More Canadian employers should consider target-benefit pension plans for their employees these days.
The model is gaining steam. In mid-December, 2020, the Quebec legislator signed into law the ability for all employers in Quebec to establish a target-benefit plan. There was overwhelming support from industry stakeholders throughout the legislative process including one of the largest unions in Quebec.
So, what’s the big deal?
Industry experts across the country and around the globe have been advocating for target-benefit plan for years. British Columbia, Alberta and New Brunswick have allowed the plans for several years and some multi-employer pension plans in Canada have operated in the same construct as the plans as well as in other countries such as Japan, Netherlands and Denmark.
Proponents of the plans have highlighted the fact that this type of plan provides a simple and efficient way for workers to save for retirement and significantly limits the employer’s exposure to risk — that risk has been the primary reason that’s been driving employers away from traditional defined benefit plans for the past two decades. Target-benefit plans combines cost certainty with similar investment and longevity risk pooling advantages as a traditional defined benefit plan, and also provides a measure of intergenerational equity.
Is a target-benefit plan too good to be true?
A target-benefit plan provides an additional tool for employers to provide a sustainable retirement income for their employees. The total risks under these plans are the same as for other retirement savings vehicles. It’s simply how the risk is shared that differentiates it from traditional pension plans.
Employers unable, or unwilling, to manage volatility related to DB pension plans will be satisfied that a target-benefit plan enables fixed accounting and cash costs, achieved by transferring that risk to plan members. As its name suggests, the target benefit payable to the participant will move from the target as the financial health of the plan fluctuates. Quebec, like other legislators, has built margins into the plan funding rules to help prevent a reduction of benefits but in extreme situations the benefit could be decreased. Sponsors could also use other levers to limit the volatility of the base benefit, for example by building more margins or making certain ancillary benefits conditional. The inherent reflex of some fiduciaries could be to take the safest route possible to avoid a benefit reduction by reducing significantly the investment risk but that is not ideal as doing so would remove the potential of investment gains, hence removing some benefit of establishing a target-benefit plan in the first place.
The opponents of target-benefit plans will argue that a plan that could reduce benefits during the retirement years isn’t appropriate, and yet, as a society we accept that hundreds of thousands of Canadians relying on a capital accumulation plan in the decumulation phase are at great risk of decreases during that phase.
In addition to providing a more valuable retirement benefit than a typical capital accumulation plan, the other main benefit of a target-benefit plan is the ability for anyone to understand the output of the savings. The CAP industry has made significant progress in the past decade to enhance the awareness of the importance of saving.
It provided models to help Canadians understand the savings required to attain certain retirement income goals and provided solutions to attain more optimal investment allocation. Even with these improvements, according to a recent Aon survey, most Canadians are concerned that they’ll run out of money in retirement. The same survey shows that many Canadians don’t have a goal on how much they need to save nor know how much retirement income they should expect to receive.
We need to see more action from legislators to make these types of plans more attractive, for example, by ensuring that the pension adjustment is calculated as if it was a capital accumulation plan. Employers would likely welcome more harmonization between the various provincial and federal legislations to simplify its inception and understanding. We also need more options for smaller employers, or those not interested or willing, to undertake the overall target-benefit plan governance to allow them to benefit from the pooling effect.
I believe that there’s strong interest in this type of plan in Canada and this interest will continue to grow as it’s better understood. La Presse and Alcoa Corp. in Quebec were already moving towards a target-benefit plan before the legislation was passed late last year. It’s encouraging to see governments, employers and plan providers continuing to innovate. This will ensure that all Canadians can have access to a secure and sustainable retirement.
Jason Malone is a partner of retirement solutions for Aon in Montreal. These are the views of the author and not necessarily those of Benefits Canada.