Defined benefit pension plan Canada: The ultimate guide from someone who actually has a defined benefit pension plan (yours truly).
Oftentimes I think of my defined benefit pension plan (DBP) is like a Set for Life Scratch & Win– except that I would have to work for another 20 years to be ‘set for life’ and have a full pension which really, would not be ideal, nor would it be the Fat Fire Financial Independence Retire Early life that I want or envision for myself.
Table of Contents
IS A DEFINED BENEFIT PENSION PLAN GOOD?
What does defined benefit pension plan mean? The term “Defined” in Defined Benefit Pension, means exactly that. With this type of pension, you know exactly what you are getting for the rest of your life once your pension starts (of course, adjusted for inflation), hence the term ‘defined’.
Defined Benefit Plan is a pension plan that gives a pension based on a benefit formula.
They are considered the “Cadillac” of pension plans, and are also called the “Golden Handcuffs” (the pension plan is too good so you want to stay in your job to continue accruing hours of pensionable service).
Defined Benefit Pensions are also known as a DB pension plan in Canada.
According to Investopedia, salary history and length of employment are factored into the calculations of the defined benefit pension and the benefit formula. The longer you work and the more you make will mean you will get a higher defined benefit pension when you choose to start your pension payments and retire.
Your pension payments are guaranteed for your lifetime and it is regardless of how the market is performing and the pension plan’s investment returns.
The calculation is based on your highest average salary, your contributory service, your pensionable service (for example, if you work part-time your pensionable service is cut in half).
Related: How Much Should I Have Saved by 40?
COMPANIES WITH DEFINED BENEFIT PENSION PLANS IN CANADA
What are some companies with a defined benefit plans in Canada? Workplaces with a DBP are actually the exception rather than the rule. Defined benefit pension plans are not common anymore.
Defined benefit pensions are found mainly in the public sector rather than in the private sector companies in Canada. The numbers are dwindling in the private sector and only 3% of private sector pension plans are a defined benefit pension.
Is your pensions protected to adjust for inflation? Not all defined benefit pensions provide cost of living adjustments, and the pensions’ Board of Trustees will consider if a cost of living adjustment is provided on an annual basis.
Also, your spouse and dependents get access to your defined benefit pension if you as a plan member dies before retirement. There are survivor benefits if you apply (such as a pension, or a commuted value amount, or even a refund of contributions plus interest).
Speaking of who gets access to a defined benefit pension….pensions are considered family assets by law, so if your are separating or divorcing and you did not have a prenup or cohabitation agreement, your ex-spouse may have entitlement to your pension.
Are Pension Contributions Taxable?
There are defined pension plan tax implications in Canada. Thankfully, contributions to the defined pension plan (a set amount is taken off your paycheque) are not taxable so you can claim it back on your tax return.
However, when you actually start receiving your pension during retirement, you will have to pay income tax on that.
For more information on optimizing your retirement nest egg, here’s my Cashflow and Portfolios Retirement Projections review.
You can also invest in RRSPs when you are contributing to a defined benefit pension but your RRSP contribution limit will be lower.
Defined Benefit Pension PLan vs RRSP
You might wonder what the difference is between an RRSP and a DBP. People with a defined benefit pension in Canada are not allowed to contribute as much to their RRSP as someone who doesn’t have defined benefit pension contributions.
There are some differences between an RRSP and a defined benefit pension.
|Defined Benefit Pension Canada||RRSP|
|Money Received in Retirement is Based on||A defined pension formula||The market and your draw down|
|Who Takes the Risk of the Investment?||The employee and their employer||The investor (you)|
|Early Retirement Potential||Yes (Temporary Annuity Option)||Yes|
|Extended health benefits||There are group rates and subsidies available (e.g. pay 25% off monthly fee)||No, would have to private pay|
|Risk of running out of money||No, not until you die (or if pension corporation collapses)||Yes, if drawn completely down|
Defined Benefit PENSION PLAN vs Defined Contribution Pension Plan IN Canada
What’s the difference between a defined benefit and a defined contribution pension plan?
