How defined contribution pension plans work

A 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 is offered by many employers as part of your compensation, along with salary and other benefits. Defined contributionContribution Money that you put into a savings or investment plan.+ read full definition pension guarantee a certain amount will be contributed to your pension each year, but it is up to you to decide how to investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition it.

On this page we answer:

What is a defined contribution pension plan?

Defined contribution (DC) pension plans guarantee the contributions to your 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. But unlike defined 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 plans, the amount you receive in your retirement is not guaranteed. And the value of your defined contribution plan can change, depending on the type of investments you hold.

Usually, both you and your employer contribute to the plan. Your employer may match some of your contributions. You are responsible for investing all contributions to grow your savings. In this way, a defined contribution pension is similar to an RRSP.

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 earns.

Learn more about investing.

How do you become a member of a defined contribution pension plan?

Many employers require full-time employees to join their defined contribution plan. This can happen when you’re hired or after a certain length of time. Other employers leave the decision to join up to you.

If you’re a part-time employee, you may be eligible to join as well. Check with your plan administrator. In Ontario, plans must let you join if you have worked for your employer for 24 consecutive months and you have either:

  • worked at least 700 hours a year for the two previous consecutive calendar years, or
  • earned about $18,000 or more in each of the two previous consecutive calendar years.

How do you manage your defined contribution pension plan?

You are responsible for investing all contributions made to your defined contribution plan account. In most of these plans, your employer will offer you a variety of professionally managed investment funds to choose from.

Your employer will provide you with investment information about each fund. Choose the fund or mix of funds to suit your situation. This will depend on your tolerance for investment risk and how close you are to retirement.

Your employer may offer single fund portfolioPortfolio All the different investments that an individual or organization holds. May include stocks, bonds and mutual funds.+ read full definition optionsOptions An investment that gives you the right to buy or sell it at a set price by a set date. The buy right is termed a “call” option, and the sell right is termed a “put” option. You buy options on a stock exchange.+ read full definition. This lets you invest in just one fund to meet your retirement goals. The advantages of single fund portfolios are simplicity and convenience. You decide on the fund. And you leave the ongoing investment decisions and portfolio adjustments to the professional money manager.

Two types of single fund portfolios are target date funds and target risk funds.

  1. Target date funds

These funds take care of the active decision making for you during your career. They also:

  • Automatically adjust the mix of stocks, bonds and cash investments as you get closer to your retirement date. The mix becomes more conservative over time.
  • Require you to invest in the fund that most closely matches your expected retirement date.
  1. Target risk funds (or assetAsset Something of value that a company or an individual owns or controls. Examples: buildings, equipment, property, a car, investments, or cash. Can also include patents, trademarks and other forms of intellectual property.+ read full definition allocation funds)

These funds are designed to match your level of investor risk tolerance — from conservative to aggressive. They also:

  • Are rebalanced regularly to ensure the fund’s target asset mixAsset mix The percentage distribution of assets in a portfolio among the three major asset classes: cash and cash equivalents, fixed income and equities.+ read full definition is maintained.
  • Require you to invest in the fund that most closely matches your investor risk tolerance.

Remember

The value of your defined contribution plan isn’t guaranteed. It can change depending on the type of investments you hold. Understand the risks before you make your investment decision.

Take advantage of any investment selection tools – or access to professional investment advice – that your plan provides.

What is a Pooled Registered Pension Plan (PRPP)?

A Pooled Registered Pension Plan (PRPP) is a type of defined contribution pension plan. It is offered by financial institutions on behalf of employers. It 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.
  • who live in a province that has put PRPP laws into place and the employer is participating in a PRPP.

Ontario enacted legislation governing PRPPs. As such, individuals who are employed or self-employed in the province can now participate in a PRPP.

Learn more about PRPPs.

 

What if you leave your defined contribution plan before retirement?

