Published in the Financial Post on April 12, 2012
By Geoffrey Young
Two budgets — in Ottawa and Ontario — have announced reforms to rich defined-benefit pension plans enjoyed by government employees. The federal government will raise employee contributions and the normal age of retirement to 65 for new employees, while Ontario will consider reducing benefits to future pensioners to help fund potential pension plan deficits.
Governments are scrambling to keep employee defined-benefit (DB) pension plans sustainable because their employees love them — yet many government employees would be better off if the plans were redesigned. These DB plans systematically transfer income away from groups of employees in occupations with slow wage growth to employees in occupations or careers with higher wage growth rates; this often means from low-income clerks to high-income deputy ministers.
The winners are employees whose earnings grow fastest over their careers — they are likely to enjoy pensions that exceed the value of the accumulated employee and employer contributions to their credit at retirement, while the losers are those who would be better off if they simply received the value of their contributions plus interest rather than rely on future payments from a discounted pension.
Canadian government employee pension plans defy the common-sense idea that saving more and working later in life will increase one’s retirement income. Instead, DB plans tie pensions of government employees to their length of service and to their highest five years of earnings. It does not matter whether the employee made large or small contributions before the five years that count toward the average.
Why five years? Perhaps the designers of the plans considered that is the time it takes to get used to living in a good neighbourhood, having a golf club membership and a cleaning lady, and spending two weeks in Europe every year. It sounds ridiculous, but there seems to be no other explanation why pensions are tied to only a few years of earnings.
Most taxpayers don’t care if government career clerks, secretaries and bus drivers contribute to support the pensions of their bosses, but taxpayers do have reason to be concerned that pensions mean that bureaucrats simply don’t work very long. Under government plan formulas, it makes no sense for most civil servants to work to 65. Continuing past 55 or 60 often means giving up a substantial current pension for little increase in future pension. Those who continue to work because they like their jobs or because they came late to the pension plan are likely to be losers, paying more into the plan than they will draw from it. Thus government employees continue to give up the productive years from 55 to 67 while the rest of us will be working.
My recent study published by the C.D. Howe Institute suggests it is time to begin reforming government pensions. Plans should stop rewarding employees who can retire early at the expense of those who need to continue to work, they should allow people to move without penalty between the government and private sectors, and they should give a fair return to the contributions paid early in their careers by those whose later careers have not been rewarded with high earnings.
Most government pension plans tell employees that their payroll pension deductions and the percentage contributions put in by the employer are enough to finance the pension. If this were true, it would mean that every plan would have winners and losers in about equal numbers, and half of plan members would logically welcome change. In fact, though, most plans have fallen short of their investment targets and have steadily raised contribution rates. Today’s senior employees will resist change because they can hope that most of the cost of their pensions will be borne by the new plan entrants who will spend their careers paying higher contributions.
Perhaps it is understandable, too, that pension plan members, even those in dead-end jobs, should believe that they too will achieve a high salary near the end of their careers and become winners in the pension lottery, drawing a pension tied to those last few high-earning years.
Recent steps to raise contribution rates and retirement ages for future employees are a start, but if government pension plans are not to become a drag on the economy and the taxpayers, more fundamental changes will be needed.
Geoffrey Young is a principal at Discovery Economic Consulting in Victoria, where he is also a city council member. He is the author of a recent C.D. Howe Institute study “Winners and Losers: the Inequities within Government-Sector Defined Benefit Pension Plans.”
