Business

Sears case shows the risk of defined benefit pensions for employees

The case of Sears's employees, who will see their pension reduced, shows the risk of depending too much on a defined-benefit pension plan to provide income in retirement if the plan is not fully funded and the sponsor goes bust.

Severance payouts gone, employees face possibility of reduced pension

Sears Canada employees had a defined benefit pension, which should guarantee benefits, but a judge has allowed the company to stop paying its obligation the plan. (Andy Clark/Reuters)

Sue Earl, a 38-year Ontario-based Sears Canada employee, was shocked when she found out she would only initially receive 81 per cent of the value of her pension as part of the company's insolvency process.

The 64-year-old from Cobourg, Ont., had assumed her defined-benefit pension was "money in the bank," a guaranteed amount she'd receive in retirement regardless of the financial health of the failing retailer.

But then, she also didn't think Sears would cancel the severance payments she'd been receiving since her store was closed last year — that's what happened after it filed for court protection from creditors in June.

She said the other 19 per cent of her defined-benefit pension is "up in the air."

"Our letter said it would be paid out to us in the next five years, but that depends what they do with it, whether they wind it up or what's going to happen," Earl said.

Severance gone, pension under threat

"It's just one more slap, really. You lose your severance and then you find out you might not get all of your pension money."

Personal finance experts say the Sears case shows the risk of depending too much on a defined-benefit pension plan to provide income in retirement if the plan is not fully funded and the sponsor goes bust.

James McCreath, an associate portfolio manager with BMO Nesbitt Burns in Calgary, says employer-sponsored pension plans are a good thing because they force people to save for retirement, but when a company isn't healthy enough to fund them, it can result in a lot of stress for employees.

"If I had a defined benefit plan, I'd certainly sharpen my pencil on reviewing it to see if there's an unfunded liability and how that perhaps would impact my retirement," he said.

Tony Salgado, director of CIBC Wealth Strategies in Toronto, says many don't even know what kind of pension plan they have, much less what their retirement income might be.

"Incorporate some wiggle room," he advises.

"If you were to take a 10 per cent haircut on what you have through your retirement pension plan, what other sources of income will you have available?"

Promise of retirement income

Defined-benefit plans promise members a retirement income usually based on salary and years of service. But an aging population that is living longer has increased the cost of the plans at the same time that low interest rates have also increased funding requirements, leaving many plan sponsors with a shortfall.

Sears has been paying $3.7 million a month to top up its underfunded defined-benefit plan, as required by Ontario provincial law, but has asked a court to allow it to suspend those payments while it restructures.

Meanwhile, Ontario has proposed new rules that would see defined-benefit pension plans it regulates not require topping up as long as they are 85 per cent funded, down from the current 100 per cent.

In Cobourg, Sue Earl says she is receiving employment insurance benefits and has started her Canada Pension Plan payments early to top up her RRSPs and pay down debt.

Remaining pension goes to locked-in account

She has received a payout on the defined-contribution pension plan Sears started in 2008, but is still waiting for payout of the defined benefit plan it replaced — both have to be reinvested in locked-in accounts until retirement.

Her husband, Ralph, has a small pension and, after a "hard look at our finances," she thinks they'll be OK.

"I mean, we're not driving Mercedes, we're going to drive our car into the ground. If we take a trip we're going to be budgeting for it. I mean, we're going to have to be careful with our money."