Defined Benefit Pension Plans (DB Plans) were once the greatest reward for retirees who had put in many years of service. These plans were popular due to the life-long guaranteed levels of income they provide. However, many large and mid-sized corporations are replacing DB Plans with Defined Contribution Pension Plans (DC Plans) due to market risks, longevity risk, and the high costs associated with DB Plans. Although some features in DC Plans make them attractive to both employers and employees, DC Plans do not offer guaranteed income for life.
The Effect on Your Financial Plan
The switch from DB Plans to DC Plans reduces the risk for corporations, while allowing employees to personally manage their retirement savings. However, the shift towards DC Plans represents a serious challenge for future retirees. Under a DB Plan, employees know exactly how much they will receive at retirement, but under a DC Plan there is no such certainty.
Canadian investors are maximizing their retirement income potential and minimizing financial risks faced at retirement by turning to Product Allocation. While asset allocation plays an important role in the wealth accumulation phase of investing, the right mix of investment products for those who require income is necessary to mitigate risk for a sound retirement income plan. This mix of investment products is known as Product Allocation.
Industry expert Moshe Milevsky recommends that, ideally, an investor's Product Allocation should consist of a mix of an Immediate Annuity, a Guaranteed Minimum Withdrawal Benefit product (GMWB), and a Systematic Withdrawal Plan (SWP) from portfolio assets. This will help ensure a guaranteed stream of retirement income similar to what a Defined Benefit Plan provides.
Using these types of products can be very useful for investors who want to turn their current DC Plan or non-guaranteed portfolio into more secure retirement income. By reallocating a percentage of investments into these products (which feature various growth potential and income guarantees), investors can recoup some of the benefits provided by the increasingly rare DB Plans. If you wish to find out more about Product Allocation and other strategies and how they may help you attain a more sustainable stream of income for your retirement contact your financial advisor.
What's the difference between Defined Benefit (DB) and Defined Contribution Plans (DC)?
Defined Benefit Pension Plans (DB Plans)
The income received under this plan is predetermined, and is based on a formula that includes the number of years an employee worked for a company and his or her average salary;
The employer is responsible for making sure that there are adequate assets in the plan to pay the promised benefits at retirement;
The employer will also have to cover any shortfalls in the plan caused by market fluctuations;
Defined Contribution Pension Plans (DC Plans)
Under this plan, the only certainty is the amount of money the employer and employee contributes;
Investments held within a DC Plan are invested at the discretion of the employee, and thus the retirement income of the employee is impacted by fluctuations in the market. Employees with little knowledge about investments may not be aware of the impact of the investments chosen and the consequences to their future pension;
When the employee retires, the accumulated capital may be transferred to a locked-in retirement account (LIRA) or used to purchase a life annuity for the employee.
Shea Sanche is an independent financial advisor with Raymond James Ltd. in Thompson. His column appears every third Friday. You can contact him with suggested topics or questions by email at: [email protected]. Raymond James Ltd. is a member of CIPF.
