How to understand your pension plan
What pension plans are and how they can help you save for retirement remains a mystery for many Canadians. If your company offers a pension plan, it’s worth getting to know the ins and outs so you can take advantage of this worthwhile savings strategy.
Your employer will generally offer a defined benefit (DB) plan, a defined contribution (DC) plan or both.
DB pension plans provide retired employees with consistent income for life, usually based on a formula involving years of service and individual earnings.
But, unless you are employed in the Canadian public sector (think government employees, health care workers or teachers), you more than likely don’t have access to a DB plan. And although a fairly large number of Canadians still have them, the number of workers covered by this plan type has been steadily declining for years.
Due to changing demographics, increasing life spans and rising costs, Canadian companies have moved to offering other ways to help their employees save for retirement, and DC plans are often the solution.
DC plan membership has been consistently rising over the last decade, and can offer employees more control over their participation and investment strategy.
A DC plan is like a personal account for retirement savings through your work. Generally, pension contributions (a percentage of your gross earnings decided by you) will be automatically deducted from your paycheque, providing an immediate tax advantage and making it easier to save.
Some companies will match a certain percentage of whatever contribution you choose to make. And on top of that they may even make additional contributions on your behalf, whether you participate in the plan yourself or not.
As your income grows, so does your contribution – even if you don’t change your contribution rate at all.
It’s important to remember there is often a limit to how much you can contribute and how much the company will match. Talk to your HR department as levels and limits vary from employer to employer.
Blair has been working at Company A for two years. Her base salary is $48,000 and she has a company matching DC plan, where the company matches 100% of her contribrutions (see Exhibit A).
Taking advantage of these additional employer-sponsored contributions can help you grow your savings with minimal effort. Deducting the income directly from your paycheque also gives you the added benefit of putting your money to work immediately, instead of waiting and contributing a lump sum near RRSP deadline time.
And there’s no need to rush in. You can start with a relatively low contribution rate, say 2% and slowly increase your level over time – either manually or with auto-escalation. Although contributions may always be voluntary, some companies may auto-enroll you after you’ve worked there for a certain number of years.
Unlike DB plans where your retirement income is determined by a calculation based on your income level and years of service, your retirement income from a DC plan is determined by how much you save and how your investments grow over time.
That’s why it’s particularly important to take an active role in determining how your contributions are invested.
DC pension plans can offer multiple investing options, including mutual funds and shares in the company you work for. Investment choices will vary from company to company, but a common scenario is choosing between:
Having an employee pension plan – whether it’s a DC or DB – could really boost your retirement savings. But it should be considered as just one part of your overall retirement savings strategy. Think of your long-term financial plan as a puzzle, and your pension plan as a piece of it.
A financial advisor can help you put that puzzle together, and ensure everything fits. Seeking guidance on the best way to take full advantage of your pension plan as well as how to integrate it with other savings strategies, like investing with RRSPs or TFSAs, can help you reach your retirement savings goals.
This information has been provided by RBC Global Asset Management Inc. (RBC GAM) and is for informational purposes only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. The information contained herein is from sources believed to be reliable, but accuracy cannot be guaranteed. Please consult your advisor and read the prospectus or Fund Facts document before investing. There may be commissions, trailing commissions, management fees and expenses associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. RBC Funds, BlueBay Funds and PH&N Funds are offered by RBC Global Asset Management Inc. and distributed through authorized dealers.
® / ™ Trademark(s) of Royal Bank of Canada. Used under licence. © RBC Global Asset Management Inc. 2017
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