Basically according to Investopedia, with a defined benefit plan, your employer manages your defined benefit plan and matches your contributions and takes control of the investing for your pension plan until you retire. You don’t have access to your money until you declare retirement.
A defined contribution plan (also known as a DC pension plan in Canada), on the other hand, is funded mainly by you as the employee, but your employer can make contributions (e.g. match your contribution to a defined amount). Your employer doesn’t do much other than match your contribution and has no control over what investments (and risk tolerance level) you pick within your defined contribution plan.
Which is better, the defined benefit plan in Canada or defined contribution plan?
Most people consider that a defined benefit pension plan in Canada is definitely better than a defined contribution pension plan.
A defined benefit pension is often considered the Cadillac of pensions, and are even referred to as the ‘golden handcuffs’ by some, because of the way it encourages people to stay in their DBP (defined benefit pension plan) jobs- you get a certain amount of money guaranteed for life when you retire.
Are Pensions Paid for Life?
The great thing about the defined benefit pension is that it is paid for life. Unlike Set for Life, which is just 25 years, the defined benefit pension is paid for life until you die.
There is an option to ‘retire early’ at age 55 instead of age 65 with a defined benefit pension, but in B.C. there are going to be some changes to the Municipal Pension Plan which will affect the bridge benefit. The bridge benefit was a temporary monthly payment to tie you over until age 65 when the Canada Pension Plan and Old Age Security kicks in. They are planning on eliminating the bridge benefit and changing it to a Temporary Annuity Option.
A Temporary Annuity Option is based on the maximum amount of the government’s old age security (OAS), which is currently around $7,362 per annum. Currently the in BC pension plan are looking add a ½ option and ¼ option so that their pension members can continue to benefit from the long-term improvement in their lifetime pension.
So essentially, if you’re planning for an early retirement in BC before age 65, you’re going to get less from your pension unfortunately.
Single LIfe vs Joint Life Pension Option
Once you retire, you will have to choose pension options.
There are numerous, like single life vs joint life pension options so it can get confusing.
These pension options are mainly options to consider for your beneficiaries or spouse when you die. Here’s the breakdown.
- Single life– You’ll receive pension payments until you die and when you die your beneficiary does not get your pension
- Single life, 5, 10, or 15 year guarantee– You’ll receive the pension payments until you die, and if you die before the guarantee period expires (e.g. certain amount of monthly payments not reached) your beneficiary will continue to receive your pension until the end of the guarantee period
- Joint life 100 percent– You will receive the pension until you die and then your spouse will receive your pension amount until they die
- Joint life 60 percent, 5, 10, 15 year guarantee– You’ll receive the pension until you die and then your spouse will receive your pension payment if you die before the guarantee period, and after the guarantee period, they will receive 60% of your pension payments (or whatever pecentage you select)
- Joint life less than 60 percent, 5, 10, 15, year guarantee– Same as above but your spouse or beneficiary will receive less than 60% of payments for the rest of their life
Now that you know the nitty gritty details of what defined benefit pensions in Canada are all about, let’s look at the pros and cons of a defined benefit pension.
Pros of a Defined Benefit Pension
- A defined benefit pension is considered a good pension plan and one of the best pension plans in Canada
- It’s almost like an annuity (a series of fixed payments over a defined period of time). A guaranteed amount of money per month that you don’t have to worry about managing (e.g. managing investments where you have to continually work on asset allocation and rebalancing)
- You won’t run out of money (unless of course, you spend more than you get paid per month!), you don’t have to employ the 4% Safe Withdrawal Rate because you know how much you’re getting and you don’t have to worry about market corrections when you are already retired (unless of course you retire early or need more income than the pension provides)
- You don’t have to pay for a management fee
- It’s fixed and stable (you will feel secure knowing you have a certain amount of money per month until a certain time)
Cons of a Defined Benefit Pension
- Money is taken out each paycheque and you don’t get to decide how to invest it
- You have to work for decades to get the ‘max’ amount of annual pension income (hence the often coined term “golden handcuffs”)
- Some people may find they get a better rate of return if they invested the money themselves instead of leaving it in the pension plan
- The tax consequences of pension income alongside full RRIF income can be a lot of tax to pay in your golden years!
