Defined-Contribution Plan Vs. Defined-Benefit Pension Plan

Retiring can be a very stressful time. It’s a big decision that can impact all aspects of your life. There are so many decisions to make, like what to do with your assets, how to invest, how you want to spend your time, what you want to do in retirement, and what you think will help you live the kind of life you want.

An employer pension plan is a registered plan that provides you with a source of income during your retirement. Under these plans, you and your employer (or just your employer) regularly contribute money to the plan. When you retire, you’ll receive an income from the plan.

There are two types of employer-sponsored retirement plans you should be aware of when retiring in Canada: defined-benefit pension plans and defined-contribution plans. Not all employers have these plans, so you’ll want to double check with them before retiring.

As the names imply, a Defined-Benefit Pension Plan provides a defined payment amount when you retire based on a formula and you know in advance what this formula is, and therefore what the amount would be. The company you work for (your employer) ‘sponsors’ your retirement plan by promising a specified pension payment.

On the other hand, a Defined-Contribution Pension Plan grants employees the opportunity to contribute funds over time to save for their retirement and the employer provides matching contributions to a certain amount.

Your employer may also have a Deferred Profit Sharing Plan (DPSP) for you upon retirement. Contributions into this plan can only be made by your employer. Those contributions, as well as any forfeited amounts that are reallocated to a beneficiary, are included in your pension credit for a year. The pension credit represents the benefit earned during the year and it reduces the amount that you can contribute to your registered retirement savings plan in the following year.

Let’s dive deeper into the Defined-Benefit and Defined-Contribution options (which are the most common), and what the advantages are for each:

Defined-Benefit (DB) Pension Plans

A defined benefit pension plan guarantees a certain level of income in retirement based on salary and years of service with an employer. In addition, payments are typically made for life. Payments can be made as a lump sum or as an annuity which will provide regular payments for life.

With this type of pension plan, your employer promises a certain amount of money upon retirement. The amount of money promised is based on the employee’s total length of service and their average salary over that time, as well as any other factors the employer chooses to consider.

Because it is a “defined” benefit, you get a specific benefit payment deposit made to you each month while you are retired. That puts the employer in the position to pay that benefit to the employee for their lifetime and they have to put considerable resources and effort into managing their employees’ pension fund. Click here to learn more about this type of plan and how it works.

When you retire with a Defined-Benefit Pension Plan, you have the option of taking the Commuted Value option, which has many benefits. Learn how to calculate it here. You can also take it out as a lump sum or move it to a Canadian financial institution through the Copycat Annuity option.

Because of the administrative costs and effort involved to maintain a pension fund for their employees, this type of pension plan is favoured less by employers these days and we’re seeing less companies offering these types of pension plans.

How Is A Define-Benefit Pension Plan Amount Calculated?

The amount that your defined-benefit pension plan is ‘worth’ is based on many factors such as:

  • Your salary / earnings history
  • Years of service
  • Age

Who Controls The Defined-Benefit Pension Plan?

In the case of a defined-benefit pension planyour company is the one that takes all of the responsibility for the investment and is in charge of distributing pension payouts to the retired employee.

Risks With Defined-Benefit Pension Plans

One of the largest risks with having a defined-benefit plan that is managed by your employer is that the returns on the investment may go up or down, and it’s up to your employer to make sure that the pension fund is able to cover your defined-benefit amount when you retire.

This is a very important point to consider when deciding to leave your pension with your company, or take it elsewhere. Is your company in a stable industry? Is your company financially strong? Do you foresee your company potentially going bankrupt in the next 10, 20, or 30+ years?

Example: Sears Canada’s Pension Fund was short $267 million, according to court documents, and retirees had their pensions cut by 30% after the retailer folded and left behind an underfunded pension plan.

You can minimize this risk by moving your defined-benefit pension plan to a secure financial institution via a copy-cat annuity.

Defined-Benefit Pension Plan Surplus Cash

Over time, depending on how the financial market and economy is doing, your company’s defined-benefit pension plan may face deficits or surpluses between the money currently in the plan and the total amount of their pension obligations. These surpluses can be of great benefit to you if you decide to move your pension via copy-cat annuity to a financial institution because it could provide you with ‘surplus cash‘ which is bonus cash given to you on top of your pension’s commuted value.

