The good, the bad and the MPF
If you've recently joined the full-time workforce or switched jobs in the past five years brace yourself for some bad news. Today's retirement schemes don't compensate loyal employees anything like the old ones honoured by large corporations.
The finding is no surprise for retirement-planning experts, who have known for years the defined contribution schemes - such as those offered under the Mandatory Provident Fund (MPF) - don't measure up financially when compared to lump-sum payouts under the defined benefit schemes of yesteryear. But just how big a difference arises between the two schemes?
For illustration, compare the benefits of an employee who joined a company around the December 2000 launch of the MPF. Under the defined-benefit plans, which were common in Hong Kong before the 1997 financial crisis, employee entitlements could be calculated in the following way: assume the plan contributed one sixtieth of final salary for each year of service. An annual salary of $480,000 divided by 60, times five years of service, would equal an annual pension payout of $40,000 for life. If determined as a lump-sum payout, the employer would conservatively offer about $500,000.
If an employee opted for the MPF, the results would be very different. The employer's contribution plus minimum employee's contribution would provide $24,000 per year. If the investment returned 5 per cent per annum, less charges, then a lump sum of $140,000 would be available.
Employees had no choice between schemes as defined-benefit plans were phased out after the MPF was introduced. A few universities and big banks might still offer them, but in general they are closed to new employees. Their decline in popularity began about 1999, or about two years after the onset of the Asian financial crisis which forced corporations to get tough on employee benefits.
Today only 9.2 per cent of pension schemes exempted from the MPF are defined benefits. But even in their heyday, the lucrative schemes made up a small portion of the total and were largely the domain of multinationals, the financial industry and some government institutions. It is hard to make a direct spread-sheet comparison of the two schemes because a lot depends on the terms and conditions and the types of asset allocations chosen by the employee. Financial planners agree that joint contribution plans - such as the MPF - are less lucrative for the employee and a lot cheaper for the employer.
During the past five years, the under-performance of the contribution-style plans has been dramatic owing to poor stock market returns, according to Gloria Siu, director and general manager at Gain Miles Assurance Consultants. 'I think the performance of the defined-benefit side would be much higher than on the defined-contribution side because over the past 10 years performance on the Hang Seng Index has not been great,' she says.
The shift towards making employees responsible for pension scheme returns is a relatively new phenomenon. Under the old system benefits were guaranteed, meaning participants did not have to hope for good investment returns. After the stock market crash in 1997 and the subdued economy that followed, many corporate pension plans emerged under-funded - a situation that set off reform of the system. Apart from gutting what was a key benefit to workers years ago, one side-effect of the new schemes is that investment risk has been transferred to the employee. This has some benefits and some drawbacks.
One danger is that individuals are generally bad fund managers who pick the wrong strategies and under-perform the market over the long term. Defined-benefit schemes, on the other hand, can hire professional fund advisers. They also hold more clout in their dealings with advisers and can exercise better control over costs.
Consumer advocate David Webb argues that one problem with the MPF is the excessive costs which benefit financial intermediaries. Over 40 years, he estimates, the average funds' 2 per cent annual expense ratio will eat up 55 per cent of capital and returns from today's contributions. An investor would do much better with exchange-traded index funds where the total expense is just 0.15 per cent per year. Only 5.8 per cent would be lost in expenses over 40 years.
Another risk is dull equity market performance. If your retirement portfolio had been geared to Hong Kong stocks during the past 5 years, there would be some capital gains, but the biggest driver would be dividends.
After expenses, the HSBC Hang Seng Index Tracking Fund, one of the funds available as part of the HSBC MPF range of unit trusts, has risen just 3.7 per cent since its December 2000 launch to June of this year. Those hoping to meet retirement goals anywhere near as lucrative as those entitlements offered under the former plans would find themselves falling behind.
Because defined-benefit plans are calculated on final salary, they generally lead to higher payouts as income rises throughout a career.
Joseph Ujobai, managing director of pension funds adviser SEI, agrees today's pension plans are less generous than their predecessors, but says there are some advantages.
'The work force has changed. It used to be that most people had a job and they worked there for life,' he says. 'The final salary scheme was never very portable, so if you left and went to work for another company, you often lost the benefits, or ultimately lost something.'
Making employees partners in the saving process can also help empower them and help keep their eye focused on the future.
It is no surprise, though, that companies are not in the giving mood. Only 20 per cent of the defined-benefit plans in the US are fully funded, while in Britain it is less than 5 per cent. 'Companies are feeling less paternalistic and they think the employees should participate in the decision over the course of their career in saving for their retirement,' he says.
More troubling, some defined-benefit plans held by employees of American motor companies and airlines could be headed for bankruptcy court.
'The issue is who's responsible for someone's welfare once they leave the workforce.
'Is it the government, your past employer, or is it you? In both cases, both are asking the employees to be a lot more a part of this process,' says Mr Ujobai.
WEIGHING THE BENEFITS
Benefits calculated through a formula that considers employee?s salary and years of service. Generally no employee contribution
Employees receive greatest accruals at end of long service. Guaranteed retirement income
More expensive for employer
Employer bears investment risk
All investment choice goes to employer, who is likely to choose low-risk fund
More complex administration
Employees must contribute
Shorter tenure as employees receive benefit based on salary, not length of service. No guaranteed income
Less expensive for employer
Employer may bear part of the investment risk only. Cost is easy to predict
Employer portion of investment choice is given to employer for most of the Orso schemes. It reverts to employee under MPF