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 – the PRPP
Effective January 1, 2013, the federal government introduced a new type of DC plan, called a Pooled Registered Pension Plan (PRPP). These plans are offered by financial institutions on behalf of employers. Multiple employers – and the self-employed – can participate in a single, cost-effective plan.
The PRPP is designed mainly for employed and self-employed individuals who would not otherwise have access to a workplace pension plan.
Currently, PRPPs are only available to people who are employed or self-employed:
- in the Northwest Territories, Nunavut or Yukon;
- in a federally regulated business or industry (like banking or transportation) where the employer chooses to participate in a PRPP; or
- who live in a province that has put PRPP laws into place and the employer is participating in a PRPP.
Quebec’s version of the PRPP – the Voluntary Retirement Savings Plan (VRSP) – takes effect on July 1, 2014. Two other provinces (Alberta and Saskatchewan) have passed PPRP laws, but they have not finalized a date for the introduction of PRPPs. Ontario continues to study PRPPs but has not introduced a law that permits them.