The payout formulas for Canadian public sector DB pension plans produce little-acknowledged inequities, according to a new report from the C.D. Howe Institute.
The report, Winners and Losers: The Inequities within Government-Sector, Defined-Benefit Pension Plans, shows that typical DB plans systematically transfer income away from employees in occupations with slow wage growth, to employees in occupations or careers with higher wage growth rates. The net result of this is that higher-income public sector roles such as deputy ministers often do better by the system than those in lower-income positions, such as clerks.
“The winners are high-flying employees who are likely to enjoy pensions that, at retirement, exceed the value of accumulated employee and employer contributions,” says report author Geoffrey Young. “While the losers are those who would be better off if they simply received the value of their contributions plus interest, rather than relying on the plan.”
The report also suggests that these plans have the potential to discourage movement of workers between the private and public sectors, threaten the availability of talent by encouraging the early retirement of those who might wish to continue to work, and lead to underfunding that requires additional taxpayer support.
Young reasons that public sector DB plans could be redesigned to retain their appeal without redistributing retirement income to the extent they now do. His report recommends three changes:
- Adjustment of the “magic number” formulas (age plus years of service) and minimum service requirements that provide long-service employees with early retirement benefits.
- Extension of the earnings base for DB formulas, usually the best five years of non-indexed earnings, to 10, 15 or more years, or to the full career average.
- A gradual reduction of the free benefit some public sector plans provide for surviving spouses (as Nova Scotia recently started to do), eventually leaving married public sector plan members to purchase their survivor benefits with an actuarial reduction in their initial pension, as is required in western Canadian public service plans.