The Key Differences Between a Defined Benefit and Defined Contribution Pension Plan
As an employer, you may be thinking about offering your employees a pension plan. If so, you have two main options: a defined benefit pension plan and a defined contribution pension plan. A defined benefit pension plan offers your employees a set amount of money when they retire, whereas a defined contribution pension plan does not.
There are four key areas you should be aware of for pension plans:
We will walk you through each of these to help give you a better understanding of the differences between the two types of pension plans.
In a defined benefit pension plan, both you, the employer, and the employee will contribute to the pension plan. The amount that you will have to contribute each year will depend on what kind of expenses the pension plan has, and the amount of funding it will require that year.
In a defined contribution pension plan, employees contribute a set amount each year into their pension. As an employer, you can choose to match or “top up” their contributions to a set amount that you define in advance.
For both types of plans, contributions are tax-deductible for the employee.
As an employer, you or your pension plan administrator will be responsible for managing the funds in a defined benefit pension plan. This applies whether the employee is actively contributing to the fund or has retired and is receiving funds from it.
With a defined contribution pension plan, you can let your employees choose how they want to invest their funds. This provides your employees with more flexibility and choice and takes the responsibility off you as the employer to manage pension funds. You will still need to arrange to have a selection of funds for your employees to select from.
In a defined benefit pension plan, an actuary will work with you (approximately every three years) to calculate how much money you will need to cover the pension expenses. The actuary must consider everything from cost of living adjustments to how many employees will be retiring.
In a defined contribution plan, the costs will be lower as less active management is required. Employees will receive whatever amount their investments are worth when they retire.
Both types of pension plans will help attract and retain employees. Since a defined benefit plan builds in value each year, it is more likely to attract employees interested in staying with your company for a long time. A defined contribution plan will still attract employees – but the pension will be less appealing than a defined benefit plan would be.
A defined benefit plan will cost you more to set up, maintain, and administer, but offers your employees more stability in their retirement. A defined contribution plan will give you and your employees more flexibility and cost you less to run.
Either type of plan will help you attract and retain employees.
When thinking about retirement, it can be overwhelming to figure out all the numbers, like what age you’re going to retire, how much money you need and how long do you need the money to last.
We’ve put together an infographic checklist that can help you get started on this. We know this can be a difficult conversation so we’re here to help and provide guidance to help you achieve your retirement dreams.
Determine how much you need in retirement.
Make sure you account for inflation in your calculations
If you have any debts, you should try to pay off your debts as soon as you can and preferably before you retire.
As you age, your insurance needs change. Review your insurance needs, in particular your medical and dental insurance because a lot of employers do not provide health plans to retirees.
Review your life insurance coverage because you may not necessarily need as much life insurance as when you had dependents and a mortgage, but you may still need to review your estate and final expense needs.
Prepare for the unexpected such as a critical illness or long term care.
Check what benefits are available for you on retirement.
Canada Pension Plan- decide when would be the ideal time to apply and receive CPP payment. (Payment depends on your contributions)
Old Age Security- check pension amounts and see if there’s a possibility of clawback.
Guaranteed Income Supplement- if you client have a low income, you could apply for GIS.
Review your company pension plan. Check if it’s a defined benefits or contribution plan. Determine if it makes sense to take the pension or the commuted value.
Make sure you are saving on a regular basis towards retirement- in an RRSP, TFSA, LIRA or non-registered. Ensure the investment mix makes sense for your situation.
Don’t forget to check if there are any income sources. (ex. rental income, side hustle income, etc.)
Are you planning to use the sale of your home or other assets to fund their retirement?
Will you be receiving an inheritance?
One other consideration that’s not included in the checklist is divorce. This can be an uncomfortable question, however divorce amongst adults ages 50 and over is on the rise and this can be financially devastating for both parties.
Contact us about helping you get your retirement planning in order so you can gain peace of mind that your family is taken care of.