the benefits of defined benefit pension plans

The Benefits of Defined Benefit Pension Plans

From a Manitoba School Sector Perspective

Defined Benefits Pension Plans

A presentation by

WALLY SKOMOROHMANITOBA SCHOOL SECTOR COORDINATOR

A Defined Benefit Pension Plan is essentially a deferred wage for the rest of your, life and possibly for the remainder of your partner’s life, where applicable

A Defined Contribution Pension Plan is basically a savings account that pays you in annuities and once the account has run dry – you no longer have a pension

Definitions: DB Plan

The objective is to provide funding required for a pre-determined level of pension

DC Plan

An account that relies on the size of money in the plan and the market conditions at the time of withdrawal (Retirement)

What are the risks associatedwith each plan?

Defined Benefit (DB)

The risk associated with this type of plan is shared between the employer and the plan members collectively, and is spread over time

DC Plan

• Because the employer has no obligation to fund any particular level of pension benefit, the risk lies entirely with the employee

• This places a greater importance on the size of your account

• The poorer your investment performance is, the lower your eventual pension will be

Essentially, you run the risk of retiring “at the wrong time”

Example:

• 1989 - $50,000 from a DC Plan could buy a $506/month life annuity for a single woman

• 1998 – The same $50,000 would only buy $344/month – a drop of 34%!

What is worse, the employer is under no obligation to maintain any set level. It is what it is!

Basically, the employer makes their obligatory contribution once – and once only. Then it is up to you to fend for yourself

Additional Benefits DB Plan Benefits may include:

• Enhanced early retirement

• Survivor benefits beyond those required by legislation

• Portability

• Disability Benefits

• Inflation Protection

DC Plan Benefits:

• Additional benefits must be purchased by each individual at the time of retirement

• This will significantly reduce the monthly income available to retirees.

• Example – A retiring plan member must take an 8% cut in their monthly payment just to make it a “Joint Life” annuity

Inflation Protection (AKA – COLA) DB Plan

• Many plans provide for increases which at least partially protect against inflation

• But even when a plan does not provide for inflation protection, pension plan surplus is frequently used to provide increases on an ad hoc basis

DC Plans

• No set monthly payment and are not protected from inflation

• It is possible to buy “protection”, but the cost is high

For example: To buy a modest 4% inflation protection,

your monthly payment reduces your initial pension by more than 27%

Plan Administration Costs

• DB Plans

Many of CUPE’s larger DB Plans are jointly trusteed

Best way to ensure plan members are represented for important issues including:

Investment of pension funds Use of surplus Improved benefits for plan members

DC Plan Administrative Costs

• They are managed as individual accounts

• Plan members have no say in the management of the plan as a whole

• Employers usually prefer DC Plans because they are easier to administer

• The costs and liabilities are strictly limited

Why does CUPE Advocatefor DB Pension Plans?

(1) Adequate, secure, and predictable pension income;

(2) Equality issues can be addressed;

(3) DB Plans are a collective approach

Example of Investment Risk in DC Plans

• John and Bev each join the plan earning $20,000/year.

• Over 30 years, each get a 3% annual raise.

• Each contributes 4%

Successive 10 Year Investment Earnings

John Bev

Years 1-10 6% 10%

Years 11-20 8% 8%

Years 21-30 10% 6%

Account Balance after 30 years

$148,212 $117,460

Monthly Income at 65 $1,431.35 $843.71

Because Bev’s “actual” versus “average” rate of return was higher when her pot of money was smaller, her account balance is significantly lower than John’s

This translates into a smaller pension wage If they were in a DB Plan, the plan is

managed over the long term with a better risk/return

Longevity

• The DB fund keeps going with decision-making based on the entire membership in the plan

• In DC Plans, the retiree has only her/his “pot of money”, which attracts huge fees

Equality Issues

DB Plans may provide for:

• Deemed Service for a leave of absence for child rearing

• Inflation Protection without reduction in basic pension wage

• Pay early retirement without penalty using criteria for short service workers like immigrants and women

• Pay spousal benefits without reduction to basic pension wage

DB v DC Pension Plan Examples

• The following examples and exercises are for illustrative purposes only.

