Guest neo Posted May 16, 2003 Share Posted May 16, 2003 Hi IFG, Yes, I find that it's difficult to write both clearly and accurately about this subject. The more precise one becomes about the various features, the more incomprehensible the explanation. Once again, anyone who's in a position where their future actually depends on getting this right truly must talk to a trustworthy financial professional. To your points: a difference in DC retirement assets of over 20% in one year for employees with similar lengths of service would surely be at the extreme end of the range. The DC funds overall would of course be held in a balanced category of investments, ameliorating big swings in pension fund value. What circumstances do you envision that would cause a significant risk of short term value swings greater than that? Furthermore-- and this in my view cuts to the heart of the matter-- what is it that insulates DB funds from similar swings in asset value? The answer is, of course: nothing. There is nothing whatsoever that's special about the managers of the funds contained in DB pensions. There is nothing special about the money itself that insulates it from swings in asset value. DB funds are subject to exactly the same value swings as are DC funds. The difference is, of course, that when that swing pulls the DC fund down, there is no liability. When that swing pulls the DB plan down, there is. For the DB fund, that liability is now born by the employees who have yet to retire. If the fund goes insolvent or pension income must be lowered then all employees, retired and working, take the hit. Carrying further on this line of thought, when a DB pension fund goes into an underfunded state, it destabilizes the entire enterprise. No matter how well run the underlying business, they cannot predict swings in pension fund value. They may be permitted, as was Air Canada, to take a holiday from pension fund contributions, only to find a few years later that the over-funded state has disappeared and has become a huge underfunded mess. If that occurs at the same time as the enterprise is suffering its own underlying financial problems, then you really have a difficult situation for all concerned. This is what's happened to Air Canada employees. This situation can never arise with a DC plan. The employer knows precisely and predictably what his liability is for funding the pension. The pension fund cannot, by definition, be underfunded. It cannot destabiiize the entire enterprise, and the lives of current employees, in order to secure (note that I did not say "guarantee") a fixed payout for retirees. Another aspect of the DB vs DC debate (for employees contemplating negotiating one with their employer,) is what will we be able to get? Is the small employer, say one with 50 or 100 workers, going to go for a DB plan? Is this employer going to submit his enterprise to the potential liability that a DB plan will always bring? He would probably rather sacrifice his firstborn. The DC plan represents an option that can bring a company pension plan to many employees who might otherwise never be able to get one. To another of your comments: Thatcherism. While I find many of Mrs. Thatcher's ideas and practices repellant, I do believe that employees can no longer afford to pretend that our demands and our expense are somehow insulated from the market in which our employer operates. As employees, we need to be far more cognizant, and responsible, about how we view our place in an enterprise. I don't say this to be nice to the employer, although that is a nice side benefit. I say this because to be cognizant and responsible in our views is enlightened self-interest. An unviable employer means an insecure job. That sucks for everbody, current employees and retirees alike. I'm not sure why my comments in this area cut you a little, but there was absolutely nothing intended as a slight on you or your viewpoint, especially given that you prefer the 'clean break' aspect yourself. To the specific example you kindly illuminated, I simply have my general comments to repeat: with either a DB or a DC pension, plan conservatively. If you have a DC plan, expect your fund on retirement to provide for the low end of the reasonable range of valuations, providing for the $50K annuity example you gave and thereby meeting your expectations. If the fund does well and you wind up with $70K, then it's Easy Street. You either get a good thing, or you get a better thing, not you win or you lose. I'd like to repeat, that there is nothing special about the investment in a DB plan. A DC plan has every reason to do just as well as far as asset appreciation is conerned, perhaps more so because the plan is out of range of employer meddling. Best wishes, neo Link to comment Share on other sites More sharing options...
