In Canada, workplace retirement plans come in a few shapes and sizes. One of the main distinctions is between registered defined benefit pension plans and registered defined contribution plans.
With a defined benefit pension plan, the payments you receive in retirement are fixed and guaranteed. Depending on your plan, the payments might even increase each year to compensate for inflation’s erosion of purchasing power. In a defined benefit plan, the employer is responsible for managing the pension investments, covers the costs and takes on the investment risk. The employee pension payments aren’t based on the investment returns of the pension plan.
This is distinct from a defined contribution plan, in which the employee takes on the investment risk, typically takes a more active role in investing decisions and receives payments based on investment performance.
Of course, the guaranteed payment offered by a may seem preferable, but it isn’t the norm in Canada. These defined benefit pension plans aren’t as prevalent nowadays and the percentage of Canadians covered by these plans is decreasing over time. However, defined benefit plans still remain common for government employees.
In a defined benefit plan, the employer promises to pay out a set monthly income amount once you retire. While this figure is generally calculated using a variety of different methods, the formula used to calculate your monthly income is generally based on your average earnings and your years of service.
For employees with defined benefit plans, the employer is responsible for ensuring there is enough money to meet the set pension income. The guaranteed benefit will not depend on you choosing assets or investment types, and as long as the scheme is still solvent it is required to pay the promised benefit.
It may be possible to transfer your defined benefit pension to a defined contribution scheme, at the discretion of the trustees. Some people may consider transferring their defined benefit pension to access earlier benefits since defined contribution schemes often can be more flexible with earlier withdrawal limits. However, you should thoroughly assess the potential effects before making this change.
Due to the decline in popularity of defined benefit plans, more and more Canadians are relying on the Canada Pension Plan (CPP). Similar employer-sponsored defined benefit plans, the CPP is an earnings-related pension scheme based on your average lifetime salary.
Those who qualify for the CPP can start taking distributions at 65. For those who may require additional funds prior to 65, you have the ability to start taking reduced distributions at the age of 60. Conversely, for those who can delay distributions, they can elect to receive increased distributions until they turn 70.[i]
In order to qualify for full CPP benefits, you must have made 39 working years of contributions.[ii] The pension scheme targets a replacement rate of 25% of earnings up to the Yearly Maximum Pensionable Earnings, based on your average lifetime salary.[iii] To account for your early working year, your pay is adjusted to mirror the economy-wide earnings.
Since the defined benefit plan is registered, you can add beneficiaries and potential survivor benefits. You may have worked with more than one employer over your lifetime with whom you took advantage of defined benefit plans. There are a few options available when you leave one plan and move to another. You can check with your pension administrator and adviser on what might be the most optimal arrangement.
Depending on your circumstances, your employer sponsored defined benefit plan may not be enough to enjoy the retirement you desire. You may require additional savings from a personal retirement account to help you meet your retirement. The sooner you recognize this need, the better chances you have of enjoying more financial freedom in your retirement years.
Having an understanding of how you will fund your retirement years can be challenging, perhaps even more challenging if you are figuring it out on your own. If you would like a better understanding of what your retirement picture will look like, speak with one of our qualified professionals today!
[i] Organisation for Economic Co-operation and Development (OECD), as of 6/14/2019. Pensions at a Glance 2017: Country Profiles – Canada. https://www.oecd.org/els/public-pensions/PAG2017-country-profile-Canada.pdf