If you’re fortunate enough to work for a company that offers a pension plan, you have another way to fund your retirement goals.
In this article, we explain what a pension plan is, discuss the main types of pension plans in Canada and explore other ways to supplement your retirement income, such as a reverse mortgage.
What is a Pension Plan?
A pension plan is a type of group retirement plan offered by employers. Pension plans in Canada are designed to provide a company’s employees with retirement income and are provided as a benefit of employment. Employer pension plans are one of the pillars of retirement savings plans, along with public pensions, such as the Canada Pension Plan, and individual retirement savings plans, such as an RRSP.
Different Types of Pension Plans
There are three main types of pension plans in Canada offered by employers: A defined contribution pension plan (DCPP), a defined benefit pension plan (DBPP) and a pooled registered pension plan (PRPP).
A Group Registered Retirement Savings Plan (GRSP) is another type of employer pension plan, but unlike the other main plans listed above, employer contributions to a GRSP are voluntary.
What is Defined Contribution Pension Plan?
Defined contribution pension plans are the most common type of pension. With a DCPP, the amount of money you contribute to the plan is defined, but the amount of money you’ll receive at retirement is not. Both you and your employer typically contribute a percentage of your salary to the plan during your time with the company.
When you retire, you can convert the funds in your DCPP into a retirement income stream. The amount you receive at retirement depends on how much has been contributed and how well the investments in your plan have performed.
Benefits of a DCPP
Some of the key benefits of a DCPP are that your contributions are tax-deductible, subject to government limits, and the funds in your plan grow tax-free until you’re ready to retire. Here are some of the other benefits:
- Your employer contributes to your plan and may even match your contributions.
- You typically have options on how to invest the funds in your DCPP
- When you retire, you can turn the plan’s assets into a retirement income stream by purchasing an annuity or converting to a Life Income Fund (RIF) or registered Retirement Income Fund (RRIF).
Disadvantages of a DCPP
The main drawback of a DCPP is that the amount of money you receive in retirement is uncertain, as it is dependent on how well your investments perform and how much has been contributed to the plan.
- Depending on your plan provider, you may have limited investment options to choose from and mutual funds may come with higher management fees.
- You take on all of the investment risk and usually have to make all the investment decisions.
What Is a Defined Benefit Pension Plan?
Defined benefit pension plans (DBPPs) are a type of pension that guarantees you’ll receive a specific – or defined – monthly income when you retire. That defined monthly retirement benefit is typically calculated using a formula that takes into account your salary, your age, and the years of service with your employer. With some DBPPs, employers make all the contributions, while other plans require that employees also contribute.
Benefits of a DBPP
There are two main benefits of a DBPP. One is that your employer takes on all the investment risk: they choose the investments and ensure there are enough funds to provide retirement benefits to employees. The other is that DBPPs provide a guaranteed pension for life. Other advantages include the following:
- Because they provide a predictable income, DBPPs make retirement planning much more straightforward.
- Some plans provide a cost-of-living adjustment that takes into account the inflation rate.
- Many defined benefit plans allow for early retirement; however, if you choose to retire early, your pension benefit will be reduced accordingly.
Disadvantages of a DBPP
Because DBPPs cost companies much more to administer, the trend is for employers to offer employees defined contribution plans instead. If you’re fortunate enough to have a DBPP, there are still some disadvantages.
- Employees with a DBPP often work longer to take advantage of their full defined retirement benefit.
- If the company does not manage their pension plan well, there may not always be funds available to provide employee pensions or employees may be asked to help make up plan shortfalls.
- If your DBPP is not linked to inflation, your pension income will not go as far and you may need to supplement it with your own savings.
What is a Pooled Registered Pension Plan (PRPP)?
A Pooled Registered Pension Plan (PRPP) is offered by financial institutions on behalf of employers (and their employees) and self-employed individuals. It is similar to a DCPP, except that employer contributions are not mandatory.
Pooled plans were introduced by the federal government in 2012 and were designed to help employees of smaller companies and the self-employed – who typically don’t have access to an employer pension plan – save for retirement.
A PRPP allows members to benefit from lower investment management and administration fees that result from participating in a pooled pension plan.
Benefits of a PRPP
Here are some other benefits of a PRPP:
- Provides access to a workplace pension for employees of smaller companies and entrepreneurs.
- PRPPs are portable, allowing employees and the self-employed to take their pension with them if they change jobs.
- Flexibility in choosing and managing their plan investments.
Disadvantages of a PRPP
One of the main disadvantages of a PRPP is that they are not available in all provinces. Currently, British Columbia, Québec, Manitoba, Saskatchewan, Ontario, and Nova Scotia offer PRPPs. Other drawbacks are similar to a DCPP:
- You take on all of the investment risk and have to make all the investment decisions.
- The amount of income you’ll be eligible to receive in retirement is not defined.
Best Pension Plans In Canada
If asked to choose, most employees would no doubt opt for a Defined Benefit Pension Plan, for two main reasons. One, they know exactly what their monthly pension benefit will be. And two, the employer assumes all the risk with a DBPP.
But whether you have a defined benefit plan or a defined contribution plan, count yourself fortunate. That’s because only 38% of Canadian employees have a company pension plan, which partly explains the appeal of pooled plans for self-employed individuals and those working for smaller companies.
It’s important to keep in mind that having a company pension plan does reduce your Registered Retirement Savings Plan (RRSP) contribution room – your available contribution room will decrease in relation to the amount of your pension.
Reverse mortgages as a Source of Retirement Income
As we’ve seen, not everyone has a company pension plan to fall back on. In addition, your company pension may not provide the income you need to live your desired lifestyle in retirement, especially in today’s climate of higher inflation. That’s why Canadians age 55+ are looking to reverse mortgages to supplement their retirement income.
For instance, the CHIP Reverse Mortgage allows you to access up to 55% of the value of your home in tax-free cash. The funds can be used to meet a variety of different needs, such as taking care of day-to-day expenses, renovating your home or helping your children with a down payment on their first home. And since the money you receive from a reverse mortgage is a loan, it’s not added to your taxable income and does not affect benefits such as the OAS.
To learn more about how a CHIP Reverse Mortgage works and how it can help supplement your cash flow needs in retirement, please call us toll-free at 1-866-522-2447.
