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Aug 12 2008

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Private Pension Crisis?

Private Pension Crisis?

So what is an unfunded liability?

It’s the amount by which the liabilities of the pension plan exceed assets in the plan, at a given date.

What are some of the factors that affect this unfunded liability and how does it occur?

1. The company is not profitable enough to keep up the payments into the plan. These plans are only as healthy as the underlying business. Look at Stelco or General Motors.

2. Retirees are living longer. This requires more assets in the plan.

3. The ratio of retires to contributing workers is growing.

While the Canada Pension Plan is a public pension, it has faced this challenge and has been in a catch-up mode for years. CPP was invested substantially in fixed-income investments; however, they recognized this would not support the large influx of retiring “baby-boomers. What did they do? For one, they’ve been raising our contribution rate which now stands at 4.95% of insurable earnings (in 2004 employment earnings between $3,500 and $40,500). If you’re an employee, your company is also kicking in an additional 4.95% and if you’re self-employed, you’re paying both amounts. That’s nearly 10%. The Secondly, CPP has also been allocating a percentage of their funds into the equity markets for several years now to improve long-term returns and lessen their liabilities.

What are private companies doing about the problem?

Companies are opting out of defined-benefit plans and evolving into “defined contribution plans” (DC). In a DC plan, the companies are responsible for contributing a percentage of your salary which is in turn invested into a group plan. However, the liability to the company stops there. You, the employee, are responsible for investment selection and ultimately for investment return.

Very recently, I now see that healthcare benefits for retires are now being reviewed with the trend towards reduced coverage,

The bottom line is that whether you have a defined-benefit (DB) or defined-contribution (DC) plan, pay attention to who’s managing it and how it’s being managed. It’s your retirement and nobody cares more about it than you. Maybe it’s time for a plan.

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