The potential pension employees can get from their defined contribution plan peaked in 2000 and if economic conditions revert to historical norms, DC pensions could be only half as much, according to a report by Morneau Sobeco.
Its Vision report finds that an employee in a DC plan with a total contribution rate of 8%—which is close to the average rate in Canada today—and 30 years of service who retired in 2000 would have been able to buy a DC pension of nearly 48% of final pay (assuming an asset mix with a 50% equity weighting).
An accumulation period of 30 years in the same DC plan would have produced a pension as low as 14% of final pay (in 1977) or as high as 48% depending on the year of retirement, according to the report. It appears to be confirmation that investment volatility can have.
However, the culprit is the variability in wage inflation. Pay increases were much higher in the 1970s than any time since then. High pay increases means lower pensions as a percentage of pay in DC plans.
“Over time, a DC participant will be more vulnerable to the rate of pay increases than to investment risk,” says the report. “This is perhaps the most critical flaw with DC plans.”
What can plan sponsors do to ensure that their long-term workers don’t retire in 2025 with only half as much of a pension as retirees received in 2000? The answer, the report says, is a plan that shares the two characteristics of an ideal plan: stable costs and predictable retirement income.
DC plan participants will probably not be able to retire with as much pension in the next 10 years as they would have enjoyed over the past 10 years. And at some point, employers will feel the pressure to shore up their DC plans in some fashion.
“The longer corrective measures are delayed, the more expensive they will be to implement,” says the report. “One possible course of action is to consider alternate plan designs now…and implement one that better protects employees, at a reasonable cost to the organization.”
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