DC versus DB Pensions
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| Retirement Planning |
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| Tax Deferred and Tax Free Savings Plans |
| Pension Plans |
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| Government Retirement Benefits |
| Retirement Planning |
Introduction
Traditional Defined Benefit (DB) pension plans have been in prolonged crisis, one whose roots were first exposed in the two recessions of 1980-82 and revealed more fully in the downturn of 1991. Those recessions most affected manufacturing companies with large workforces, first the steel industry, then companies such as IBM, extending now into the auto sector and the airline industry. Such industries faced two challenges. The first was that, with restructing, there was no longer a growing workforce to match the increasing number of retirees, whether long-timers or those who had taken early pensions. The solution would have been to raise contribution rates for new workers in what was treated much like a pay-as-you-go pension scheme (as, for many years, the Canada Pension Plan was). That structural problem was avoided, to some extent, by better rates of return offered by shifting the asset mix from bonds to equities. But that gravy train came to halt with the 2000-2002 bear market.
As pension burdens become increasing problematic, companies are shifting to Defined Contribution (DC) plans. While DC plans provided startups in such industries as high-tech the flexibility to grow into mature companies without heavy upfront costs for pensions, they also exposed plan members to investment risk as well as longevity risk: inadequate retirement savings.
Increasingly, pension experts are examining a hybrid DC-DB plan with compulsory contributions.
Who Carries the Risk?
In a traditional DB pension plan, the plan sponsor bears the risk that the plan may not be sufficiently funded, and must top up any shortfall. The primary difference between a DB and DC plan is that, in the latter, the subscriber, not the sponsor, carries the risk. Thus, DC plan contributors who invested heavily in equities during a market crash, may have suffered a substantial drop in the value of their pensions. Because of the potential for a large drop, some DC plan sponsors may limit the equity percentage that subscriber can hold.
