Rounding it up
There are three main types of pensions available to Canadians; some guarantee income during your retirement, others offer more control over the investments.
You can get pension plans from your employer, from the government, and/or on your own.
A mix of different pension and retirement accounts, combined with a comprehensive budget, is the best way to ensure you meet your goals.
Pensions are a critical device in the retirement planning toolbox. They provide a defined income for the remainder of your life based upon the number of years you’ve paid in and when you begin taking disbursements. Pensions are also subject to stiff regulations that protect consumers, so you can calculate and plan on pension disbursements in perpetuity.
But did you know that there are different types of pension plans? There are also various places to get pensions and several regulations that govern exactly how you access and take advantage of them.
You’d think such a crucial tool for the long-term well-being of Canadians would be an easy, straightforward process. Unfortunately, pensions are often shrouded in a misty cloud of confusing terms. Let ’s see if we can demystify some of these options available to you.
First of all, what is a pension?
A pension plan is a type of retirement plan that requires employers to pay into a fund that is disbursed to employees at a set age. Technically, any type of account that offers a set payment at retirement is called a pension. However, the common use of the word refers to a defined benefit plan (we’ll get into this below) where the employee receives a set payment each month in retirement.
A pension often has specific vesting, or eligibility rules, as well. When a company contributes to a pension, they can define the length of an employee’s time at the company to qualify. For example, an employee may become eligible to participate in a pension after a year of employment. If they leave within five years, they may only qualify for 10% of pension payments. After ten years, they may be entitled to 50%. If the employee makes payments to the pension themselves, they’d qualify for 100% of it, regardless of tenure.
Pensions come from either the government or private sources (again, more on this below). This distinction is important because pension funds that come from some government pensions are non-taxable, like government assistance.
Pensions that come from the CPP or QPP are taxable in the year you receive them. Private sources are not taxed when deposited and are taxable at the disbursement stage.
Pensions sound great — do all companies provide them?
Nope. Traditional pensions end up being great for the employee but not so much for the employer. The employer ends up committing to pay out a certain amount for all their employees, regardless of performance.
Consequently, Direct Contribution Pension Plans are very popular. This option allows the employee to know exactly what they’re contributing but not the exact number they’ll get to draw at retirement. Additionally, The Canadian Pension Plan — or Quebec Pension Plan — is still popular with many. It requires the employee to pay during their working years and be guaranteed about 25% of their income in retirement. This, along with private retirement, generally provides fairly stable earnings.
The onus for retirement has shifted from the company to the employee and thus, the rise of personal retirement accounts.
"Take your retirement into your own hands."
What types of pensions are there?
Defined benefit pension plans (DBPP)
Defined benefit pension plans are the ones generally falling out of favour with employers, as they tend to be expensive and very inflexible. Typically, employees love DBPP for the ability to calculate exactly how much you’ll be receiving in retirement. All you need to do is average your five best years of salary, multiply it by the agreed-upon factor, combined with how many years of service.
For example, an employer may offer a pension plan that gives 2% per year of service on the average of the five best years of salary.
So, if the average of the salaries is $100,000 and you worked at the company for 20 years, you can expect to receive $40,000 per year — and that $40,000 is guaranteed for your entire life. Additionally, you can usually extend the pension to spouses for a fee.
There are a few things to keep in mind here, however. First, most companies have a very rigid set of requirements. Employees who work for a company for a shorter time period will have a smaller pension. Additionally, the employee has very little control over the investment itself. The advent of the internet and the ease with which consumers can invest on their own has resulted in DBPPs becoming quite outdated.
Defined contribution pension plans (DCPP)
Defined contribution pension plans take the risk from the employer and puts it squarely with the employee. Here, the employee will direct a certain percentage of their salary each month or year to a retirement account. The investments of that account are managed entirely by the employee. The employer will often offer to match the employee’s contribution; say 100% up to 3% of annual salary.
However, there are risks here as well. Employees take care of all the investing themselves and it’s possible for the employee to outlive the money.
Registered Retirement Savings Plan (RRSP)
An RRSP can be both employer-sponsored and private. The employer-sponsored version is quite similar to DCPP plans, but offers some differences of how much and when you can withdraw. Employers can still offer matching and other benefits to the account. If you decide to explore this route, just be sure that you stay under the limits set by law for retirement contributions.
The Canadian government also offers the Canada Pension Plan. It is intended to replace a small portion of your income during retirement but should not be considered a total solution. Another option is the Old Age Security (OAS) benefits, designed for individuals who do not have enough retirement income. On top of that, the government offers Guaranteed Income Supplement (GIS) payments for low-income seniors in conjunction with OAS benefits.
You can learn more and apply via your My Service Canada Account.
Financial security can be a difficult topic to wrap your head around. At the end of the day, you’ll want to ensure you are crushing your present goals, while still planning ahead for retirement. The best advice we’ve come across? Take your retirement into your own hands. Understand the options you have available, contribute to the pension and retirement accounts that align with your financial goals, and take charge of your own post-work life.
Dan is a runner and writer living in the Washington, D.C. area, where he currently works for a financial services trade association as the Communications Director.