Do you have a defined benefit pension plan at work? Consider yourself fortunate. Only one-third of employees have any pension plan (that includes defined benefit, defined contribution and group RRPSs). Today I’m going to explain how a defined benefit plan works, so what better way than to look at my company’s pension plan?
I work for Towers Watson, a global pension and benefits consulting firm. We administer the defined benefit pension plans for Canada’s largest employers, including GE, Pepsi, and Manulife. With a lot of employers switching to defined contribution, I’m fortunate to still have a defined benefit pension plan.
Here’s a helpful article I wrote about pension plans: Pensions 101 – The Basics of Defined Benefit and Defined Contribution Pension Plans.
My Company’s Retirement Plan
Although my pension plan isn’t as good as public sector employees, it’s still decent. When I first started, my company was going through a merger. Although my pension plan isn’t as good as the 2% final average earnings plan I started with, it’s still decent.
My company’s retirement program includes:
- Defined Benefit (DB) Pension Plan that provides a lifetime pension
- FlexPension Plus, designed to enhance my DB pension
- Additional savings vehicles to complement my retirement savings
About the Defined Benefit Pension Plan
My Defined Benefit Pension Plan (DB Plan) provides a lifetime pension based on a career average benefit formula. My company pays the full cost of this plan. For each year of service, I accumulate a benefit equal to:
1.3% of eligible earnings up to the YMPE
2.0% of eligible earnings above the YMPE
For example, if the average salary over my career was $50,000 and I worked for 25 years, I would receive an annual pension of $16,250.
$50,000 x 1.3% x 25 years = $16,250
YMPE: Similar to most defined benefit pension plans, my employer provides a higher accrual (2.0%) above the YMPE ($52,500 in 2014). The higher accrual is because any earnings earned above the YMPE are not covered by Canada Pension Plan (CPP). Referred to as CPP integration, the higher accrual allows me to maintain the same income replacement in retirement.
Portability: Instead of a monthly pension, I can elect to receive a lump sum payout, the commuted value, even at retirement (although it would be locked-in).
My DB Plan pension is unreduced at age 62 (a lot of plans are unreduced at age 65). I can choose to retire as early as age 55, but if I start my pension early it will be reduced by 4% per year. For example, if I started by pension at age 55, it would be reduced by 28% (4% x 7 years = 28%).
About FlexPension Plus
FlexPension Plus is designed to enhance the DB Plan by making voluntary tax-deductible contributions. When I leave the company, I can use my FlexPension Plus account to purchase enhancements to my DB pension:
- Earnings update: increase the earnings on which my pension benefit calculation is based (e.g., use earnings on my termination or retirement date)
- Early retirement reduction: decrease the amount by which my pension is reduced on early retirement
- Inflation protection: annual increases to my pension
- Bridging benefit: provide a temporary benefit payable from the start of my retirement to age 65, the age at which government benefits typically begin being paid in full
- Enhanced survivor benefit: provide lifetime retirement income to my spouse, or a death benefit to my beneficiary, after my death
Contributions: Contributions are made conveniently though payroll deductions. There are two types of contributions: basic contributions and additional contributions. I can make basic contributions of 1% or 2% of eligible earnings, which my company will match 100%. In addition, I can make additional contributions in excess of 2% of eligible earnings to further increase my retirement savings.
The biggest advantage of FlexPension Plus is that it lets me enhance my pension without worrying about going over my RRSP contribution limit. Unlike my DB Plan, I won’t receive a pension adjustment for FlexPension Plus contributions. If you have a FlexPension plan and your employer provides a match, you’d be crazy not to contribute!
About Additional Savings Vehicles
My company also offers additional savings vehicles to help complement my retirement savings. I can contribute to an RRSP, Tax Free Savings Account (TFSA), or non-registered account. Similar to most defined contribution plans the investment choices are limited, although the investment fees are lower than individual plans.
If you don’t know your company’s retirement plan, you should speak with human resources today. If your employer offers matching start contributing today. By not joining, you’re leaving free money on the table.
Do you have a retirement plan at work? What type of plan (defined benefit, defined contribution, Group RRSP) do you have?