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Retirement savings

February 05, 2018

How do employee pension plans work?

Defined benefit, defined contribution, group registered retirement savings plan — the list goes on. Here’s what you need to know.

To be employed by an organization that provides its people with a retirement savings plan is one of the greatest financial advantages you can enjoy in Canada. These plans come in a variety of shapes and sizes, but they all have 1 thing in common: They help you achieve your retirement savings goals.

Employer-sponsored plans are complicated. But with a few basic facts, you can make better decisions for you and your family.

1. What kinds of employee pension plans are there?

There are 2 basic kinds of plans: defined benefit plans and defined contribution (sometimes called capital accumulation) plans.

Defined benefit plans provide members (pension-speak for employees who participate in the plan) with a level of retirement income based on a calculation that typically factors in years of service with the employer and salary earned. The member may contribute to the plan during his or her time as an employee with the organization. Employer and member contributions are pooled in a pension fund and invested. The pension plan sponsor (the employer) is responsible for ensuring that the plan can pay members the required retirement income.

Defined contribution plans allow organizations to sponsor plans without bearing the investment risk that comes with a defined benefit plan. Each member has his or her own account. Employer and member contributions are invested, usually based on investment options selected by the member. Your retirement income is determined by how your investments perform. Defined contribution pension plans, group registered retirement savings plans, employee share purchase plans, deferred profit-sharing plans and group tax-free savings account plans are all examples of defined contribution schemes.

2. What role does my employer play in the plan’s management, and who else is involved?

Typically, pension plan sponsors rely on a range of service providers, including plan administration services providers, investment fund managers, life insurance companies, trust companies and consultants.

Third-party administration providers offer record-keeping and other services to defined benefit and defined contribution pension plans. Investment managers invest the pension fund assets. Insurance companies can provide third-party administration services and investment management. Trust companies provide custodial services. Consultants support plan sponsors and pension funds with services such as plan valuation, pension design consulting, member communications consulting and fund manager search services.

3. What happens if I leave my employer?

If you’re leaving a plan for any reason, it can be useful to talk to a financial advisor. You’ll have several options, many of which are complex.

Under pension legislation in most Canadian jurisdictions, defined benefit and defined contribution pension plan members may be automatically “vested.” This means you are entitled to receive the benefits of your own contributions and those of your employer under the plan, without losing your employer’s contributions. In some provinces, you may need to work for your employer or be a member of the pension plan for a specified period before you become vested; if you leave before the benefits vest, you will receive only the value of your own contributions and earnings. If your benefits are vested when you leave, you have several options, depending on the applicable legislation and the plan. You may be able to:

  • Leave your assets in the plan you’re exiting.
  • Transfer the value (“commuted value”) of your pension to another pension plan, if you’re joining another one that allows such a transfer.
  • Transfer your commuted value to a registered retirement savings plan or other plan, which may be locked in (meaning you can’t withdraw the money until retirement).
  • Take the cash value (if it’s not locked in).

4. Do I pay a fee to participate in a plan?

Defined benefit plan members do not pay fees directly, although the pension plan may pay fees for such things as investment management, actuarial services, etc., out of the pension funds.

Defined contribution plan members may pay fees for investment management, plan administration and other services. Often these fees are built into the management expense charges of the plan. These fees are typically low compared to those charged to retail account-holders outside an employer-sponsored plan.

What are the advantages of being a member of an employer-sponsored plan?

3 important advantages of workplace pensions:

  1. Pension plans have lower fees than most people can obtain for their own individual investments. For example, defined contribution plan funds typically charge relatively lower investment management fees than would be available to an individual — often less than 1%.
  2. Employers typically also contribute to their employee pension plans. If you have an option to participate or to contribute, choosing not to join a plan or contribute can be like saying no to free money.
  3. Plans require you to save, thus taking away guesswork and many of the risks of trying to “time the market” (predict market up-and downturns). It can be difficult to take the time each month to set aside money for retirement savings, but pension plans provide valuable discipline. For example, defined contribution plan members can benefit from dollar-cost averaging when markets are down. By automatically investing a set amount regularly, you’re often able to buy more when prices are lower, instead of being tempted to pull out of the market. A pension plan can remove emotion from your investment decisions and help you stay invested for the long term, so you can make the most of your investments.

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