• While the methods used are reasonable, they cannot be relied upon as a guarantee of the pension benefit for either plan

DC Plan Exercise

MSBA Statement

(a) Value of Pension Account at Most Recent Date

(1)

(b) Estimated Value at Retirement Age

(i) Pick age 55, 60 or 65

(ii) Estimated Future Contributions

(Multiply Line (1) x 2 for every ten years remaining)

(2)

(iii) Estimated Investment Income

(Line (2) x Estimated Return Rate [0.08])

(3)

(c) Total Estimated Value of Pension at 55, 60 or 65

Line (1) + Line (2) _____+

Line (3) = (4) __________

(d) Estimated Monthly Pension at Retirement

Line (4) divided by 100,000

= (5)

Then

Line (5) _______ x the number chosen from the appropriate annuity table

= estimated monthly pension

DB Plan Exercise

(a) Pick an age of retirement – Magic 80, 55, 60 or 65

(b) Estimate “Best 5 year average” salary at that point (Take years remaining, multiply by 1.02 (2% wage increase) to calculate annual wage increases, minus 3 years to get the average best salary)

(c) Apply Formula: Base pension = 1.5% x number of years of pensionable service x average salary = (1)

(d) Calculate penalties if applicable (If retiring after 55 with 5+ years of service and do not meet Magic 80 requirements)

(i) Number of months before age 60 ____________ (2)

(ii) ¼% x 1% x Line (2) = __________ (3)

(iii) Line (2) x Line (3) = ___________ (4)

(iv) Line (1) minus Line (4) = _______ (5) Pension

Total Pension Payable = Line (5) ________

MSBA (DC Plan) = /monthly

DB Plan – Line (5)/12 = /monthly

New Employee DC Plan Example MSBA Statement

a) Value of Pension Account at Most Recent Date

(1) $11,18.08

(b) Estimated Value at Retirement Age

(i) Pick age 55, 60 or 65

(ii) Estimated Future Contributions

(Multiply Line (1) x 2 for every ten years remaining)

(2) L (1) x 2 x 2 x 2 = $94,544.64

(iii) Estimated Investment Income

(Line (2) x Estimated Return Rate [0.08])

(3) Line (2) x 0.08 = $7,583.57

(c) Total Estimated Value of Pension at 55, 60 or 65

Line (1) $11,818.08 +

Line (2) $94,544.64 +

Line (3) $7,583.57

= (4) $113,946.29

(d) Total Estimated Value of Pension at 55, 60 or 65

Line (1) $11,818.08 +

Line (2) $94,544.64 +

Line (3) $7,583.57

= (4) $113,946.29

(e) Estimated Monthly Pension at Retirement

Line (4) $113,946.29 divided by 100,000

= (5) 1.13

Then

Line (5) 1.13 x the number chosen from the appropriate annuity table ($559.21 based on 65 year old woman)

= $631.91 estimated monthly pension

DB Plan Exercise

(a) Pick an age of retirement – Magic 80, 55, 60 or 65

(b) Estimate “Best 5 year average” salary at that point (Take years remaining, multiply by 1.02 to calculate annual wage increases, minus 3 years to get the average best salary) = $51,908.97

(c) Apply Formula: Base pension = 1.5% x number of years of pensionable service x average salary = (1) (35 yrs x 1.5%= 52.5% x 51,908.87) = $27,251.74

(d) Calculate penalties if applicable (if retiring after 55 with 5+ years of service and do not meet Magic 80 requirements)

(i) Number of months before age 60 (2)

(ii) ¼% x 1% x Line (2) = N/A (3)

(iii) Line (2) x Line (3) = N/A (4)

(iv) Line (1) minus Line (4) = $27,251.74 (5) Pension

Total Pension Payable

= Line (5) $27,251.74

MSBA (DC Plan) = $631.91/monthly

DB Plan – Line (5)/12 = $27,251.74/12 $2,270.98/monthly

Long Term Employee DC Plan Example MSBA Statement

(a) Value of Pension Account at Most Recent Date

(1) $53,601.84

Estimated Value at Retirement Age

(i) Pick age 55, 60 or 65

(ii) Estimated Future Contributions

(Multiply Line (1) x 2 for every ten years remaining)