Guest neo Posted May 16, 2003 Share Posted May 16, 2003 Hi IFG, Yeah, I expect that I sound more like I'm sniffing glue than pasting with it. It's difficult to write both clearly and accurately about this subject. The more precise one becomes about the various features, the more incomprehensible the explanation. Once again, anyone who's in a position where their future actually depends on getting this right truly must talk to a trustworthy financial professional. To your points: a difference in DC retirement assets of over 20% in one year for employees with similar lengths of service would surely be at the extreme end of the range. The DC funds overall would of course be held in a balanced category of investments, ameliorating big swings in pension fund value. What circumstances do you envision that would cause a significant risk of short term value swings greater than that? Furthermore-- and this in my view cuts to the heart of the matter-- what is it that insulates DB funds from similar swings in asset value? The answer is, of course: nothing. There is nothing whatsoever that's special about the managers of the funds contained in DB pensions. There is nothing special about the money itself that insulates it from swings in asset value. DB funds are subject to exactly the same value swings as are DC funds. The difference is, of course, that when that swing pulls the DC fund down, there is no liability. When that swing pulls the DB plan down, there is. For the DB fund, that liability is now born by the employees who have yet to retire. If the fund goes insolvent or pension income must be lowered then all employees, retired and working, take the hit. Carrying further on this line of thought, when a DB pension fund goes into an underfunded state, it destabilizes the entire enterprise. No matter how well run the underlying business, they cannot predict swings in pension fund value. They may be permitted, as was Air Canada, to take a holiday from pension fund contributions, only to find a few years later that the over-funded state has disappeared and has become a huge underfunded mess. If that occurs at the same time as the enterprise is suffering its own underlying financial problems, then you really have a difficult situation for all concerned. This is what's happened to Air Canada employees. This situation can never arise with a DC plan. The employer knows precisely and predictably what his liability is for funding the pension. The pension fund cannot, by definition, be underfunded. It cannot destabiiize the entire enterprise, and the lives of current employees, in order to secure (note that I did not say "guarantee") a fixed payout for retirees. Another aspect of the DB vs DC debate (for employees contemplating negotiating one with their employer,) is what will we be able to get? Is the small employer, say one with 50 or 100 workers, going to go for a DB plan? Is this employer going to submit his enterprise to the potential liability that a DB plan will always bring? He would probably rather sacrifice his firstborn. The DC plan represents an option that can bring a company pension plan to many employees who might otherwise never be able to get one. To another of your comments: Thatcherism. While I find many of Mrs. Thatcher's ideas and practices repellant, I do believe that employees can no longer afford to pretend that our demands and our expense are somehow insulated from the market in which our employer operates. As employees, we need to be far more cognizant, and responsible, about how we view our place in an enterprise. I don't say this to be nice to the employer, although that is a nice side benefit. I say this because to be cognizant and responsible in our views is enlightened self-interest. An unviable employer means an insecure job. That sucks for everbody, current employees and retirees alike. I'm not sure why my comments in this area cut you a little, but there was absolutely nothing intended as a slight on you or your viewpoint, especially given that you prefer the 'clean break' aspect yourself. To the specific example you kindly illuminated, I simply have my general comments to repeat: with either a DB or a DC pension, plan conservatively. If you have a DC plan, expect your fund on retirement to provide for the low end of the reasonable range of valuations, providing for the $50K annuity example you gave and thereby meeting your expectations. If the fund does well and you wind up with $70K, then it's Easy Street. You either get a good thing, or you get a better thing, not you win or you lose. I'd like to repeat, that there is nothing special about the investment in a DB plan. A DC plan has every reason to do just as well as far as asset appreciation is conerned, perhaps more so because the plan is out of range of employer meddling. Best wishes, neo Link to comment Share on other sites More sharing options...
Guest neo Posted May 16, 2003 Share Posted May 16, 2003 In paragraph 3, this line, "For the DB fund, that liability is now born by the employees who have yet to retire..." should have read, "For the DB fund, that liability is now born IN PART by the employees who have yet to retire." Link to comment Share on other sites More sharing options...
