How is Your Retirement Shaping Up?
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.
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