(2) L (1) x 2 = $91,123.13

(iii) Estimated Investment Income

(Line (2) x Estimated Return Rate [0.08])

(3) Line (2) x 0.08 = $7,289.85

(c) Total Estimated Value of Pension at 55, 60 or 65

Line (1) $53,601.84 +

Line (2) $ 91,123.13 +

Line (3) $ 7,289.85

= (4) $152,014.82

(d) Estimated Monthly Pension at Retirement

Line (4) $152,014.82 divided by 100,000

= (5) 1.52

Then

Line (5) 1.52 x the number chosen from the appropriate annuity table ($559.21 based on 65 year old woman)

= $850.00 estimated monthly pension

DB Plan Exercise

(a) Pick an age of retirement – Magic 80, 55, 60 or 65

(b) Estimate “Best 5 year average” salary at that point (Take years remaining, multiply by 1.02 to calculate annual wage increases ($36,000 in 2012), minus 3 years to get the average best salary) = $38,967.55

(c) Apply Formula: Base pension = 1.5% x number of years of pensionable service x average salary = (1) (25 yrs x 1.5%= 37.5% x $38,967.56) = $14,612.84

(d) Calculate penalties if applicable (If retiring after 55 with 5+ years of service and do not meet Magic 80 requirements)

(i) Number of months before age 60 _______ (2)

(ii) ¼% x 1% x Line (2) = N/A (3)

(iii) Line (2) x Line (3) = N/A (4)

(iv) Line (1) minus Line (4) = $14,612.84 (5) Pension

Total Pension Payable = Line (5) $14,612.84

MSBA (DC Plan) = $850.00/monthly

DB Plan – Line (5)/12 = $27,251.74/12 $1,217.74/monthly

Male Mid Career Employee DC Plan Example

MSBA Statement

(a) Value of Pension Account at Most Recent Date

(1) $63,786.08

Estimated Value at Retirement Age

(i) Pick age 55, 60 or 65

(ii) Estimated Future Contributions

(Multiply Line (1) x 2 for every ten years remaining)

(2) L (1) x 2 = $114,814.94

(iii) Estimated Investment Income

(Line (2) x Estimated Return Rate [0.08])

(3) Line (2) x 0.08 = $9,185.20

(c) Total Estimated Value of Pension at 55, 60 or 65

Line (1) $63,786.08 +

Line (2) $ 114,814.94 +

Line (3) $ 9,185.20 = (4) $187,786.22

(d) Estimated Monthly Pension at Retirement

Line (4) $ 187,786.22 divided by 100,000

= (5) 1.88

Then

Line (5) 1.88 x the number chosen from the appropriate annuity table ($557.28 based on 60 year old man)

= $1,047.69 estimated monthly pension

DB Plan Exercise

(a) Pick an age of retirement – Magic 80, 55, 60 or 65

(b) Estimate “Best 5 year average” salary at that point (Take years remaining, multiply by 1.02 to calculate annual wage increases ($40,000 in 2012), minus 3 years to get the average best salary) = $53,834.74

(c) Apply Formula: Base pension = 1.5% x number of years of pensionable service x average salary = (1) (36 yrs x 1.5%= 54.0% x $53,834.74) = $29,070.76

(d) (d) Calculate penalties if applicable (If retiring after 55 with 5+ years of service and do not meet Magic 80 requirements)

(i) Number of months before age 60 ______ (2)

(ii) ¼% x 1% x Line (2) = N/A (3)

(iii) Line (2) x Line (3) = N/A (4)

(iv) Line (1) minus Line (4) = $29,070.76 (5) Pension

Total Pension Payable = Line (5) $29,070.76

MSBA (DC Plan) = $1,047.69/monthly

DB Plan – Line (5)/12 = $27,251.74/12 $2,422.56/monthly

Questions?