IFG Posted May 17, 2003 Share Posted May 17, 2003 We're probably getting to the circle point here, neo. I don't think we have a huge difference in principle, more one of emphasis or magnitude. There's lots to like about DC plans. They're fully portable, so you're not enslaved by a golden collar to your employer, they let you save for the future while working at small entrepreneurial companies (DB obviously only fits large employee groups), and indeed somewhat fulfill the same spirit in the employee. There are even some arbitrary inequalities in DB plans as well due to the actuarial assumptions that must be made, and the way pensions are calculated. The only thing I'm really questioning is what seems to be your assessment of the relative risks that the two structures entail, but of course that assessment will pull one way or the other won't it?. IMHO, you both overweigh the risks to the contributions in a DB plan, and underweigh those of going it alone. First, re: "DB funds are subject to exactly the same value swings" - Actually, not totally so IMO. But first I'd like to cover one aspect of why these things usually get in arrears. To paraphrase James Carville, "it's the [contributions], stupid". The funds are segregated, investments are pretty conservative and regulated etc, but they do go up and down. If you don't make the contributions when they're up, it can bite you. OTOH, it might be said that another few hundred million more on the debit side of AC's books would have brought things to a head sooner. But my main point here is that the rollover effect of large DB plans, one part building up while the other is paying out, provides a lot of stabilization just not available to solo plans. That was what my clumsy supertanker analogy was about, not only size, but also the ability to roll through multiple swells [cycles] from bow to stern while the individual boater rode up and down each one. Is that a guarantee - of course not, but by and large IMO your returns are safer. Rather than focusing on investment strategy (from a safety point of view, managers have a pretty good record), vigilance ought to be directed to making sure the contributions and valuation targets are met, an inherently more straightforward task than second guessing the managers' investment choices. Re: "What circumstances do you envision that would cause a significant risk of short term value swings greater than that [20%]?" - It's not about short term swings, but about comparing individual cumulative totals over the long term on an ongoing basis. I'll try and explain. Damned if I can find a link with the right kind of data to refer you to, but you can get a feel for the possibilities with simple spreadsheeting. The range of scenarios is endless, but for simplicity I plugged in contributions that gradually quadrupled over 25 years. Differences of less than 2%/yr in average returns will break your "extreme" 20% difference in total at the end. 3% (say 7 vs 10%) difference in the averages pops the final tallies by well over 40%. And consider the cyclical variation within even the same average. e.g., The difference between good times while your contributions and total plan are low, compared to the reverse of good times coming later in your career will easily vary the value of two plans that averaged 8%, by 20% and more at the end. BTW I adjusted for two 5-year periods early & late, alternately up and down 2% - hardly wild swings. These are not extreme scenarios at all, and in my book, structural tendencies to fluctuate my retirement income by 20 or 30% or more do get my attention. Freedom 55 has already turned into Freedom 57 or 58 and counting, admittedly because I don't want to cut back at all if I don't have to. Re: "Thatcherism" - Thought that might stir a response. Altho' I still say it's a different discussion, sociological or cultural more than economic, I'll touch on it as you did. Personally I'm repelled by the notion that employees are dependant on an employer, and even more that an employer might regard me them way too. I couldn't agree more with your comment about being simply a valued employee wanting fair compensation. A good pension scheme does not have to be seen as some sort of welfare coddling (a red herring IMO), but rather as one of the quid-pro-quos for being that valued employee for most of a career (in the few places where DB's still exist) as a small fish in a very big pond: a (albeit collectively) negotiated system for achieving deferred compensation for retirement years rather than an individual savings vehicle and a virtual wager with older or younger colleagues on who in the end has the most fortuitous retirement date. An apple and an orange. I'm trying like hell to get you to see the truth of the matter, neo - am I getting close? Cheers, IFG Link to comment Share on other sites More sharing options...
