I’m ancient so I remember when defined contribution pension plans were new and different and when most people (if they had any pension plan at all) had defined benefit plans. The company I was working for then brought in DC pension plans gradually. They actually asked you to pick whether you wanted to go DC or DB. Once you chose, though, you were stuck with your decision. Now, though, most employees have no choice. Defined Contribution plans are almost all that is on offer.
Defined Contribution Plans are not Inherently Evil
The problem I see isn’t with DC plans in and of themselves. DC plans even have some advantages, particularly if you change jobs often. The problem is hidden but huge.
How Do Average Canadians Handle Their Financial Affairs?
If you read or watch the news the same themes keep coming up in business news stories:
- small businesses complain they can’t hire part time workers who know basic math and who can make change
- investors are losing millions of dollars by choosing high risk investments when they thought they were choosing secure investments
- people are losing money by investing in mutual funds with high expenses, sometimes expenses that are so high they make no gains on their savings over 2, 5, or even 10 years
- credit card debt is out of control
- housing prices are extremely high but may crash at any moment yet people are still buying
- Canadian debt is at an all time high
- people are spending more than they are earning
- Canadians approaching retirement are expecting to have to keep working because they can’t afford to stop
- various groups are clamouring for required financial education courses in school
To me, it sounds like the average Canadian is not particularly good at handling money. They may not know how to budget. They may not have the basic math skills necessary to follow a budget if they do know how to set one. They may not understand more advanced math, even basics like “how much money do I get if my investment pays a 2% rate of return?” Most don’t seem familiar with the effects of inflation on money. Investment risks don’t seem widely understood either.
The Danger of DC Pension Plans Lies in the Implementation
Now what happens when you put these same average Canadians directly in charge of their own financial future?
When Defined Benefit pension plans were the norm, the average Canadian had to show up, work hard and well, and after 40-50 years they could retire. They would keep getting a regular cheque, admittedly a smaller one, from their former employer’s pension plan. Some Canadians suffered when their companies went bankrupt or suffered because their pension cheques were unexpectedly small, but overall most managed reasonably well. OAS and GIS were invented to try to catch those in dire straits.
Behind the scenes, paid money management professionals were in charge of the Defined Benefit pension plan funds. They would invest in money markets, commercial paper, both government and corporate bonds, preferred shares, small, medium and large cap companies and frankly anything else that they considered a good decision. Keeping the fund solvent and sufficiently large to pay the claims was their job. This was their professional job. They were accountable to various other groups and they knew what they were trying to achieve and how to do that.
But with DC pensions that all changes. How hard you work or even for how long is not necessarily going to ensure you get a decent pension. And you have to be the professional money manager!
To Get a Decent Pension from a Defined Contribution Plan You Have to Invest Wisely and Have Luck
Suddenly, with DC Pension plans, the average Canadian worker is expected to replicate the job of trained, accredited, paid professional money managers. The average worker is expected to understand how and in what to invest their entire pension savings in order to accumulate enough capital to generate enough income to live on after retirement.
The same guy who can’t tell you what coin you should get if you give them $2.07 to pay a $1.82 bill is supposed to choose what to invest in, when and where and manage it for 40 years to generate a livable pension.
Doesn’t this frighten anyone else?
But Employers are Responsible for Helping Employees Make Reasonable Educated Choices, Aren’t They?
No, they’re not. In fact what we received from one of our employers along with the list of investments to choose from was the one line statement: “We suggest you discuss what investments best suit your needs and risk tolerance with your financial advisor.”
Oh, of course! That’s exactly what the average guy putting 12-pound bobbins of yarn into a box for twelve hours a day or night shift will do. He’ll just pick up the phone and discuss this with his financial advisor.
- Did it say where to find a financial advisor?
- How to judge the qualifications of a financial advisor?
- How to PAY a financial advisor?
- What to ask a financial advisor?
Don’t be silly.
The Hidden but Real Danger of DC Pensions
So we have a huge population of employees who have limited or no financial training left adrift trying to choose what to invest their pension savings in, for how long, and where. No one is warning them that as they approach retirement it might not be a good idea to keep 100% of their money in stocks of venture capital companies in BRIC countries. No one is warning them that keeping 100% of their money for 40 years in a money market fund will get them a pension of about $100 a month in retirement. If they make terrible personal investment decisions no group or advisory committee is stepping in and stopping them or even warning them. No one is providing them with education seminars, case studies, examples or interpretations. They are on their own and there are not enough lifeboats for all.
Will No One Warn Canadians There’s an Iceberg Looming?
I couldn’t watch the movie Titanic because I couldn’t stand the feeling of helplessness knowing they were driving straight into that iceberg. Unfortunately, I’m going to have to watch the disaster when the bulk of the Canadian population gets to retirement age with only the pittances in their mismanaged Defined Contribution pension plans to see them through their golden years.
Why is no one else talking about this?
Do you think that average Canadians understand how to manage their DC pension plans? Please share your opinion on this frightening topic with a comment.