of how employers, savers and governments encourage or nudge people to make certain decisions; trying to make the easiest option, the best option for people.
Tom: Yeah, that’s what I was thinking. As you’re saying, that stat is not just a lack of financial knowledge. Procrastination is a terrible thing. You could go many years before you ever get around to looking into a pension you’ve got or employ stock options and things like that. It’s all just stuff employers might offer that you’re never actually looking into.
Jason: Insurance, wills, all those things where you’re thinking, “That’s not going to happen to me. It doesn’t matter to me. I can think about saving later. I can pay off that credit card debt later. “
Tom: Yeah, there’s always more time to grow up. I’ve said on this podcast many times that I kind of wasted my 20s. It took me until 30 to kind of start thinking about these things and get a little more serious about them. This has been great. Can you tell people what you do and where people can find you?
Jason: I’m a fee-only financial planner. It’s a very different approach to financial planning. We are shared objective financial partners who charge clients for time, whether it’s a project fee or an hourly fee. Some of our clients work with us to year in, year out. It’s an annual fee but we don’t sell any financial products like investments or insurance. I write for the Financial Post and for Money Sense, Canadian Money Saver – Retire Happy. So I’m definitely out there in the media a lot. The website is objectivefinancialpartners.com. Follow me on Twitter @jasonheathsCFP (as in Certified Financial Planner). And just like you, I think a real big proponent of financial knowledge and an education—not everybody needs an advisor. People can go out and learn some of the stuff on their own. But even people who do work with an advisor, I think a little bit of knowledge will help you ask the right questions and make better financial decisions with a professional or without.
Tom: Sounds great. Thanks for being on the show.
Jason: Thanks for having me, Tom. Appreciate it.
Thanks, Jason, for showing us the value of contributing to a workplace pension plan. You can find the show notes this episode at maplemoney.com/jasonheath. If you live in the Calgary area, It’s not too late to come and join me for free screening of the documentary, Playing with Fire, this Friday, February 22nd. For event details, visit maplemoney.com/playingwithfire or check the link in the show notes. Hope to see you there. As always, thank you for listening and we’ll see you next week.