Target Benefit Plans: The Overlooked Gem in the OECP Report

Specifically, the OECP report – like similar reports released recently by the Alberta/British Columbia Joint Expert Panel on Pension Standards and the Nova Scotia Pension Review Panel—promotes target benefit plans as a practical alternative to traditional defined benefit (DB) and defined contribution (DC) plans. In fact, the OECP sees target benefit plans as a way to “tempt employers back into offering pensions.”

Target benefit plans

Target benefit plans have been around since the 1940s and have provided a very successful alternative to traditional DB and DC plans. The OECP’s recommendation is a call to allow for the expanded use of target benefit plans beyond the multi-employer sector where they currently dominate.

Presently, target benefit plans provide pension benefits to almost one million Ontario workers (or 43% of all Ontarians covered by pension plans). Commonly known as multi-employer pension plans (MEPPs), the first target benefit plan in Canada was developed in the 1940s by Sam Eckler. Today, these plans are very popular with unionized workforces in the construction, manufacturing and public sectors, as well as among religious organizations.

The OECP recommends changing legislation to allow the implementation of plans with design, funding and governance characteristics similar to MEPPs, in employment environments where they are not traditionally found or allowed under the current rules. The recommendations would permit sponsors of single employer pension plans (SEPPs) to establish jointly governed target benefit pension plans (JGTBPPs).

The OECP envisions that target benefit plans could also serve as a means of facilitating the growth of large-scale plans—through legislation enacted to enable and promote large, commingled target benefit plans—and encourage cooperation among small and medium-sized plans.

The target benefit plan advantage

What makes target benefit plans so appealing is that they move beyond the notion that retirement benefits can only be provided by a “pure” DB or DC approach. This is accomplished by combining a DB approach to providing pension benefits with a DC approach to funding those benefits. In the process, target benefit plans effectively eliminate the plan sponsor risk associated with DB plans and significantly reduce plan member risks associated with DC plans.

Key advantages of target benefit plans

For members: works much like a DB plan

• Pension benefits are determined by a set formula
• Assets are invested on an aggregate basis (benefits are not tied to investment performance on an individual’s account)
• Mortality risk is pooled (no risk of outliving retirement savings)
• Access to DB-type pension features, such as subsidized early retirement survivor pensions, pre-retirement death, and termination and disability benefits
• Surplus is used for the benefit of plan members (e.g., to improve benefits)
• Members have a say in plan governance

For employers: works much like a DC plan

• A fixed schedule of contributions: no financial liability beyond paying predetermined contributions, and pension cost for accounting purposes is equal to employer contributions (i.e., accounting costs are fixed)
• Contributions are typically expressed as a percentage of pay (or a fixed amount per hour)
• Easy for members to understand and appreciate the value of the plan
• The employer is not required to comply with CAP guidelines (which apply when members are offered investment choice under a DC plan)

Key disadvantages of target benefit plans

• Target benefit plan benefits may be reduced
• Plan membership may result in a greater reduction in RRSP contribution room

Here’s how target benefit plans work:

The level of contributions to the plan is fixed, and contributions are determined based on a formula—normally related to compensation or hours worked—and do not vary based on the financial position of the pension plan.

The plan uses a predetermined pension formula, which can be based on average earnings or a fixed amount per year of service, or related to contributions on hours worked. The formula is based on the expected contributions flowing into the plan, plan member demographics (e.g., service and salary), ancillary benefit costs, assumptions for future investment return, and expected incidence of member retirements, terminations, et cetera.

If the pension formula turns out to be too low given actual plan experience, benefits can be increased. Conversely, if the formula turns out to be too generous, benefits can be reduced. The goal is to maintain a stable formula that provides predictable benefits for members.