A pension plan can provide you with income during retirement. Being part of a pension plan may help give you more peace of mind about the future during your earning years.
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What is a pension plan?
A pension plan is designed to provide you with retirement income. Many employers offer pension plans as part of their employee compensation. The employer and employee make regular contributions to the plan. You can only receive income (or make withdrawals) from these plans during retirement, typically from age 55 onward.
Pension plans can offer:
- higher rates of employer contributions than savings plans (for many plans, but not all).
- built-in discipline to ensure you have the income you need in retirement.
There are two main types of pension plans:
- Defined benefit (DB)
- Defined contribution (DC)
How do defined benefit (DB) pension plans work?
A defined benefit pension plan promises to pay you a certain amount of retirement income for life. The amount income you receive is based on a formula. That formula usually considers 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.
How is a defined benefit pension plan calculated?
A formula is used to calculate your defined benefit. For example, a company could calculate the defined benefit based on:
- 2% of your average salary per year of employment.
- multiplied by the number of years you were a plan member.
If you were employed for 30 years, with an average annual salary of $50,000, the annual pension would be: $30,000.
|Years of plan membership||30|
|Formula calculation||$50,000 x 2% x 30|
Learn more about defined benefit pensions.
How do defined contribution (DC) plans work?
In a defined contribution pension plan, the amount of your contribution is guaranteed, but not the amount of retirement income.
Usually, both you and your employer contribute to the plan. Your employer may match your contributions. You are responsible for investing all contributions to grow your savings. In this way, the plan is similar to an RRSP.
The amount of money available for your retirement depends on:
- the total contributions made to your account.
- 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.
Learn more about defined contribution pensions.
What is a workplace savings plan?
Some employers offer savings plans instead of, or in addition to, pension plans. These types of plans are more flexible. You may not be allowed to take money out while you are with your employer. But once you leave your employer, you can transfer your savings out of the plan to use for retirement or any other goal.
Savings plans can offer:
- the flexibility for you to save for goals other than retirement.
- investment management fees that are often lower than those you pay as a retail investor.
- more savings – if both you and your employer contribute, your savings power is doubled.
- automatic saving – your contributions come off your paycheque before you may be tempted to spend it on other things.
Workplace savings plans can vary greatly in their design and purpose. It’s important to understand how your employer’s plans work and any rules that apply. Make sure you know about fees that apply, and whether you can opt-out of the plan later.
Employers may offer other financial resources besides pension or savings plans, such as learning tools, access to a professional financial advisor, and online account access. Check what resources may be available at your workplace.
Your employer may offer a pension plan or savings plan as part of your compensation. These are both ways to help you save for the long term. Keep in mind:
- Pension plans have a single focus: retirement.
- Savings plans can be for any goal. But you may not be able to withdraw money from your savings plan while you are with your employer.
- Defined benefit plans guarantee you a retirement income for life, based on a formula.
- Defined contribution plans guarantee contributions, but not your income, in retirement.