Understanding Your Retirement Benefits: Part 3 – Private Pension Plans

According to Statistics Canada, in 2012 38.4 percent of employees were enrolled in a Registered Pension Plan. The most common types of pension plans are defined benefit (DB) and defined contribution (DC).

Of those employees, 71.5 percent were in a defined benefit plan. Defined contribution plans accounted for 16.7 percent. (The remainder belong to some sort of hybrid or other plans such as Group RRSPs.)

Defined Benefit Pension Plans

DB plans have been long considered the gold standard of pension plans. Although they are becoming increasingly rare in the private sector, they are still the norm in the public sector.

In a typical DB plan, employees contribute a percentage of their income and the employer makes a matching contribution. The funds are invested by professional money managers. Members are guaranteed a specific income level at retirement according to a formula that can vary from one plan to another.

The formula may be based on the number of years of service plus an income factor. More generous plans define income as the average of your best three or five years. Others use your final three or five years, while some base the pension on average career earnings. If you’ve decided to ease into retirement by working part-time for a few years you should definitely find out how retirement income is determined by your plan.

A typical formula based on best earnings is this:

(2% x years of service) X average of best five years of income = Annual pension income

That amount would be guaranteed, assuming the pension fund remained solvent.

It’s important to find out which approach your plan employs. How will the pension be calculated when the time comes to stop work? Ask for a calculation of your projected pension at retirement. The closer you are to retiring, the more accurate the projection will be.

If you leave the plan before your retirement date, you’ll usually be offered a deferred pension or a lump-sum buyout. Generally, the deferred pension is the better choice, especially if you have been in the plan for many years.

Questions to ask about your benefits:

• Is the plan integrated with CPP? This means that benefits paid by the plan will be adjusted to reflect payments you receive under the Canada Pension Plan. Most DB pension plans are integrated with the CPP.

• At what age can I retire? Some pension plans allow for retirement after a certain number of years of service; with others, you must reach a specific age. A formula often used involves adding age to years of service; if the total is equal to or greater than a target number (e.g. ninety) you may retire with full benefits.

• Are benefits indexed? Very few offer this desirable feature, and those that do are mainly in the public sector. If you have an unindexed plan, the buying power of your pension cheque erodes, but if you know this up front you’ll be able to plan accordingly.

Defined Contribution Pension Plans

Most people who are fortunate to have a pension plan while working in the private sector will likely have a DC plan. Here, the onus is put on you to manage the money to your best advantage.

Related: DC Plans – Why opting out shouldn’t be an option

The amount of money you will have at retirement is based on the amount of contributions made and the earnings of these investments. At retirement you use the money in your account to generate retirement income. You can do this by:

• Buying an annuity.
• Transferring your savings to a locked-in retirement income fund (LRIF).

Conclusion

Your pension can become the cornerstone of your retirement plan providing you with steady income that will last a lifetime.

No matter which type of plan you have, it is essential that you understand it thoroughly and have a good idea of how much you are likely to receive when you retire.

Once you have a reasonably clear idea of what to expect, you’ll be in a better position to plan what you will need from your investments.

Further reading:

• Understanding your retirement benefits: Part 1 – CPP
• Understanding your retirement benefits: Part 2 – OAS and GIS