How is Your Retirement Shaping Up?

/in , , , , , /by

Defined Benefit vs. Defined Contribution Pension Plans

If you are one of the lucky ones who participate in a pension plan, consider yourself to be very fortunate. Statistics show that only approximately one-third of paid workers in Canada are covered by a registered pension plan. * If your plan is a Defined Benefit Pension Plan (DBPP) you can consider yourself even more fortunate as this is considered to be the crown jewel of pension plans. The other type of plan available is a Defined Contribution Pension Plan (DCPP). So, how do these plans differ?

Defined Benefit Pension Plan

With a DBPP, your employer is obligated to pay you a pre-determined monthly income for the rest of your life after retirement. The amount of this income, or your pension, is calculated by applying a formula which can vary but is typically based on your highest average earnings and how long you have worked for your employer. For example, one common formula for an annual pension amount is 2% of your average yearly pensionable earnings during the best five earning years, times your years of pensionable service.

Let’s say that the average of your five best years is $75,000 per year and you have been a member of the pension plan for 22 years. Your annual pension would be $33,000 (2% X $75,000 X 22). The pension income is typically paid monthly to the retiree.

Usually, both the employee and the employer contribute to the plan. The employer is responsible for managing and assuming all the risk of the investments (this task is usually given to professional investment managers) and has an obligation to make the pension payments regardless of the performance.

Defined Contribution Pension Plan

Under a DCPP, the employee will contribute a certain percentage of their annual income (for example, 5%) with the employer typically making a matching contribution. Unlike with a DBPP there is some flexibility in how the contributions are invested. The plan may contain the ability for the individual to allocate his or her contributions according to their personal goals and risk tolerance. As in the DBPP, employers would usually avail themselves of investment managers to manage the pension funds.

Upon retirement, the amount of pension that an employee will receive will depend on to what amount the contributions have grown. Unlike a DBPP, there is no guarantee. In this way, the DCPP is similar to a group RRSP but is subject to pension legislation to prevent withdrawals prior to retirement.

Generally, the costs associated with Defined Benefit Plans are considerably higher than with Defined Contributions. This is partially due to the actuarial valuation which is required every three years for a DBPP. There is more cost control with a DCPP. While both plans are very effective in encouraging employee attraction, Defined Benefit Plans are more successful in creating long term retention.

What Plan Do You Have?

One-third of paid workers in Canada are covered by a registered pension plan with public sector workers accounting for a little more than half of all pension plan members. The question is, if you aren’t a member of one of these large plans, how is your retirement shaping up? A 2023 Canadian Retirement Survey conducted by the Healthcare of Ontario Pension plan, found that 32% of Canadians have set aside nothing for retirement. If you are included in this number be sure to contact me as soon as possible so we can discuss your retirement future.

* Statistics Canada.

Copyright @ 2024 FSB Content Marketing Inc.- All Rights Reserved

Understanding Early CPP: When and Why to Consider It

/in , , , /by

New Rules governing the Canada Pension Plan took full effect in 2016. Under these rules, the earliest you can take your CPP Pension is age 60, the latest is 70. The standard question regarding CPP remains the same – should I take it early or wait?

If you take it at the earliest age possible, age 60, your CPP income will be reduced by 0.6% each month you receive your benefit prior to age 65. In other words, electing to take your CPP at age 60 will provide an income of 36% less than if you waited until age 65.

CPP benefits may also be delayed until age 70 so delaying your CPP benefits after age 65 will result in an increased income of 0.7% for each month of deferral. As a result, at age 70, the retiree would have additional monthly income of 42% over that what he or she would have had at 65 and approximately 120% more than taking the benefit at age 60. The question now becomes, “how long do you think you will live?”

Assuming that an individual has $10,000 of CPP pension at age 65, and ignoring inflation (CPP income benefits are indexed according to the Consumer Price Index), the following table compares the total base income with that if benefits are taken early or late:

Total benefit received CPP Benefit Commencement
Age 60 Age 65 Age 70
One year $6,400 $10,000 $14,200
Five years $32,000 $50,000 $71,000
Ten Years $64,000 $100,000 $142,000

The question of life expectancy can be a factor in determining whether to take your CPP early. For example, according to the above table, if you take your pension at age 60, by the time you reach age 65; you would already have received $32,000 in benefits. With $10,000 in pension income commencing at age 65 the crossover point would be age 73 (the point at which the total income commencing at age 60 equals the total income commencing at age 65). If you were to die prior to age 73, you would have been better off taking the earlier option.

If your choice is to delay taking the pension until age 70 instead of 65, the crossover would not be reached until age 85.

Some individuals may wish to elect to take the pension early and invest it hoping that the income from age 60 combined with the investment growth will exceed the total income that would be received by starting at 65.

Remember, if you elect to take your pension before 65 and you are still working, you must continue to contribute to CPP. After age 65, continuing contributions while working are voluntary. On the plus side, these extra contributions will increase your pension under the Post-Retirement Benefit (PRB).

Reasons to take your CPP before age 65

  • You need the money – number crunching aside, if your circumstances are such that you need the income then you probably should exercise your option to take it early;

  • You are in poor health – if your health is such that your life expectancy may be shortened, consider taking the pension at 60;

  • If you are confident of investing profitably – if you are reasonably certain that you can invest profitably enough to offset the higher income obtained from delaying your start date, then taking it early may make sense. If you are continuing to work, you could use the CPP pension as a contribution to your RSP or your TFSA.

Reasons to delay taking your CPP to age 70

  • You don’t need the money – if you have substantial taxable income in retirement you may want to defer the CPP until the last possible date especially if you don’t require the income to live or support your lifestyle;

  • If you are confident of living to a ripe old age – if you have been blessed with great genes and your health is good you may wish to consider delaying your CPP until age 70. Using the earlier example and ignoring indexing, if your base CPP was $10,000 at 65 then the pension, if delayed until age 70, would be $14,200. If you took the higher income at 70, you would reach the crossover point over the age 65 benefit at age 84 and after that would be farther ahead.

This information should help you make a more informed choice about when to commence your CPP benefits. Even if retirement is years away, it is never too early to start planning for this final chapter in your life. Call me if you would like to discuss your retirement planning.

If you found this article helpful, please share it with others who might benefit from it.

Copyright @ 2024 FSB Content Marketing Inc.- All Rights Reserved