In Canada, the issue of retirement readiness shows up in headlines virtually every day — and the dominant theme is uncertainty.
Changes to retirement benefits in recent years, combined with poor equity market performance, have led to increased pressure to save for retirement.
Even those with a defined benefit (DB) pension plan, who presumably have brighter prospects for a comfortable retirement, haven’t done the planning necessary to ensure their retirement income will meet their expectations, according to a 2011 RBC Dexia survey.
Although 83 per cent of DB plan members showed a high degree of confidence their pensions would be there when they needed them, 31 per cent said they didn’t know what percentage of their annual income they would need to achieve their expected standard of living in retirement. This is a significant disconnect and has implications for employers.
Banking on the ‘pension promise’
Trust in the viability of a DB pension plan is likely well-placed — the employer is responsible for investing contributions while employees’ pension income is guaranteed for life. Further, many plans match inflation, which means a member’s spending power doesn’t erode over time.
What’s troubling is few people are aware of issues that could affect their pension income. Only five per cent of respondents to the RBC Dexia survey could recall hearing about underfunding problems or deficits in DB plans, and only four per cent were aware they were being phased out.
In an environment of low interest rates and weak market performance, underfunding is a significant issue for many DB plans. Employers are allowed to take several years to restore plans to full funding but if they go bankrupt before full funding is restored, plan members and retirees may receive less than 100 per cent of their promised pension.
One well-known example of underfunding due to insolvency is Nortel Networks. Its pension fund had a shortfall of $1.2 billion at its last assessment in 2009 when the company sought creditor protection. Last year, the company’s 12,000 Canadian pensioners saw their benefits reduced by an average of 25 per cent.
Because most DB plan members are public sector employees, their pensions aren’t likely to be affected by underfunding — at least not yet. The greater issue is their pensions may change and more plan members should be aware of this possibility.
Increasingly, employers are winding down DB plans in favour of more cost-efficient defined contribution (DC) plans. As of 2010, 75 per cent of Canadians with a registered pension plan were in a DB plan, down from 85 per cent one decade earlier, according to Statistics Canada.
Meanwhile, DC plan membership accounts for 16 per cent of all registered pension plan membership, up 2.4 percentage points from 2009.
While DC plans are less expensive for an employer to maintain, the switch is significant for plan members. Employees lose their income guarantee as they assume responsibility for investment decisions, which will likely have a major impact on their retirement income.
Lack of engagement in pension matters is not surprising, given the state of people’s financial and retirement planning knowledge. In Ontario, only 29 per cent of consumers had the basic financial knowledge needed to navigate everyday life, according to a 2011 study by the Investor Education Fund (IEF). More importantly, they were unable to translate financial knowledge into real-life application.
For example, 93 per cent of respondents correctly understood the longer you owe money, the more you pay in interest costs. But when asked about the cost of a 25-year mortgage compared to a 20-year mortgage, just 55 per cent understood it would cost more to borrow the money longer.
Low financial literacy is evident at the workplace as well. More than one-third (38 per cent) of plan members didn’t know what percentage of their salary they contributed to their pension plans, and only 49 per cent knew how much they would be receiving from their pensions when they retired, found the RBC Dexia survey.
Considering three-quarters said their pension is their primary retirement savings vehicle, this disconnect is troubling. If these pensions were to undergo a significant change, the lack of planning could have a significant impact on their retirement income.
On a large scale, low financial literacy translates into a poor balance sheet for Canadian households. Canadians save less than four cents for every dollar earned, a decline from 13 cents in 1990, according to Statistics Canada. The average household debt load is about 150 per cent of income, up from 93 per cent in 1990.
While federal and provincial governments are becoming more active in improving financial literacy as a whole, more is needed to convince people to take an active interest. Through pension and retirement savings programs, employers already play an important role in helping Canadians become better prepared for retirement — but more can be done.
How employers can help
Retirement planning is a complex process that requires independent research and decision-making. Frequent communication, written in clear terms and delivered in an approachable way, is essential for helping employees become better-equipped to make financial decisions.
Here are some ways to boost financial literacy efforts:
• Increase communication about pensions, retirement planning and financial planning in general. Provide a steady drumbeat of personal finance materials throughout the year in a variety of ways. Try to make it practical and personally relevant. For example, explain one aspect of the company’s pension coverage and how it impacts employees.
• Integrate personal finance materials into as many internal communication vehicles as possible. This could include: organizing a speaker series on various aspects of financial planning; building and actively promoting a financial planning section on the intranet; and putting retirement planning information in an internal newsletter.
• Inform employees by providing them with unbiased, independent, research-based resources.
Retirement is at the forefront of issues affecting employers and its importance will only increase as baby boomers exit the workplace. Taking steps now to help employees make better financial decisions will pay dividends down the road.
Perry Quinton is vice-president of marketing at the Investor Education Fund in Toronto, a not-for-profit authority in financial literacy, education and research. For more information, visit www.GetSmarterAboutMoney.ca.
3 things DB pension plan members should know
How much retirement income will I have?
Your total retirement income will come from your pension, government benefits including the Canada Pension Plan (CPP) and personal savings you may hold in a registered retirement savings plan (RRSP), tax-free savings account (TFSA) or other savings or investment accounts. Use Service Canada’s online retirement income calculator at www.servicecanada.gc.ca to estimate your monthly income.
How does my pension plan work?
The amount of your pension is based on a formula that usually takes into account your earnings and years of service with your employer. The retirement age for most plans is 65 but some plans let you retire earlier with a full pension if you meet certain milestones.
What spousal benefits does my DB plan provide?
If you have a spouse when you retire, he will receive 60 per cent of your pension if you die first. This is called the survivor pension and it’s required of most plans. If you die before retirement, your spouse (or your beneficiary or estate if you don’t have a spouse) will be entitled to the cash value of the pension benefits you earned to your date of death. If the benefits are going to your spouse, he may be able to receive them as a deferred pension or transfer the amount directly to his own RRSP or locked-in retirement account tax-free. Otherwise, payments are made in cash and are taxable.