Q. I have received notice that my employer is switching my Defined Benefit Pension Plan to a Defined Contribution Plan. What are the implications to my future retirement?
You are not alone. More and more companies are replacing defined benefit plans with defined contribution plans. This is primarily due to the rising expenses and long-term obligations (people living longer) associated with running a defined benefit plan.
Defined benefit plans essentially promise to pay eligible participants a guaranteed monthly amount (the benefit) in retirement over their lifetime. The amount is based on a formula, typically using income and years of employment, and sometimes other variables. To make these payments it is important for the company to have a properly funded plan.
Alternatively, a defined contribution pension plan lowers the risk to the employer. They no longer have any obligation for the performance of the plan. The onus to properly save for retirement is put on the individual employee. Planning for one’s future retirement becomes more challenging when pension plans and rules change, especially if the pension could provide less income than you originally might have planned or hoped for.
As per the name, employees usually contribute an amount based on a percentage of their salary. The funds are invested in a choice of various mutual fund or GICs within the plan.
The advantage of defined contribution plans is they offer an employee more choice and flexibility to tailor the plan to suit his or her investment goals and risk tolerance, and the benefit of dollar-cost averaging.
You have total control over your portfolio, so make sure you put some effort into this.
Make the most of your defined contribution pension plan by:
- Continuing to make contributions
- Maximizing the amount you contribute to take advantage of as much of employer matching you can
- Reviewing your plan statements to understand how your investments are doing
A defined contribution pension does not pay a specific benefit. There is no guarantee as to how much income you will receive at retirement. It’s harder to predict what you’ll end up with at retirement. Your payments will depend on the value of your account when you retire.
This amount you will depend on how much your employer contributes to the plan, how much you as an employee save in the plan, how and how long the funds are invested, and how well your investments perform. The main risk is that a significant market crash could wipe out a big chunk of savings just when you need it.
A major decision at retirement is how to invest the money. You have a choice of transferring the funds to a locked-in RRSP, or if you need income right away, a LIF or annuity. Your retirement income will depend on the option(s) chosen.
Understand what your pension will provide. Use a retirement calculator to figure out how much you are likely to save (include the employer contribution) and how much annual income it would provide. This can also give you a guide for how much to save outside your pension plan.
Don’t wait until you retire to you figure this out.
An additional note; today a retiree aged 55 can access income from their defined benefit plan and income split with their spouse on their taxes. However, when income is taken from a defined contribution plan, these funds are not eligible for income splitting until both spouses are 65.