Ask your financial advisor or a retirement pension expert details about how you could receive surplus cash on your pension payout.

We can assess your commuted value and let you know about the opportunity of potential surplus cash. Call us at 1-888-554-6661.

Defined-Contribution (DC) Pension Plans

This is the type of pension plan most commonly offered by employers. The benefits are based on contributions and investment returns. These pensions do not provide a guaranteed income in retirement, and they can be very risky depending on how well the plan investments perform. As the contributor, you are responsible for managing the investments and should understand the risks.

With this type of pension plan, employees and employers both contribute to a retirement fund. Typically, the employer provides matching contributions to a certain amount, but the employer’s contribution can vary from year to year. This type of pension plan is mainly funded by you, the employee. A portion of your salary gets taken out of your paycheck and set aside in your retirement plan for when you retire.

The amount that you contribute (matched with your employer’s contribution) is then invested, at your (the employee’s) direction, in select mutual funds, annuities, money market funds, or other financial options offered by the plan.

At the end of their working life, employees who have contributed to the plan can receive a lump sum representing their total contribution, or they can choose to take out a monthly pension for the rest of their life.

Because you, the employee, are responsible for directing the contributions and investments, these plans require little work and are low risk to the employer. Your employer has no obligation toward the account’s performance after the funds are deposited.

With defined-contribution plans, an outside insurance company typically manages the plan. This is beneficial for you because it’s flexible. When you quit or retire, that money is yours, and you move it to a personal retirement plan.

Investing is a very complicated topic. If you don’t have the time or knowledge to invest, it’s important to use a Certified Financial Planner (chat with one from Pension Solutions Canada for free by calling 1-888-554-6661). A Certified Financial Planner can look at your finances and help you decide the best way to invest your money. They can help you identify your goals and then develop a strategy to help reach them. If you have any money that you want to invest or if you’re planning on retiring soon, work with your financial planner to not only make sure you have all your ducks in a row, but also to make sure you’re going to ENJOY retirement to the fullest!

Why Are Companies Today Offering Defined-Contribution Pensions Instead of Defined-Benefit Plans?

The industry has generally moved to defined-contribution plans because it puts the onus on the employee to contribute enough and make sure it’s properly managed. In a defined-contribution plan, the employer has no obligation to provide the employee with an income upon retirement. Alternatively, a defined-benefit pension plan has your employer taking a lot more of the risk and promising a specified pension payment amount when you retire. This is referred to as your pension’s “commuted value“. The great thing about defined-benefit pensions is that employers guarantee a very specific retirement benefit amount for each participant in the plan.

No matter which type of employer-sponsored pension you have, it’s important to know what will be taxed when you retire and make sure you are as debt-free as possible before retirement.

Make sure that your pension can be adjusted periodically to reflect changes in costs such as inflation or increases in life expectancy.

When you start getting payments from your pension plan it is very important that you understand how these payments affect your eligibility for federal government programs like Old Age Security (OAS), Guaranteed Income Supplement (GIS), the Age Credit amount and Canada Pension Plan benefits (CPP). There may even be provincial government programs affected.

I’m Planning To Retire Soon From My Company, What Should I Do?

First, speak with a Certified Financial Planner. Call us at 1-888-554-6661 to get started.

Second, you want to know what your “Commuted Value” is. Get a statement with this calculation from your employer to know in advance exactly how much your pension is worth and the amount you’ll be paid out for life once you retire. Watch this video where we have special guest Jon Hreljac (Retire & Estate Planning Services at Manulife Financial) explain the advantages of taking your pension’s Commuted Value option.

Next, start planning, use our retirement resources, and put together your retirement plan and estate plan. Your Certified Financial Planner can help with this.

