By Robert D. Baldwin

Debates about the relative merits of defined-benefit (DB) and defined-contribution (DC) pension plans have been a prominent part of pension discourse over the past forty years. The intensity of the debate has ebbed and flowed over the years but has been more intense in recent years as there has been a shift from DB to DC plans in Canada. This shift has left the remaining members of DB plans feeling threatened and, for many, the sense of threat has been compounded by the emergence of target-benefit (TB) plans. Discussions of DB, TB and DC in the abstract tend to obscure basic issues related to the similarities and differences among these plans that should be taken into account. My hope is to provoke an examination of some of these issues free from the hyperbole that is widely invoked in partisan debates about DB and DC. In both the private and public sectors, I hope this would lead to the exploration of ways to limit the financial risks of a workplace pension plan (WPP) without going to pure DC. I will also note some measures that will help make DB plans more transparent. Basically, I will argue that: 1) There is so much diversity in the design of DB and DC plans that generalizing about the merits of DB versus DC has little precise meaning. 2) While DB plans generally go further than DC plans in achieving a predictable gross replacement rate (the ratio of retirement income to pre-retirement earnings), they will give rise to a variety of net replacement rates (taking into account factors like taxes and mortgage payments) and may push pre-retirement living standards below post-retirement levels. Net replacement rates come closer to defining living standards than do gross rates. 3) The financial and economic circumstances of the early 21st century have been difficult for all types of pension and retirement savings plans and I will focus on the impacts on DB plans that explain the changes noted above. 4) The relative advantage of DB plans in providing predictable benefits stems from cross-subsidies among the members. These are not inherently problematic but transparency problems may arise because cross-subsidies are not identified and measured. 5) There are measures that plan governors can adopt that can help reconcile the (un)predictability of contributions and benefits and make DB plans more transparent. Finally, I argue that regulatory and tax policy can be adapted to facilitate more flexibility in plan designs.

Source: SSRN