What the Heck Are Pensions, Anyway? 

Employer pension plans in Canada are investment accounts that you and your employer contribute to. It is an investment that will provide you with regular income throughout your retirement – Sweet! How much you will receive depends on several factors, such as the type of plan you are enrolled in, how long you have been contributing, and more. 

Pensions (or Registered Pension Plans – a.k.a. RPPs) such as Defined Contribution or Defined Benefit plans are most often associated with public sector employers and unionized workplaces. Private companies may offer Group RSPs to their employees as a benefit. All of these options involve the employer collaboratively contributing to your retirement savings! That’s almost like FREE MONEY! Except it is a part of your total compensation. So be sure you are not leaving that money on the table by delaying enrollment in your plan! If you aren’t sure what your workplace provides, you need to inquire now and learn how to take advantage of these fantastic benefits. 

Pensions are a vital part of retirement savings for many Canadians! Most Canadians will plan on retiring with a mix of their savings and investment accounts and public pensions like CPP/QPP and OAS.  In addition, those with company pensions in Canada gain the advantage of employer contribution matching, which can accelerate their retirement savings and ensure they receive consistent income in retirement.

Joe Curry tells us, “Pension plans are an incredible benefit many Canadians will never receive. If you are lucky enough to participate in one of these plans, take the time to understand what the pension will provide for you.  While they are a great benefit, for many people, they will not be enough to fund their retirement lifestyle fully.”

The Golden Handcuffs

The term Golden Handcuffs refers to receiving employment benefits that are so enticing that you don’t want to leave your workplace (until retirement). A robust pension is the ultimate example of golden handcuffs. After speaking with my financial planner and comparing scenarios where I stayed in my pensioned role or left the pension program and my employer for other work, the amount I would have to save to make up for the loss of pension personally was a disincentive for me to leave my employer. 

Whether the incentive/disincentive is enough for you is a personal decision you will have to make. Discussing these decisions with family or a financial planner is a great way to determine what it would mean for you and your retirement planning. You should consult an advice-only or fee-based financial planner who can help you with a financial plan. 

Types of Pension Plans in Canada 

You may have a pension – but what do you actually know about it? There are a lot of details and terminology that are important to learn when it comes to pensions! First and foremost, you need to figure out the type of pension plan you have. Regarding formal employer-sponsored pensions in Canada, there are three common types: Defined Benefit, Defined Contribution and hybrid pension plans. 

Defined Benefit 

What is a Defined Benefit Pension Plan?

A DB Pension,  as it is commonly known, is a pension plan that promises a specific and predetermined retirement benefit to its enrolled members.  That means you know exactly how much money you will get from the month you retire until you die. Your payments are guaranteed.  Typically, it’s based on a complicated formula considering factors like years of service and final average salary. 

Guaranteed Retirement Income: One of the critical features of a DB pension plan is that it provides a guaranteed and predictable retirement income. Employees can generally calculate their future pension benefits with a high degree of certainty, which can be reassuring for retirement planning.

The great thing about planning with Defined Benefit plans is their exactness. You can work out exactly how much you may need to save for retirement in addition to your pension by doing some simple calculations. To find out how much you need to save, you first need to estimate your post-retirement spending goals and expenses. Then, you calculate your DB plan benefits + CPP + OAS to identify the amount you need to fill with personal retirement savings.

Employers are primarily responsible for funding and managing DB pension plans. They contribute funds to the plan on behalf of employees, invest those funds, and assume the investment risk. If the plan’s investments underperform, it’s the employer’s responsibility to make up the difference to ensure that promised benefits are paid. 

Advice-only Financial Planner Joe Curry from Retirement Planning Simplified states that “typically, both employer and employee contribute to DB plans. The employer must fund at least half of the contributions in a given year, though they can fund more than half, or all the contributions if they choose to do so. But any shortfall in funding is on the employer.”

Unlike defined contribution (DC) plans, DB plans do not have individual accounts for each participant. Instead, the employer maintains a collective pool of assets to fund all future pension payments.

When employees retire, they typically have several options for receiving their DB pension benefits. You could choose from receiving a monthly pension for life, choosing a joint and survivor option to provide benefits to a surviving spouse, or going for a lump-sum payout. 

Many DB plans have vesting periods, which means you need to work for a certain number of years before you become eligible for the full pension benefit. In some cases, employees who leave the company before retirement may have the option to transfer the commuted value of their pension to another registered pension plan or to their personal accounts. 

Joe advises that “when transferring the commuted value to a personal retirement account, depending on the plan specifics, all or a portion will go to a locked-in retirement account. This account will act like an RRSP but, in most cases, cannot be accessed until at least age 55. Anything that exceeds what can be transferred into the locked-in retirement account will be paid in cash. This is taxable, but if you have RRSP deduction room available, it can go to your RRSP and the taxes will be offset by the RRSP deduction.”

DB pension plans can face funding challenges if investment returns fall short of expectations or plan demographics change (e.g., a higher number of retirees relative to active employees). The risk is on the employer to increase or make additional contributions to meet their obligations to plan members.

Defined benefit pensions are the top-of-the-tops when it comes to retirement plans because they provide retirees with a predictable and secure stream of income in retirement. However, they are becoming less common  due to the financial burden they can place on employers. Many employers have shifted to defined contribution plans to transfer investment risk to employees. 

If you have a DB pension plan, it’s essential to understand its terms, the calculation of benefits, and your options upon retirement.