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Retirement Savings
Providing comfortably for retirement was an individual
responsibility in years gone by. Retirement from corporations
was accompanied by a gold watch and a small monthly stipend in
the years following the massive industrialization in the 1800s
and early 1900s. The growth of unions and the inevitable
vagaries of human nature caused these private and informal
arrangements to become regulated by governments. This ensured
funds were set aside to provide for pensions and that these
funds were safe from graft and corruption. Governments got into
the act of providing retirement benefits with Old Age Security
and compulsory pension schemes, such as the Canada Pension Plan,
as their "welfare state" grew.
Pension Plans
Pension plans are essentially a promise by a sponsor, usually a
company or a union, to pay a pension to the plan member.
In a "Defined Benefit" plan, the promised pension is based on a
clearly defined formula such as years of service or hours
worked. In a "Defined Contribution" plan, the promised pension
pension is based on whatever the invested contributions grow to.
The difference between the two types of plans lies in the
obligation of the sponsor and who accepts the investment risk of
the plan.
In a defined benefit plan, the sponsor owes the pension to the
plan member according to the established formula, independent of
the investment results of the plan. If the investment earnings
of the plan are inadequate to fund the promised pensions, the
sponsor is obligated to pay the pension anyway. Governments
mandate that pension plans must be valued by actuaries on at
least a triannual basis to ensure the "solvency" of plan.
Actuaries estimate the amount owed the sponsor, the liability,
and compare this to the invested assets of the plan. If they are
equal, the plan is said to be "funded"; if the liability or
amount owed is in excess of the invested funds available, the
plan is said to be "under funded"; if the assets of the plan
exceed the potential liability, the plan is said to be in
surplus. The ownership of this "surplus" is one of the more
controversial issues in the retirement world today. Since the
1980s and 1990s have been very good years for investment
results, many defined benefit plans are in substantial surplus.
Sponsors, arguing that they are only legally liable to pay the
promised pension argue that the surplus is theirs alone. They
also argue that they would have been liable to pay any shortfall
in the plan. Employees argue that the pension plan exists to pay
them pensions and any shortfall is theirs alone. As in most
matters financial, the argument has been referred to the courts
who examine the plan history and documents to decide who owns
what.
Defined Contribution plans involve contributions by either a
plan or a sponsor or both. These contributions are put into an
investment fund in the plan members's account and grow with the
investment earnings of the fund. At retirement, the accumulated
funds are used to purchase an annuity or a retirement income
fund, which pays a retirement income. Sometimes employers
mandate how their share of the contributions must be dealt with
but there is no argument over who owns the funds as they are
clearly the employee's.
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