2 main types of pension plan
There are 2 main types of pension plans: defined benefit (DB) and defined contribution (DC).
1. Defined benefit plan
5 things to know about DB plans
- A DB pension plan promises to pay you a certain amount of retirement income for life.
- The amount of your pension is based on a formula that usually takes into account your earnings and years of service with your employer.
- In most plans, both you and your employer contribute.
- Your employer is responsible for investing the contributions to ensure there’s enough money to pay the future pensions for all plan members.
- If there’s a shortfall in the money needed, your employer must pay the difference.
Sample formula – 2% x your average salary in the past 5 years x number of years you were a plan member.
|Years of plan membership
||$50,000 x 2% x 30|
2. Defined contribution plan
5 things to know about DC plans
- With a DC plan, contributions are guaranteed, but retirement income is not.
- Usually, both you and your employer contribute to the plan. Your employer may match some of the contributions you make.
- You are responsible for investing all contributions to grow your savings. In this way, the plan is similar to an RRSP.
- The amount available for your retirement depends on the total contributions made to your account and the investment returns this money earned.
- At retirement, you use the money in your account to generate retirement income. You can do this by:
- buying an annuity from an insurance company, or
- transferring your savings to a locked-in retirement income fund (LRIF) or similar income fund designed specifically for pension savings.
New type of DC plan on the horizon
The federal government is introducing a new type of DC plan, called a Pooled Registered Pension Plan (PRPP). These plans would be offered by financial institutions on behalf of employers. Multiple employers – and the self-employed – would participate in a single, cost-effective plan.
The government introduced legislation to allow PRPPs on November 17, 2011. Provinces must pass their own laws to let these new plans operate. While PRPPs are not yet available, the federal government has set out the general framework for how they will work.