Earlier this month, The Globe And Mail reported that Canadian pension plans”keep booming” and are getting healthier due to high equity prices and rising interest rates.
Two companies that measure Canadian plans’ funding were quoted, showing the growth in the first quarter:
- Aon PLC said “its measure of DB pension solvency in Canada increased from 89.4 per cent on Dec. 31 to 94.8 per cent”.
- Consultants Mercer Canada Ltd. said its Pension Health Index “increased from 114 per cent at the end of 2020 to 124 per cent at the end of March”, which is an all-time high.
This is very good news for members of defined benefit pension plans.
Let’s recall that at this time last year, a few plans were frozen to withdrawals due to the underfunded position of those pension plans.
Some background: these actuarial calculations are important forecasting tools but they in no way impact the amount of money in those pensions.
It’s like this: you have $100k in your RRSP and 10 years to live according to your doctors. If you are extremely cautious you put this money in your pillow so you won’t run out before you die. You withdraw $10,000 per year from your pillow.
But pension plans & RRSPs don’t put money in pillows. They make investments. If you assume a 5% annual growth rate for your RRSP then your income can be increased a bit beyond $10,000 per year, let’s just say you can withdraw $12,000.
You have made an actuarial calculation based on the expected rate of return. In this example, your RRSP is 100% funded based on the 5% rate of return.
Last year, occurred a drop in the expected rate of return due to low interest rates. If you are going to withdraw $12,000 per year for 10 years but the rate of return drops to zero, then your plan is “underfunded”.
Clear as mud? Good. Call me if you wish clarification. 1-888-554-6661
BRUCE YOUNGBLUD, CFP, CIM
President of Pension Solutions Canada