The payout formulas for defined-benefit (DB) pension plans, such as those typically provided to government employees across Canada, produce striking inequities, according to a report from the C.D. Howe Institute.
Typical DB plans systematically transfer income away from employees in occupations with slow wage growth, to employees in occupations or careers with higher wage growth rates. In practice, this often means high-income deputy ministers do better by the system than do low-income clerks, found Winners and Losers: The Inequities within Government-Sector, Defined-Benefit Pension Plans.
“The winners are high-flying employees who are likely to enjoy pensions that, at retirement, exceed the value of accumulated employee and employer contributions, while the losers are those who would be better off if they simply received the value of their contributions plus interest, rather than relying on the plan,” said report author Geoffrey Young.
Other problems with these DB plans include: they potentially discourage movement of workers between the private and public sectors; they “waste human potential” by encouraging the early retirement of those who might wish to continue to work; and they lead to underfunding and further calls on public funds, found the report.
Public-sector DB plans could be redesigned to retain their appeal, including certainty and efficiency, without redistributing retirement income to the extent they now do, said Young. He recommends the following changes:
•Adjusting the “magic number” formulas (age plus years of service) and minimum service requirements that provide long-service employees with early retirement benefits, not given to late arrivers.
•Extending the earnings base for DB formulas, usually the best five years of non-indexed earnings, to 10, 15 or more years, or to the full career average.
•Gradually reducing the free component of the survivor benefit in plans that provide a free benefit for surviving spouses, eventually leaving the married to purchase their survivor benefits with an actuarial reduction in their initial pension.
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