Pension Plans: What Is The Difference Between A Defined-Benefit And A Defined-Contribution Pension Plan?

There are two types of employer-sponsored retirement plans: defined-benefit pension plans and defined-contribution plans. These are completely separate from CPP and OAS.

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.

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.

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.

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.

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.

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.

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

Consult With Retirement Planning Experts

The team at Pension Solutions Canada is here to help you. If you’re unsure if you’ll have enough money when you retire, give us a call. We’ll also assist you with estate planning, address tax minimization, and answer all of your retirement questions.

Call us at 1-888-554-6661 to get started. Our services are no cost to you.

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