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Company Pension Plans in Canada

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This article provides an introduction to company pension plans as well as a discussion of several issues currently facing company pension plans in Canada.

Company pension plans are considered one of the three pillars of retirement planning, together with government pensions and personal savings. Understanding what to expect from a company pension is essential to effective retirement planning.

According to 2008 figures from Statistics Canada1, only 38% of paid workers had a company-sponsored pension plan as part of their compensation. For those who are covered, the two main types of company pension are the Defined Benefit pension plan and the Defined Contribution pension plan.

The Types of Pension Plans

A Defined Benefit pension plan (DB Plan) offers an employee the security of knowing what to expect at retirement. A monthly retirement income is specified up front (based on a formula set out in the plan). It is up to the employer to contribute enough to the plan to ensure that sufficient funds are available in the future. How much an employer must contribute will vary based on the changing market value of their investments. Thus, the investment risk is on the employer. The funds for all pension plan members are pooled into one investment plan and controlled by a plan administrator. The income that a retiree will receive is based on the set formula, usually dependant on years of service and income, for example, the average of their last five years' earnings.

In contrast, in a Defined Contribution pension plan (DC Plan), an employer specifies how much will be contributed to the plan on a regular basis. Investment of the funds is generally directed by the employees from a selection of investment options available within the plan. This is similar to managing a personal RRSP. The amount a retiree will receive will vary based on the amount contributed and the performance of the invested funds over time. The DC Plan offers more flexibility for an employee than a DB Plan but puts all the investment risk on the employee.

A summary of the key differences between DB and DC Plans is given in the appendices of this article.

Who Contributes

Contributions to a pension plan are made by the employer alone or the employer and the employee with contributions by both employer and employee being the most common arrangement. Rules for contributions are specific to each plan and may include matching cash contributions (either dollar amounts or percentages.

In Canada, pension plan funds are held in trust, separate from the company. This means that the funds are held by an independent plan administrator. Once in the plan, the pension assets are not available to the company to draw on.

Tax considerations: Employee contributions are tax-deductible, like an RRSP contribution. Employer contributions reduce the amount of RRSP room an employee has available.

What does the employee receive when retiring?

If the plan is a DB Plan, the employee will receive the specified monthly income for the rest of their life. Most plans allow for payments to continue to their spouse or common law partner and some may also allow for inflation adjustments.

If they have been part of a DC Plan, at retirement they will receive all of the funds which they have contributed, those which their employer has contributed, as well as all accumulated investment income. At retirement, they have the choice of transferring the DC Plan funds to a locked-in RRSP, a Life Income Fund (LIF) or an annuity. These choices are explored in more detail in our RRIF vs. Annuity article . Retirement income will depend on the option(s) chosen.

Tax considerations: A pensioner pays tax on the pension/annuity benefit received or the registered plan withdrawal(s) made.

For example:

DB Plan: Let's take the case of an employee making $40,000 per year who joins a DB Plan at age 35 and retires at age 65. The terms of the plan are:

The contributions and benefits would be calculated as follows:
Assumption: $40,000 salary grows at rate of inflation but all values are stated in today's dollars

DC Plan: Let's look at a similar employee making $40,000 per year who joins a DC plan at age 35 and retires at age 65. The terms of the plan are:

The contributions and benefits would be calculated as follows:
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