Comparison of DC versus DB Pension Plan
1. DEFINITIONS
A defined benefit (DB) plan is a plan which bases the pension at retirement on the member's length of service and, usually, his or her average salary at retirement. The current University of Winnipeg plan is a defined benefit plan.
A defined contribution (DC) plan is a plan which bases the pension at retirement on the accumulations in the member's account at that date. These accumulations are made up of the member's contributions plus interest and the University's contributions on the member's behalf plus interest.
2. KEY DIFFERENCES
a. In a DC plan, the member's pension at retirement is directly related to the investment return on the member's account. If that return is good the pension is higher and vice versa.
In a DB plan, there is no direct relationship between the investment return and the member's pension. If the return is good, that will lead to surpluses in the plan which may result in a better pension. If the return is poor, the University is responsible for covering any shortfall in the fund.
b. In a DC plan, the University's matching contribution is directly allocated to the member's account so that on death, retirement or termination of employment, the member's benefit is equal to the sum of the member and the University matching contributions plus interest. In other words, a DC plan provides for full portability.
In a DB plan, the University's matching contribution is directed into the pension fund but is not allocated to individual members. At death, retirement or termination of employment, the member's benefit is equal to the "value" of the defined benefit and is not related to the matching University contribution. In practice, for members who die or terminate prior to age 55, the University's share of the value of the benefit is likely to be somewhat less than the matching contribution.
c. In most DC plans, and in the design being proposed by the University, the member can direct his or her own investment strategy through a variety of pooled funds (pooled funds are much like mutual funds but with lower management expenses). In this way, the asset mix of a member's account can be tailored to an individual's preferences.
In a DB plan, the funds are invested by the manager in a manner which satisfies the needs of the plan as a whole.
d. In a DC plan, the annual Pension Adjustment (PA) which reduces RRSP contribution room in the following year is simply the sum of the member and the University contributions on the member's behalf. In a DB plan, the annual PA is determined from a formula based on the amount of pension earned in the year. Based on the current University DB plan and a DC plan which has the same contribution structure as the current DB plan, the PA under the DC plan is lower at all salary levels (i.e. it will allow for higher RRSP contributions), as shown below:
Pension Adjustment for 2000
| Salary Level | DB | DC |
| 30,000 | 3,180 | 2,646 |
| 40,000 | 4,570 | 3,572 |
| 50,000 | 6,370 | 4,772 |
| 60,000 | 8,170 | 5,972 |
| 70,000 | 9,970 | 7,172 |
| 80,000 | 11,770 | 8,372 |
| 90,000 | 13,570 | 9,572 |
On conversion from a DB plan to a DC plan, the sum of the member's DB PA's since 1990 are compared with the amount transferred to the DC plan in respect of service since 1990. The difference is a PAR (Pension Adjustment Reversal) and this is added to the member's RRSP contribution room.
e. In a DC plan, day to day operation of the plan is much simplified - for example it would be quite practical for different groups on campus to negotiate different levels of contribution and have different benefit levels - something which would be very difficult under the DB plan.
On the other hand, because the investment decisions made by individual members are so important under a DC plan, there is an increased responsibility on the sponsor of such a plan to ensure that each member receives on an initial and continuing basis, sufficent information and education on the risks and rewards of investing so that the member can make an informed decision about the investment of his or her account.
4. COMMENTARY
a. If you don't plan to eventually retire from the plan, you would almost certainly be better off in a DC plan - thus on termination of employment, you will get the full share of the University contributions and, in the meantime, you will be able to make higher RRSP contributions.
b. If you do plan to retire from the plan but not until you are 65 or older, you might well be better off in a DC plan. The benefits on early retirement in the DB plan involve a substantial subsidy from the plan. If you are not going to take advantage of that, the DC plan will likely provide a similar benefit but with the possibility of higher RRSP contributions in the meantime. The exception to this would be those hired in their 50's or 60's whose DB pension will likely be higher than the DC plan.
c. If you plan to retire from the plan in the 55 to 61 age range (assuming that you would be eligible for an unreduced pension at age 61) you are more likely to be better off by staying in the DB plan. However, it should be noted that the combination of high interest credits on members' contributions and low salary increases has meant that the difference is not as great as it once was. Thus based on 60 faculty members aged between 55 and 60 who could retire at September 1, 2000, the average of the ratio of the value of their defined benefit pension on their retirement at that date to their projected defined contribution accumulations at that date (2 x contributions with interest) is about 110%, with the range from about 85% to 135%. Those whose ratio is less than 100% would have been better off in a DC plan.
d. Under the current DB plan, the University is the ultimate guarantor of the pension. Under the proposed DC plan, the University's guarantee is limited to the contributions. A younger plan member (say 45 and under) can offset this loss of benefit guarantee by being more aggressive with the investment of his or her account. Aggressive in this context does not mean foolhardy - rather it would reflect a higher proportion of equity investments. The characteristics of equity investments are that, over the long term, they generate a higher return than fixed income investments but, in the short term, they are more volatile. But for an investor 10 or more years from retirement, volatility in his or her retirement account is not a problem since the member won't need to (and, in fact, can't) access those funds for many years. An older plan member may need to be more conservative so that the investment mix of his or her retirement account might look something like the current pension plan.
5. A NOTE ON THE UNIVERSITY OF MANITOBA PLAN
The University of Manitoba pension plan is a "hybrid" ie. the pension at retirement is the better of the pension produced by a DB formula and that which can be produced by DC contributions.
The DB part of the UOM plan is considerably inferior to that provided under the UOW plan. Thus the UOM formula is 1.3%/2.0% for all service since January 1, 1966 compared with the UOW formula of 2.0% for service up to December 31, 1987 and 1.4%/2.0% since then. On retirement prior to 65, the UOM DB pension is reduced by 0.25% per month. Under the UOW plan, there is no reduction where the member is age 61 or more and age plus service is 85 or more. Finally member and University contributions to the UOM plan are each 1% higher than under the UOW plan.
Given the combination of high investment return and low salary increases in recent years, the UOM plan has operated largely on a DC basis because that pension has been so much higher than the DB pension. Nevertheless, the calculation of Pension Adjustments is still based on the DB benefit formula where that produces a higher PA than the sum of the contributions.