Personal Finance

Unfortunate developments highlight the need for employers to convert DB pensions to defined contribution plans and group RRSPs.
By Steven G. Kelman | 02/08/17

I have a lot of sympathy for the former employees of Sears Canada, now under creditor protection, who besides losing their jobs and benefits, won't get the pensions they expected. As it stands at the time of this writing, they will get only 81% of the commuted value of their defined benefit pensions. That's better than a kick in the pants, but it still means that these people will get less for their retirements than they planned for, and there is little if anything they can do about it. They are simply unsecured creditors (Ontario residents may be better off; more on that below).

About the Author
Steven G. Kelman is president of Steven G. Kelman & Associates Limited. His company provides specialty publications and training for the mutual fund industries. Steven is the author of several personal finance books and is author or co-author of courses offered by the Investment Funds Institute of Canada, including the Ethical Conduct and Behaviour continuing education course and the Labour-Sponsored Investment Funds course. He received a B.Sc. from McMaster University, an MBA from York University and holds a Chartered Financial Analyst designation.

The reason for the shortfall is that the Sears Canada pension plan has been underfunded for years. Its state of affairs is a further indication that defined benefit pension plans are going the way of the dinosaurs.

The future costs and uncertainties of returns in a low interest rate environment simply make DB plans too risky for corporations. Indeed, employees with DB plans also may be open to different financial options after seeing, as in the case of Sears Canada, that the retirement incomes expected can be illusory when a company gets into trouble. The alternative retirement savings programs are defined contribution plans and group RRSPs, where employer costs are known and the investment risks are transferred to employees.

This isn't new. The shift from DB plans to alternatives based on returns on contributions is a trend that has been happening for decades. Whether the last DB plan in Canada is closed to new participants before or after the Toronto Maple Leafs win their next Stanley Cup is beyond my predictive capabilities. Nevertheless, in my opinion, the extirpation of DB plans is inevitable, with Crown corporations and governments being the last to make the switch.

Meanwhile governments, in my opinion, should kick in the shortfalls to make the Sears former employees and others in similar predicaments whole. The predicament these people find themselves in was beyond their control and the result of underfunded plans which were allowed by government.

Moreover, older members of pension plans for many years had draconian restrictions on what they could contribute to RRSPs to supplement their pensions. For example, in the early 1980s your maximum contribution to an RRSP if you were not a member of a pension plan was 20% of earned income up to a maximum of $5,500. However, if you were a member of a pension plan the maximum you could contribute to both your RRSP and your pension plan was $3,500. So, whether your pension plan was good or whether it was crap, your maximum RRSP contribution was still $2,000 lower than if you were not a member of a pension plan. Furthermore, in those years unused RRSP contributions couldn't be carried forward, putting members of pension plans at a further disadvantage.

Getting back to underfunded DB plans, the problems at the Sears Canada pension plan and other DB plans that are underfunded are reflections of employer contribution holidays. Simply put, if corporations had high returns for a number of years as was the case in the 1990s, they could, and in many cases would, take a holiday from making contributions to their employees' plans.

To use a very old analogy, seven years of plenty followed by seven years of hunger resulted in pension surpluses becoming unfunded pension liabilities for those companies that took pension contribution holidays and didn't have the cash flow required to get on side. There are rules that require that the deficits be eliminated within specific time frames, but governments extended these time limits, recognizing that interest rates were low and stock market returns volatile.

To the best of my knowledge, only Ontario has a pension guarantee fund. It kicks in if the sponsor becomes bankrupt or the pension plan is wound up. The maximum benefit is $1,000 a month, which was a reasonable amount when the plan was established 37 years ago.

So, what should be done? I've seen the suggestion that governments should change the rules so that pensioners rank ahead of secured creditors if a company becomes insolvent. That way obligations to pensioners get paid first before anyone else. That could cause its own set of problems. For instance, if funds are limited, will pension obligations rank ahead of severance pay? And if a trustee is trying to sell the corporation's business as a going concern, how will pension obligations impact the value of the business and the willingness of a buyer to assume the obligations?

The best bet in my opinion is to put into place some sort of mandatory pension insurance, with all provinces and the federal government participating and guaranteeing payments. The premiums should be high enough to encourage both employers and employees to consider converting DB plans to defined contributions plans. For the near term, companies should consider setting up, for new employees, defined contribution plans or group RRSPs.

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