In Ontario, you have 3 options when you leave your defined contribution plan before retirement:

  1. Transfer to an individual locked-in retirement account (LIRA)Locked-in retirement account (LIRA) An account that holds money moved out of a pension plan. You may use one if you are changing companies and can take your pension savings with you. It works like an RRSP, but your money is locked in. You cannot withdraw the funds until you retire.+ read full definition – a LIRA works much like an RRSP. You set it up with a bank or other financial institution.
  2. Transfer to 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 to buy a deferred annuityAnnuity A contract usually sold by life insurance companies that guarantees an income to you or your beneficiary at some time in the future. An annuity is a contract with a life insurance company. When you buy an annuity, you deposit a lump sum of money, and the insurance company agrees to pay you a guaranteed…+ read full definition – this is a contractContract A binding written or verbal agreement that can be enforced by law.+ read full definition that guarantees to pay you an income for life. The start date is “deferred” until a future time when you want to begin receiving income. Learn more about annuities.
  3. Transfer to another pension plan – transfer your pension to your new employer’s plan if they will accept it.

You may face challenges in life that you were not expecting. If you become disabled before leaving the plan, check with your plan administrator about the disability benefit rules. If you are off work due to disability, you may be able to continue earning benefits under the plan.

If you die while you are still a member of the plan, your savings will be transferred to your spouse or beneficiaryBeneficiary The person(s), institution, trustee or estate you choose to give money, property or other benefits when you die. You may name beneficiaries in your will, insurance policy, retirement plan, annuity, trust or other contracts.+ read full definition. The amount can be transferred to your spouse’s RRSPRRSP See Registered Retirement Savings Plan.+ read full definition or RRIF. The savings remain taxTax A fee the government charges on income, property, and sales. The money goes to finance government programs and other costs.+ read full definition-sheltered until your spouse withdraws the funds.

Some provinces allow transfers only to the locked-inLocked-in An account that you cannot take money out of until you retire. In most cases, you can’t get a cash payout. Your plan may make exceptions if you have a terminal illness, or a small pension benefit.+ read full definition versions of these plans (locked-in retirement account or locked-in retirement income fund). In Ontario, and some other provinces, you and your spouse can waive your spouse’s right to this entitlement.

Payments made to any non-spouse beneficiary can be paid out in cash and are fully taxable to the beneficiary.

Designate a beneficiary for your plan. Benefits can be paid directly from the plan to your beneficiary upon your death. Your plan administrator can tell you how.

What are your defined contribution pension options at retirement?

In Ontario, there are two options for your defined contribution plan when you retire:

  1. Transfer to an individual locked-in income fund (LIF) – in Ontario and most provinces, these funds require you to withdraw income each year between certain minimum and maximum amounts. While you have some flexibility in how much you withdraw each year, these funds are structured to ensure you have retirement income for your lifetime.
  2. Buy an annuity from an insurance company – this is a contract that guarantees you an income for life. Once you buy the annuity, you don’t have to make any investment decisions or manage your savings in any way. Learn more about annuities.

You can also combine the two options listed above. You could consider using some of your money to buy an annuity and transfer the rest to a LIF. You can also use LIF savings to buy an annuity at any time in the future, if your need for guaranteed income increases as you get older.

How is your defined contribution pension plan protected?

All contributions made to your defined contribution plan account (both yours and your employer’s) go to the plan administrator. This is typically an insurance company or other financial institution. The plan administrator holds the money in your plan account and invests it according to your instructions.

This money is held in trustTrust An account set up to hold assets for a beneficiary. A trustee manages the assets until the beneficiary reaches legal age.+ read full definition and cannot be accessed by your employer — even if they are in dire financial need.

Summary

Defined contribution plans are a common type of pension plan. You are guaranteed a contribution amount. But the amount you receive in retirement depends on the growth of the savings. In a defined contribution pension plan:

  • Your money is held in trust.
  • Plan eligibility rules may vary if you work part time.
  • Most of these plans require you to transfer your money out of the plan when you leave your employer.
  • You have two options at retirement: transfer your funds to a locked-in income fund (LIF) or buy an annuity.
  • Remember to designate a beneficiary for your plan.

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