Defined-Benefit Public Sector Pension Plans: Who Wins and Who Loses?

The payout formulas for defined-benefit (DB) pension plans, such as those typically provided to government employees across Canada, produce little-acknowledged yet striking inequities, according to a report from the C.D. Howe Institute. In "Winners and Losers: The Inequities within Government-Sector, Defined-Benefit Pension Plans," Geoffrey Young shows how plan formulas can produce redistribution of retirement income among members and recommends potential reforms.

The report 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. In practice, this often means high-income deputy ministers do better by the system than do low-income 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 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." Other problems with these DB plans should concern the public: they potentially discourage movement of workers between the private and public sectors, waste human potential by encouraging the early retirement of those who might wish to continue to work, and bias plans toward underfunding and, hence, further calls on public funds.

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Public-sector DB plans could be redesigned to retain their appeal, including certainty and efficiency, without redistributing retirement income to the extent they now do. As a start, Young recommends three changes: (1) The "magic number" formulas (age plus years of service) and minimum service requirements that provide long-service employees with early retirement benefits, not given to late arrivers, could be better tuned. (2) The earnings base for DB formulas, usually the best five years of non-indexed earnings, could be extended to 10, 15 or more years, or to the full career average. (3) Plans that provide a free benefit for surviving spouses could gradually reduce the free component of the survivor benefit (as Nova Scotia recently started to do), eventually leaving the married to purchase their survivor benefits with an actuarial reduction in their initial pension, as is required in western Canadian public service plans. If smarter formulas allowed employees to work longer, by enabling them to choose their retirement age without fear of sacrificing benefits they have paid for, all employees could benefit, Young concludes. For the study go to: (Link)