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The hidden costs of switching to a cheaper pension plan

Posted by on Jul 19, 2011 in Retirement | 0 comments

By Janet Mcfarland

Published Monday, Jul. 18, 2011 7:22PM EDT

Closing traditional pension plans to new hires is an increasingly popular way for employers to curb soaring funding obligations, but it’s not a quick fix and can even lead to unexpected costs.

Air Canada and Canada Post both proposed the idea in high-profile labour disputes with employees last month, and numerous other employers are taking steps to close their traditional defined-benefit employee pension plans. Typically, new workers are then enrolled in defined-contribution plans, which do not pay a guaranteed level of retirement income, so employers are not required to fund shortfalls.

While funding problems mean the conversion trend from defined-benefit (DB) to defined-contribution (DC) is unlikely to slow, pension experts say companies should be aware it can take decades for funding costs to start to come down, and in the meantime they can face unexpected human-resources costs, such as the loss of a key employee-retention tool.

“[The conversion strategy] doesn’t do much for about 20 years,” says Mercer pension consultant Paul Forestell, who has worked with companies closing their pension plans. “We’ve looked at it for clients where their liabilities don’t even start to peak until 10 years out … It’s like a snake – until you get that bulge through, you don’t save any money.”

That’s because employees remaining in the traditional DB pension plan still carry high costs, particularly as they reach their peak earning years.

The Saskatchewan government was one of Canada’s first employers to close its pension plans to new hires, starting in 1977, and switch new workers into DC plans, where pensions vary depending on investment returns.

Thirty-four years later, there are still 1,000 active employees in the old plans who haven’t retired yet, said assistant deputy minister of finance Brian Smith. He estimates it will take well over 80 years until the last remaining members of the DB plans – which pay a guaranteed income in retirement – have died and the plans can be wrapped up.

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