IFG Posted May 17, 2003 Share Posted May 17, 2003 We're probably getting to the circle point here, neo. I don't think we have a huge difference in principle, more one of emphasis or magnitude. There's lots to like about DC plans. They're fully portable, so you're not enslaved by a golden collar to your employer, they let you save for the future while working at small entrepreneurial companies (DB obviously only fits large employee groups), and indeed somewhat fulfill the same spirit in the employee. There are even some arbitrary inequalities in DB plans as well due to the actuarial assumptions that must be made, and the way pensions are calculated. The only thing I'm really questioning is what seems to be your assessment of the relative risks that the two structures entail, but of course that assessment will pull one way or the other won't it?. IMHO, you both overweigh the risks to the contributions in a DB plan, and underweigh those of going it alone. First, re: "DB funds are subject to exactly the same value swings" - Actually, not totally so IMO. But first I'd like to cover one aspect of why these things usually get in arrears. To paraphrase James Carville, "it's the [contributions], stupid". The funds are segregated, investments are pretty conservative and regulated etc, but they do go up and down. If you don't make the contributions when they're up, it can bite you. OTOH, it might be said that another few hundred million more on the debit side of AC's books would have brought things to a head sooner. But my main point here is that the rollover effect of large DB plans, one part building up while the other is paying out, provides a lot of stabilization just not available to solo plans. That was what my clumsy supertanker analogy was about, not only size, but also the ability to roll through multiple swells [cycles] from bow to stern while the individual boater rode up and down each one. Is that a guarantee - of course not, but by and large IMO your returns are safer. Rather than focusing on investment strategy (from a safety point of view, managers have a pretty good record), vigilance ought to be directed to making sure the contributions and valuation targets are met, an inherently more straightforward task than second guessing the managers' investment choices. Re: "What circumstances do you envision that would cause a significant risk of short term value swings greater than that [20%]?" - It's not about short term swings, but about comparing individual cumulative totals over the long term on an ongoing basis. I'll try and explain. Damned if I can find a link with the right kind of data to refer you to, but you can get a feel for the possibilities with simple spreadsheeting. The range of scenarios is endless, but for simplicity I plugged in contributions that gradually quadrupled over 25 years. Differences of less than 2%/yr in average returns will break your "extreme" 20% difference in total at the end. 3% (say 7 vs 10%) difference in the averages pops the final tallies by well over 40%. And consider the cyclical variation within even the same average. e.g., The difference between good times while your contributions and total plan are low, compared to the reverse of good times coming later in your career will easily vary the value of two plans that averaged 8%, by 20% and more at the end. BTW I adjusted for two 5-year periods early & late, alternately up and down 2% - hardly wild swings. These are not extreme scenarios at all, and in my book, structural tendencies to fluctuate my retirement income by 20 or 30% or more do get my attention. Freedom 55 has already turned into Freedom 57 or 58 and counting, admittedly because I don't want to cut back at all if I don't have to. Re: "Thatcherism" - Thought that might stir a response. Altho' I still say it's a different discussion, sociological or cultural more than economic, I'll touch on it as you did. Personally I'm repelled by the notion that employees are dependant on an employer, and even more that an employer might regard them way too. I couldn't agree more with your comment about being simply a valued employee wanting fair compensation. A good pension scheme does not have to be seen as some sort of welfare coddling (a red herring IMO), but rather as one of the quid-pro-quos for being that valued employee for most of a career (in the few places where DB's still exist) as a small fish in a very big pond: a (albeit collectively) negotiated system for achieving deferred compensation for retirement years rather than an individual savings vehicle and a virtual wager with older or younger colleagues on who in the end has the most fortuitous retirement date. An apple and an orange. I'm trying like hell to get you to see the truth of the matter, neo - am I getting close? Cheers, IFG Link to comment Share on other sites More sharing options...
IFG Posted May 17, 2003 Share Posted May 17, 2003 Hi, Conehead - In trying to learn more, do consult a pro. Neo and I are just a couple of interested, somewhat informed retail-level punters batting some ideas back and forth in our own very humble opinions, recommending nothing for anybody. With that caveat, Here's a link that summarises savings vehicles: http://www.altamira.com/altamira/products/desc/registered+retirement+savings+plan+(rrsp)/_links/_typeofrrsp.htm And this one provides a little more on closing out options: http://www.altamira.com/altamira/products/desc/registered+retirement+income+fund+(rrif)/_links/_options.htm As for your AC plan, I may be out to lunch, but (again IMOVHO!) I don't think things are necessarily as dire as all that for you guys. The fund is below where it actuarialy should be, which makes it a lousy time to wind it up, if it does come to that. With some adjustments and some time, it can probably recover IF the mothership keeps sailing. Hopefully on the good side of disappointing rather than disastrous, but as neo has pointed out, DB plans are not completely risk-free. I live in the Soo, where Algoma Steel has shrunk from around 12 or 15K employees to about 3K, with a bankruptcy and restructuring along the way. Pensioners didn't escape completely, but I believe they're making out OK. It's always a good idea to supplement a pension plan thru' RRSP's, and whatever other means. Hope that helps some, but get the real goods from somebody reputable with some kind of sheep-skin hanging on their wall. Cheers, IFG Link to comment Share on other sites More sharing options...
