#BT Column – Should I stick with old pension plan or switch?

Recently my workplace has announced that it will be changing the pension plan. We have been asked to choose whether we will remain in the original plan or switch to the new one. With the new one, employees have to contribute to it, and the company will match what we contribute. We have been told that we can also carry the money that is in it with us if we choose to leave the company at any time. I am being asked to choose but I don’t know what I should do. What is the real difference? Would I get the same amount when I retire if I switch to the new plan? Can I switch back if I change my mind later?

There are two types of pension plans which employers can implement for their employees: defined benefit plans or defined contribution plans. The name of the plan gives insight into its characteristics.

What is the difference between defined benefit and defined contribution pension plans?

A defined benefit (DB) pension plan sets out an amount at the outset which the employee will receive when (s)he retires. The amount to be paid to the employee is determined by a number of factors including:

· the employee’s length of service i.e. how long (s)he has worked for the company

· the employee’s salary while working. Consideration may be given to either the employee’s final salary or an average salary over a specified period

· the proportion of the employee’s salary which is intended to be paid as retirement income.

Under the defined benefit plan, the pension benefit to be paid to the employee will only change when the employee’s salary changes, or when the number of years worked increases. With this type of plan, the employee can rely on receiving the benefit amount calculated at the outset (determined by the above variables) for the duration of their retirement. The employee can rely on this benefit as long as he/she remains with the company or works with it continuously for a specified time.

The defined benefit plan does not require any contributions from the employee as it is fully funded by the employer. The employer is responsible for making sure that there is enough money in the scheme to pay employees when they retire and for however long they live. Some plans also guarantee payments to the spouses for a period of time after the employees are deceased.

This type of plan is usually the most rewarding option for employees because they do not have to worry about making investment decisions and, by nature of its predictability, it provides certain financial security for the employee for the duration of his/her natural life. Many public sector entities provided defined benefit plans as a means of compensating workers in lieu of salary increases. In the private sector, these plans were usually negotiated by workers’ representatives.

On the other hand, a defined contribution (DC) plan is one in which the employee’s pension is made up of an accumulation of funds. Under this type of plan, employees pay an agreed portion of their salary to the pension scheme each salary period. Their individual contributions are generally (but not always) matched by contributions from their employer. For example, if an employee contributes two percent (2%) of his/her salary each month toward the pension plan, the employer contributes the same amount.

These two payments (i.e. employee and employer contributions) are combined and invested in a fund to build retirement benefits for the employee. In this type of plan, the value of the employee’s retirement fund can change, depending on the performance of the fund it is invested in. The rate at which money accumulates in the fund depends also on the level of risk you are prepared to take. High risk investments can yield high rates of return (make lots of money quickly) but can also result in heavy losses. Low risk investments are much safer but rates of return on investments are much lower.

The amount a defined contribution pension is worth when an employee retires then, can depend on:

· The amount of money the employee has paid into his/her own pension fund.

· How much money the employer has paid into the employee’s pension fund.

· Where the money was invested (and the level of risk associated with the investment).

· How the investments have performed over time.

As a result, at retirement the employee may or may not have sufficient savings to maintain the standard of living to which (s)he is accustomed.

A person enrolled in a DC pension plan must be updated regularly on how their fund is performing and the predicted value of their pension at retirement. They may also be able to give further instructions, after their review of the fund’s performance.

Based on our explanation of the two types of pension plans, you can see that your employer is seeking to transition from a defined benefit plan to a defined contribution plan. Since the DB plan was the plan offered to you when you commenced work there, your employer cannot now unilaterally impose the decision to change the type of plan offered to you (or other existing employees). You can however agree to make the switch if you consider this a more attractive option.

With a better understanding of the differences between the two types of pension plans, you have now to decide whether you will remain with the plan you are presently in or switch to the new one. If you do decide to switch to the new plan, it is highly unlikely that you will be afforded the opportunity to go back to the original plan since your employer may be seeking to phase the DB plan out.

You should now be in a better position to understand what your employer is offering and can assess for yourself the advantages and disadvantages of each. Weigh your options carefully and make your choice based on what you believe is best for you at this stage of your working life.

About Lifeline Labour Solutions: Lifeline Labour Solutions is a boutique partnership providing people management solutions to workplace challenges Partners Carol- Ann Jordan and Jacqueline Belgrave are established practitioners with a wealth of knowledge and experience in Employment Relations, Labour Relations and Human Resource Management between them. Email: info@ lifelinelabour.com; Tel: 1(246)247- 5213