When faced with pension decisions, how do you know what is best for your circumstance? Understanding your how your pension benefit works will help you plan for your future.
What is a pension?
A pension is simply a source of income that you draw during your retirement. There are two main types of pension plans: Defined Benefit Plans (DB Plans) and Defined Contribution Plans (DC Plans). This article will focus on Defined Contribution Plans. To learn about Defined Benefit Plans read this blog post.
Defined Contribution (DC) Plan
The Basics
A Defined Contribution Plan is simply that. At the outset of the plan, the plan sponsor (an employer, government, or union) defines what contribution they promise to pay, usually based on a percentage of the employee’s salary. These funds are in placed in the employee’s individual pension accounts and invested.
How much benefit will I receive?
Unlike Defined Benefit Plans where you can calculate your pension benefit based on a predetermined formula, it is difficult to predict the retirement benefit in a Defined Contribution Plan. The employer typically establishes the plan and contributes a fixed or variable amount to the employees’ pension accounts based on limits governed by pension legislation. Once the employer has made their retirement contribution to the fund, the investment risk falls largely on the employee. There is no obligation for the employer to make up for investment losses.
How is a Defined Contribution Plan different from a Group RRSP?
These plans are similar in many ways with a few key differences.
The Role of the Employer – In a DC Plan the employer contributions are mandatory based on the percentage of the employees’ salary subject to legislative limits. For a Group RRSP the employer contributions are voluntary. Employers often choose to match employee contributions but there is no obligation for them to do so.
Contribution Limits – In a DC plan there are more restrictions and limits on employer and employee contributions. For a Group RRSP the limits follow the RRSP limits established by CRA.
Vesting – Vesting is the point at which you have ownership of the employer’s contribution to your plan. In some jurisdictions employers can have vesting provisions in their DC Plans where if an employee leaves within the vesting period they will lose the employers contributions. All Group RRSP contributions are immediately vested although the employer may choose not to contribute to the Group RRSP until a certain time has passed.
Portability – Moving funds from DC plans can be more restrictive (see the following section) whereas Group RRSPs can generally be transferred to individual RRSPs.
Investment Options – DC plans typically have the employees pension funds professionally managed as directed by a group of trustees with some investment options offered to the employee. Group RRSPs usually have a wide range of investment fund options the employee can chose from.
Defined Contribution Plan and Group RRSP differences