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

  1. A DB pensionPension A steady income you get after you retire. Some pensions pay you a fixed amount for life. Others save up money for you while you are working. You use that money to create income after you retire.+ read full definition plan promises to pay you a certain amount of retirement income for life.
  2. The amount of your pension is based on a formula that usually takes into accountAccount An agreement you make with a financial institution to handle your money. You can set up an account for depositing and withdrawing, earning interest, borrowing, investing, etc.+ read full definition your earningsEarnings For companies, it’s the money they make and share with their shareholders. For investors, it’s the money they make from their investments.+ read full definition and years of service with your employer.
  3. In most plans, both you and your employer contribute.
  4. Your employer is responsible for investing the contributions to ensure there’s enough money to pay the future pensions for all plan members.
  5. 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.

Average Salary $50,000
BenefitBenefit Money, goods, or services that you get from your workplace or from a government program such as the Canada Pension Plan.+ read full definition percentage 2%
Years of plan membership 30
Formula calculation $50,000 x 2% x 30
Annual pension $30,000

2. Defined contribution plan

5 things to know about DC plans

  1. With a DC plan, contributions are guaranteed, but retirement income is not.
  2. Usually, both you and your employer contribute to the plan. Your employer may match some of the contributions you make.
  3. You are responsible for investing all contributions to grow your savings. In this way, the plan is similar to an RRSP.
  4. The amount available for your retirement depends on the total contributions made to your account and the investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition returns this money earned.
  5. At retirement, you use the money in your account to generate retirement income. You can do this by:
    • buying an annuity from an insurance companyInsurance company A company that sells insurance products. Some companies sell only life insurance. Some sell only property insurance. Others sell all types of insurance.+ read full definition, or
    • transferring your savings to a locked-in retirement income fund (LRIF)Locked-in retirement income fund (LRIF) A fund that you open with the money from your pension plan when you leave your company or retire. They give you a regular flow of income, but they have rules about how much you withdraw each year.+ read full definition 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.

2 key points

  1. DB plan – guarantees you a retirement income for life, based on a plan formula
  2. DC plan – guarantees contributions, but not your income in retirement
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