- It reduces the amount of RRSP contribution room you have
- Most importantly, you don’t get get to use it until you retire
- The math usually doesn’t make sense to keep your money in a defined benefit pension/ LIRA (Locked in Retirement Account) and it is usually better if you take the commuted value and invest it yourself … if you were to quit your job for example.
Definied Benefit Pension Plan Calculator
How do you calculate how much your defined benefit pension plan is worth? Well, as mentioned, it depends on your salary and also how many years you worked.
If I worked full-time for another 20 more years (oh gosh, the thought of that just makes me tired), I would get $3333 per month with a bridge benefit until age 65 of $823, which brings the total my monthly income for 10 years to $4156.
After age 65, I would just get $3333 per month until I die (that’s almost $40,000 in annual income from a pension, not including my intended dividend income). This will be in addition to the Canada Pension Plan income that one is expected to start receiving at age 65, which averages to be $673.10 on a monthly basis (and can be up to $1134 per month).
If I left the pension as is and quit working now, I would get around $1500 a month starting at age 65. This will be in addition to the Canada Pension Plan income that one is expected to start receiving at age 65 and the Old Age Security Income, which is expected to be just under $16000 combined.
You can also do your own Canada retirement income calculations with the government’s Canadian Retirement Income Calculator. it’s kind of fun and surprisingly quite detailed!
To get this amount of ‘dividend income‘ ($1500 a month) with a portfolio that earns about 3.5% dividend yield, I would need an investment portfolio of around $430,000.
The above pension income is just the pension income. It doesn’t include other sources of income such as dividend income that I plan to have, which would amount to around $2900 a month if I have my targeted $35,000 of dividend income annually.
Is Doing a Pension Buy Back Worth It?
On my first maternity leave in Canada, I was on employment insurance payments for half of the leave. I did not contribute to my DBP (pension) at this time and had the option of ‘buying back’ my leave for the pension.
You usually have a period of five years after the end of your leave to purchase service. This is called a past service pension adjustment.
Here’s the details and math as to whether I think doing a defined benefit pension buy back is worth it.
In the end, I decided against buying back my pension. However, many people think buying back their leave is worth it. In short, I think it can be worth it for those who want guaranteed income and don’t want to bother with DIY investing.
Is a Defined Benefit Pension Guaranteed?
Well, unfortunately not always- a defined benefit pension plan is not always guaranteed. I think there is more risk in the private sector with defined benefit pensions, hence why there are fewer and fewer defined benefit pension plans offered in the private sector.
Case in point- Sears went bankrupt and so a lot of people who were banking on Sears’ defined benefit pension payouts were left stranded.
Personally, I like to diversify my portfolio similar to how I want to diversify my retirement because I don’t like putting all my eggs in one basket.
I don’t mind having a bit of pension income, some drawing down of my RRSP, drawing down some of my TFSA, or even just not touching the principal and not deploying the 4% safe withdrawal rate and instead riding out my dividend income and defined benefit pension plan income until I die.
There are other ways to generate retirement income other than from your defined benefit pension though. Here are some other ways, according to My Own Advisor.
Anyway, congratulations on being a the stage in life where you’re thinking about your defined benefit pension! Now you’ll just have to focus on how to retire happy.
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Do you have a defined benefit pension or a defined contribution pension plan?
GYM is a 30 something millennial interested in achieving financial freedom through disciplined saving, dividend and ETF investing, and living a minimalist lifestyle. Before you go, check out my recommendations page of financial tools I use to save and invest money. Don’t forget to subscribe for blog updates, a free dividend yield spreadsheet, and the free Young Money Bootcamp eCourse.