Pensions are kind of the golden ticket in retirement planning as they have such a huge impact on how much money will be coming in the door after you retire but not all pensions are created equal. Today I’m going to break down the basic kinds of pensions that may be offered through your employer. This doesn’t include government pensions like CPP and OAS; we’ll tackle those another day.
Defined Benefit Pension Plans
DB plans are the real winners in the pension world, and when most people think of a pension, this is what they’re thinking of. A DB pension will pay you a guaranteed monthly pension after you retire that will be based on your years of service, salary and a bunch of far more complicated calculations. This means that you will get a pension cheque every month after you retire until you die (depending on the option you choose your spouse may even still receive your pension payment after you die). This is the ultimate in security (guaranteed), and you would need to have a lot of money invested to come anywhere near the amount your pension will pay out.
Let’s look at a quick example. Say you receive a monthly pension of $2,500/month that will be paid out from when you retire at age 60 until you pass away at age 90. In this scenario you would get: $2500 x 12 months per year x 30 years = $900,000.
Some defined benefit pensions also have indexing built into them. This means that they will increase over your retirement to either completely or partially keep up with inflation. As we’re all aware, prices tend to go up over time (that’s inflation) so $2,500 today will not have the same buying power as $2,500 in 20 years, that’s what indexing tries to solve. A fully indexed, defined benefit pension plan is the best and safest option you can have in retirement, the problem is, not many jobs come with that benefit anymore because it’s incredibly expensive for employers. Keep in mind though, if you do get a DB pension with your job, make sure you weigh that if you’re considering a job switch. You may get a higher salary somewhere else, but that payment in retirement could be enough to make a lower salary worth sticking with.
Defined Contribution Pension Plan
The other big option (and much more common these days) in pensions are DCPP’s. These plans have both you and your employer contributing a portion of your salary into a retirement account that is similar to an RRSP but with some extra restrictions. The big difference between the two types of pensions is that the DB plan will pay you out a guaranteed amount until you die, and the DCPP will provide you with money only until you run out. If you end up with $500,000 in your DCPP at retirement and you spend it all in the first 10 years of retirement, that money is goners, so you need to make sure you plan your withdrawals accordingly.
There are a couple other factors of DCPP’s that many people do like. You can usually move your funds out of the plan at retirement (and sometimes before). That gives you the chance to make your own investment decisions (just as you would a personal RRSP). Another thing is that if you die that account will remain with your estate and pass on to whoever you have listed as the beneficiary. Except for your spouse (if you choose a joint pension option), your DB pension will stop paying if you die. If you don’t live that long after you start collecting your pension you won’t receive that much money…of course, this is impossible to know.
Now, when I say DCPP’s go into an account similar to an RRSP this is true, but you do need to be aware of certain limitations. The accounts are usually called Locked-In RRSP’s and they are exactly as they sound. Except for some exceptional situations (hardship or shortened life expectancy), you cannot pull any money out of the account until you are retired and even then there are yearly minimums and maximums. The government does this so you don’t do what I said above and go out and spend the whole $500,000 (or whatever) in the first few years of retirement…they force you to be at least somewhat responsible.
Now group RRSP plans aren’t actually a type of pension, but since they are also often offered by employers, I thought I would include them here too. Similar to a DCPP, your employer would match a set amount of your own contributions to the RRSP. Many of these plans still have restrictions on moving the funds to a different place while you are still working with the company but would abide by the same rules as a regular RRSP after you retire. The limitations on withdrawals is not an issue with RRSP’s as it is with DCPP’s.
Ok guys, those are the basics. Any type of pension is a great added benefit, and if it is offered with your company, you should definitely sign up. Do you have workplace benefits or are you on your own when it comes to saving for retirement?
This post was proofread by Grammarly.