In the Canadian psyche, the RRSP has become synonymous with retirement. So much so, that most folks forget to factor in other sources of pension, which make up a significant part of their retirement incomes — in many cases more than their personal savings.
Alternative pension plans have become an even more important component of the income support system for retirees, given volatile markets, the challenges of an aging population, and the changing nature of pension plans.
Kirk Polson, an investment advisor for the Polson Bourbonniere Financial Planning Group at Dundee Wealth, agrees defined contribution plans are too often neglected by employees. “To me it’s a no-brainer. You want to make sure you take advantage of all the employer contributions,” he says.
He adds advisors have a huge role to play in making sure clients make the right investment choices within pension planning, and that their defined contributions are coordinated with their overall retirement strategies. “And coordinated not only for investment, but also for when the clients want to retire and how much income they wish to draw at retirement.
“If a client has 10 to 20 investment choices in the defined contribution plan, the tendency is to look at those choices and chase the returns, without considering the investment time horizon,” Polson adds.
Advisors, he says, can determine what investments make the most sense by looking at a client’s pension plan to see how much he or she might need to contribute; determining whether, and how much, company money is actually going into the pension plan; weighing investment options; measuring risk tolerance; and ascertaining retirement objectives.
When it comes to balancing a defined contribution plan with an RRSP, Polson suggests advisors make sure not to duplicate the investment options the employer already has in the pension plan, but rather look at a different management approach. “If they have all active managers in the pension plan, we’d look toward having more passive managers outside it.”
Defined benefits vs. defined contributions
In these volatile times, many employers have switched from defined benefit plans to defined contribution plans in an effort to cut costs and remain profitable. Benefit plans establish payouts for employees once they retire. Thus, in times of economic distress, companies are forced to make up shortfalls resulting from lower investment returns in their pension funds. By contrast, defined-contribution plans set out how much cash workers and companies put into the retirement pot, not how much gets paid out. The employees are responsible for selecting the investments they hold, and therefore responsible for the returns they earn.
Polson says a lot of employees are pleased with the switch because suddenly they have access to a pool of capital. “But they need to take stock of how the new defined contribution plan measures with the old defined benefit plan. They also have to keep in mind how much risk they are prepared to take, because now the employer contributions will fluctuate with the markets.”
In such an environment, he stresses advisors must religiously review their clients’ investments in a defined contribution plan, and have a carefully designed plan for a long-term strategy. “Especially, given the current markets, advisors must reconfirm if their clients’ financial goals have changed, or if they need to reassess their risk tolerance.”
Polson adds employees quite often miss the boat in understanding the role asset mix plays. “They have to understand asset mix drives the returns. Sometimes being conservative is a risk too.”