Guest neo Posted May 17, 2003 Share Posted May 17, 2003 Hi IFG, You wrote: "The only thing I'm really questioning is what seems to be your assessment of the relative risks that the two structures entail, but of course that assessment will pull one way or the other won't it?. IMHO, you both overweigh the risks to the contributions in a DB plan, and underweigh those of going it alone." Ah, well if that's ALL you're concerned about, please let me put your mind at ease. While I've certainly mentioned various general risks associated with both plans, I don't recall ever quantifying or comparing them. That would be far beyond my expertise, and in any case is impossible without knowing the specifics of any given plan. That fact is a good deal of the reason why I won't advocate one type of plan over the other. I'm sure there's good and bad pension plans of either the DB or DC flavor; each will have its own specific attributes. If, for instance, I mention six examples of risk associated with DB plans and only three with DC plans, that has no bearing whatsoever on the LEVEL of risk associated with either one. That would take a far, far more involved assessment, as mentioned above. The sole quantifiable comment I can recall making about DB plans is that employees will need to take a closer look at the risk of plan insolvency and employer failure than we have in the past. It's quite possible, in my view, that we will need to assign a HIGHER level of risk to those contigencies. That's about as far as I'm willing to go on any relative risk declaration. We are clearly talking about different things regarding differences in pension payout for employees retiring at different times. You will recall that my example only stated that employees (with similar lengths of service) retiring a year apart should not see any great difference in payout. Your counter example, as I understand it, talks about differences in payout based on different hypothetical average long-term returns. Well SURE that's going to make a big difference. But how can it affect the employees in any given pension fund in the way you describe? They are all subject, within a narrow range, to the same long-term rate of return. Employees retiring with similar lengths of service, within a few years of each other, should see pension payouts that are within sight of each other. You're absolutely right that DB plans, like a supertanker (which I thought was a good analogy) keep plowing along through stormy seas. This feature, if employees in a DC plan wish it, can be approximated by investing in a larger fund (or perhaps more wisely, in a group of larger funds) which are designed to do the same thing. The less risk within the investment made by the DC plan contributors, means the less variation in plan value over time, which means less variation in plan payout over time. My point about employees views of their employers and their benefits is a philosophical one, obviously. I've come to the view that employees only harm themselves when they view their own welfare in isolation from that of the employer. To a degree, DB plans contain a risk of this sort. The employer is on the hook for meeting the pension commitments, in perpetuity. That commitment is NOT completely predictable; there is always an element of risk that the underlying assumptions on which the plan is funded will change for the worse. When that happens the enterprise, on which both current AND retired employees depend, is affected detrimentally. Assuming the company and plan remain solvent, it's the CURRENT employees and CURRENT employer who are now on the hook to guarantee the income of retired employees. We both are of the same mind that an employee should be valued and treated fairly, but my view of that symbiotic relationship is that it ends upon retirement. It's the employer's job to look after you (within reason) while you are an employee; not when you no longer are. I believe that we as employees should recognize that once we retire, our former employer is no longer responsible for our well-being, and that we must plan accordingly. And please don't think that my mind works this way because I've got my retirement ducks in a row. My retirement, currently, looks like a financial disaster area: the product of working for too many small employers who had no pension plan at all, the collapse at AC, and my own fiscal irresponsibility. So I think I deserve a little credit for arguing against my own best interests in this area. The TRUTH of the matter? Well, you're a braver man than I in that claim. About as far as I'm willing to go is that I truly believe that both plans have their pros and cons, and that employees should examine which type of plan is preferable for themselves, if they have a choice. Beyond that level of truth I fear to tread. Best wishes, neo Link to comment Share on other sites More sharing options...
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