Australian Experience Shows Pitfalls of Ending Traditional Pensions
PensionDialog welcomes the following post from the Alliance for Retirement Income Adequacy, a network of Canadian organizations which are promoting an informed discussion about the importance of income adequacy in retirement.
These days, in Canada and around the world, headlines talk about switching public sector pension plans from traditional “defined benefit” plans to newer “defined contribution” models—such as 401(k)-type plans that are in the U.S.
Those who favour the DC plans argue that they cost less – typically the contributions made by plan members and employers are lower – and that the employer (or the taxpayer) does not have to worry about shortfalls when the plan is underfunded.
The private sector seems to have embraced DC, or so the argument goes, so why not the public sector?
The average starting pension from the Healthcare of Ontario Pension Plan – a defined benefit plan for healthcare workers in Ontario, Canada – was $18,400 in 2010. That sounds fairly modest. But if you were to receive that pension for 20 years in retirement, you will have received $460,000 in income. That’s significant. This is also augmented by government social programs like the Old Age Security (OAS) and Guaranteed Income Supplement (GIS).
Australia scrapped nearly all of its DB plans, replacing them with employer-funded DC plans, which are mandatory for all adults. And when it comes to savings, Australia has an enviable record: by the mid-1990s, 81 percent of workers were covered by a DC pension plan – 95 percent of full-time workers, and 72 percent of part-timers, were covered.
However, figures from the Australian Investment Institute show that at retirement, the average Australian male has just $130,000 (Australian) accumulated in his DC “super” plan at retirement. Females have just $45,000 (Australian). If received for 20 years, that means an annual income of $6,500 for Aussie males, and only $2,250 for Aussie females. And worse, the Institute’s figures show that only 35 percent of Australian seniors have any money left in their DC accounts after age 75.
The Aussie pension schemes are a bit unique in that they are mandatory, but all contributions are made by employers. When the plans were first started, employers contributed 3 percent of each employee’s annual salary to the DC plan. And despite the fact that the employer share has increased regularly over the years – currently to 12 percent – Australians are still retiring with inadequate savings.
In fact, statistics from the Melbourne Institute show that half of Australian seniors are living below the country’s poverty line. Statistics from the Conference Board of Canada bear that out, showing that only Irish seniors live in more poverty than their Australian counterparts.
The problem with the Australian DC pension is that it does not replace a portion of the retiree’s income, as a DB plan does. Neither does it include an “escalation” of contributions – putting more money in when investment returns are flat isn’t a feature of most DC plans. Typically 3 to 5 percent of the employee’s salary is put into the plan – sometimes with matching contributions from the employer – and is invested according to the member’s choices.
Fees are charged against the savings regardless of whether markets are up or down, and when markets are down, the loss to the DC plan’s assets is real, and can affect a member’s ability to retire.
As the Australian experience shows, a DC offering is simply not an effective alternative to DB plans for generating a defined retirement income stream.
– To read more, visit the ARIA blog at ariapensions.ca