Questions To Ask Your Pension Plan Administrator

Review the information your employer sends employees about your retirement plan. Make sure your employer is aware of your plans to retire. If your employer is a big company, chances are it has resources to help you. Contact your employer or pension plan administrator to let them know that you plan to retire soon, and ask them the important questions you might have about your pension plan such as:

    • What type of pension plan are you registered in? (eg. Defined-benefit, Defined-contribution, etc).
    • How does your employer calculate the amount you will receive when you retire?
    • What happens if you leave the company before you can collect your pension?
    • What happens if the plan goes bankrupt?
    • How much money has been contributed to the plan, and how much money will be left when you are eligible to retire?
    • How much of your contributions are tax deductible?
    • Are you able to retire early? If so, how will it affect your pension?
    • How much will your beneficiaries get if you die before you reach the normal age of retirement?
    • Who will get your pension if you die before you reach the normal age of retirement?
    • Do you have to make any special pension-related decisions while still working?

Once you have all the information you need, review your retirement plan and estate plan with a Certified Financial Planner. Chat with one today at Pension Solutions Canada by calling 1-888-554-6661.

Pension Adjustments

If you’re about to retire, you can also ask your pension plan administrator for a copy of the Statement of Pension Adjustment (S.O.P.A.). This statement shows the value of benefits you earned under your employer’s Registered Pension Plans or Deferred Profit Sharing Plans.

Read The Information Your Employer Sends About Your Pension Plan Carefully

The information you get from your employer about your pension plan will help answer some critical questions you should know the answers to in order to prepare for your retirement. If you don’t get the answers from the informational material your employer provides, be sure to call someone in the HR department and ask them questions so you have the answers you need.

Some questions you’ll want to know the answers to:

  1. What type of pension plan does your employer have? (eg. Defined-benefit, Defined-contribution, etc).
  2. How does your employer calculate the amount you will receive when you retire?
  3. What happens if you leave the company before you can collect your pension?
  4. What happens if the plan goes bankrupt?
  5. What are the rules for changing your pension benefits?
  6. How much money has been contributed to the plan, and how much money will be left when you are eligible to retire?
  7. How much of your contributions are tax deductible?
  8. At what age can you start to collect your pension?
  9. Are you able to retire early? If so, how will it affect your pension?
  10. How much will your beneficiaries get if you die before you reach the normal age of retirement?
  11. Who will get your pension if you die before you reach the normal age of retirement?
  12. What happens if you leave the company or change jobs before you can collect your pension?
  13. What happens if the plan goes bankrupt?

Obtaining A Final Pension Statement

When you retire, you must get a final statement that tells you the value of your pension. Bond rates change every day, so it’s important to get this final statement with an actual final value amount (the commuted value) so you can start to plan with your Certified Financial Planner what you’ll do next with that amount of money. You can also take that final pension statement and shop around for a Copycat Annuity from a Canadian financial institution, which may also lead to a cash surplus (extra bonus cash paid to you on top of your pension).

If you are going to get a lump-sum payment, the statement must give you information that will help you decide whether to take the lump-sum payment or to take a monthly income from the plan.

How Much Do I Need To Retire In Canada?

Knowing how much money you will need to retire can be tricky, but it’s important to get a handle on this before you retire. You don’t want to find yourself in a situation where you are completely dependent on others for your income.

Think about how you’re going to be able to pay for your lifestyle without working.

A lot of people have the misconception that they need to live a certain lifestyle in order to retire happy and enjoy the freedom it brings. But, in reality, retirement is about being able to enjoy your time off without having to work full-time.

Connect With A Friendly Certified Financial Planner Today Absolutely Free

Retirement planning doesn’t need to be scary, icky, or overwhelming. It just needs to be honest and simple. At Pension Solutions Canada, we want to help you plan for the future with confidence, knowing exactly what you need to do to get where you want to go.

Pension Solutions Canada specializes in helping individuals prepare for retirement and protect their assets. If your pension is currently with your employer, we can walk you through the steps of moving it out of the company through a copycat annuity with a larger insurer such as Canada Life or Sun Life. We’ll also help you with estate planning, address tax minimization, and answer all of your retirement questions.

Schedule a 15-minute call here with one of our Certified Financial Planners!

More Resources

For more information and resources for planning your retirement, visit our Ultimate Canadian Retirement Planning Guide [2022].

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