As your advisor, it is important that I am aware of all the pieces of your financial life. If you are one of the fortunate people who have a pension or Group RRSP through your employer, we must examine just how much this plan will contribute to your retirement income—and whether you can rely on your work pension plan. First, let’s explore the Defined Benefit Plan.
If you have one of the old pension plans that have been in existence for decades, it may well be a Defined Benefit Plan. These are often fully funded by the employer, and they state that they guarantee a specific monthly income if you retire on a specific date. This date is often a combination of your age and years of service.
In the past, these pensions were considered the Rolls Royce of pension plans. Unfortunately, there are now large cracks in this structure. When these plans were constructed, we were in a time of much higher interest rates (meaning the investments in the pension plan made more money), and there were a lot fewer retirees. With better medical care today, many people are living in retirement for twenty five or thirty years. This eventuality was not taken into consideration when these plans were implemented in the middle of the last century (most people expired fairly soon into retirement, or at least well before age eighty), and as such the contribution rates over the years were not enough to sustain the plans.
Many, or I would even say most defined benefit pension plans today are underfunded. This would beg the question—will employees in these plans get the monthly pensions they are expecting? Company pension plans are monitored and if underfunded are instructed to increase their contributions to make up these shortfalls (there is legislation that governs them). That is fine as long as the company remains comfortably profitable. If it doesn’t, then it has no way of making up these shortfalls. That can be disastrous for both the company and all of its employees. Downsizing, closure of plants and even bankruptcy can be the result. If the company can no longer support the shortfalls in the pension plan then the current and future retirees face cuts in their benefits.
If you have a defined benefit plan, it can be a good anchor for your retirement, but I would urge you to have other savings as a back-up plan. Be sure to ask your HR department about the current funding level of your Defined Benefit Plan, and if it has a shortfall how it is being made up. Finally I would urge you to share this with your advisor—we can help you put together a contingency plan.
Our next post will discuss the other kind of employer funded retirement account—a Defined Contribution Plan.