Why DC is better for us

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Why DC is better for us

Andrey Pavlov

Professor of Finance

Beedie School of Business

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Why Defined Contribution is Better for Us Pays you (much) better at retirement DC is tax efficient If you leave you get all your money DC is safe and secure even if the plan goes bust It’s fair

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Why DC is Better for Us

Pays you (much) better at retirement DC is tax efficient If you leave you get all your money DC is safe and secure even if the plan goes bust It’s fair

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Portfolio Value Jan 2008 - Jul 2014: 60% Stocks (XIU and IWM), 40% Bonds (XCB and XGB)

Rebalanced monthly, dividends reinvested

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Portfolio value was below previous peak for 27 months

Average annual return, including the financial crisis =

7.15%

This 60/40 portfolio is simple, Requires no expertise to implement, Does not employ active mutual fund managers, Fees and expenses that are the same or lower than the BC

College Plan. If you can pay your bills online you can set up this portfolio.

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31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 650

20000

40000

60000

80000

100000

120000

140000

160000

Tyical salary and pension contributionStart at step 1 for assitant, Grow at 1.3 steps a year

pay

contribution (SFU + member)

Age

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DC and DB Annual Pension (7% rate of return)

DB assumptions:

2% * highest average salary * pensionable service

5-year guarantee

Retire at age 65

Source: https://www.pensionsbc.ca/portal/page/portal/general_pension_estimator/cpp_general_estimator

Contribute 20% of salary each year Invest in the 60/40 portfolio Use up all funds over 20 years

Contribute 20% of salary each year Invest in the 60/40 portfolio Use ONLY investment gains, do not

touch the capital

A switch to DB benefits only people who are 60 or older!!!

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DB assumptions:


5-year guarantee

Retire at age 65



Contribute 20% of salary each year Invest in the 60/40 portfolio Use up all funds over 20 years

Contribute 20% of salary each year Invest in the 60/40 portfolio Use ONLY investment gains, do not

touch the capital

A switch to DB benefits only people who are 55 and older!!!

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What about annuities

A common concern is that nobody has enough to buy a proper annuity Annuities are some of the worst investments possible

(Banks are booking huge profits because of these types of retail products)

If the BC College Plan were buying annuities (or using them to calculate solvency), they would be insolvent.

Sticking to a balanced diversified portfolio will almost certainly pay you better Even if you start right before a financial crisis

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SFU plan is tax efficient The contributions YOU make should go into

Spousal RRSP (this is golden) TSFA (excellent) You should let your spouse save

If he/she has lower income If he/she is paid as a contractor

If you make over $170,000 Much of your DB contributions are from

AFTER-TAX dollars (as per Dominique Roelants’ presentation on the BC College Plan)

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If you leave (7% return)

You start at 30 and leave in … 5 years 10 years 15 years 25 years 35 years

DC pays 82,417 217,630 421,592 1,161,352 2,764,181

DB pays 10,040 34,748 83,412 345,508 1,072,541

DB assumptions:

Retirement pay based on


Start work at age 30, retire at age 65

Receive pension for 20 years

No spouse

7% annualized rate of return

The actuarial value of your pension is next to nothing because it is so far in the future

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If you leave (5% return)

You start at 30 and leave in … 5 years 10 years 15 years 25 years 35 years

DC pays 82,417 217,630 421,592 1,161,352 2,764,181

DB pays 20,802 65,512 143,104 490,837 1,261,678

DB assumptions:

Retirement pay based on


Start work at age 30, retire at age 65

Receive pension for 20 years

No spouse

5% annualized rate of return

The actuarial value of your pension is next to nothing because it is so far in the future

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DB plans often default Detroit (2014) Orange County (1994)

Dominique Roelants (of BC College Plan) did not inspire confidence: Mr. Roelants’ explanation for the compulsory nature of

the BC College Plan was misleading He overstated the impact of the 2008 financial crisis

on a balanced and diversified portfolio His comparison between our current plan and the BC

College Plan at the end of his talk completely ignored the member contributions the College Plan requires

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Why DC is Better for Us Pays you (much) better at retirement DC is tax efficient If you leave you get all your money DC is safe and secure even if the plan goes bust DC is fair

DB takes from the young to subsidize the old DB takes from everyone and pays the government

Because it is tax inefficient DB magnifies the effects of any discrimination

DB benefits people who progress fast through the ranks and penalizes people who have relatively flat salary over their career

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Appendix

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Current age 30 40 50 55 60

Current salary 65,003 95,206 124,232 135,215 144,629

SFU plan annual income for 20 years

252,424 140,929 64,122 36,778 15,702

SFU plan annual income forever

187,193 104,511 47,552 27,274 11,644

BC College plan annual income for life

101,240 72,314 43,389 28,926 14,463

DB assumptions:


5-year guarantee

Retire at age 65



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Current age 30 40 50 55 60

Current salary 65,003 95,206 124,232 135,215 144,629

SFU plan annual income for 20 years

146,151 91,971 47,004 28,499 12,825

SFU plan annual income forever

91,068 57,308 29,289 17,758 7,992

BC College plan annual income for life

101,240 72,314 43,389 28,926 14,463

DB assumptions:


5-year guarantee

Retire at age 65



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Why DC is better for us