Defined benefit plan and defined contribution plan
A company pension plan can be a great perk of the job. But unfortunately, only 37% of employees in Canada have access to a company plan. In the past, these plans would have been the gold-plated defined benefit pensions. But the shift towards defined contribution pension plans now puts more of the retirement planning responsibility on the shoulders of the employees and not the employer. Show
Are you part of the lucky 37% of Canadian employees who have a pension plan but are not sure precisely what that means? Keep reading to learn the difference between defined benefit and defined contribution pension plans. What is a defined benefit pension plan? A defined benefit pension plan is a traditional pension. It is one that provides a specific and predictable benefit (or amount of income) at retirement. Essentially, a defined benefit plan offers guaranteed income for life. And because of this, DB pensions are often referred to as gold-plated or golden handcuffs. Usually, the formula dictates your defined benefit pension plan and includes your salary, years of service, and potentially your age. The calculation your specific pension uses may differ slightly, but most look something like this: 2% x Average Yearly Pensionable Earnings During Highest 5 Years x Years Pensionable Service For example: 2% x ($100,000) x 35 Years = $70,000 With a defined benefit retirement plan, the employer takes on the investment risk and responsibility for ensuring that there is enough money in the investments to fund the pension payouts. These types of plans often require complex actuarial projections and insurance for guarantees resulting in higher administrative costs. While defined benefit pension plans were once fairly common nowadays, they are usually only found within the public sector. The risk of DB pension plans is too much for employers in the private sector, so they opt for other options. Benefits of a defined benefit pension Employees prefer defined benefit plans, and it's no wonder with the many advantages they provide with minimal risk to the worker.
Disadvantages of defined benefit pensions Although defined benefit retirement plans are known as gold-plated and provide guaranteed income for life, they do come with some disadvantages for the employee.
What is a defined contribution pension plan? A defined contribution pension plan is one in which the employer and employee make contributions. Those contributions are invested over time to provide a payout at retirement. The final benefit amount of the pension is unknown because it is based on contributions and growth. And the investment returns are unpredictable and subject to market volatility. The administration costs are relatively low with a defined contribution plan because the employer has no obligation to the plan's account's performance. The employee makes contributions and chooses what to invest in from the investments offered within the retirement plan. Most defined contribution plans offer some form of contribution match up to a certain amount. If an employee contributes 10% of their gross salary, the company may match 50% up to $10,000. Here's what that would look like for an employee with a $100,000 gross salary. [($100,000) x (10%) = $10,000] + [($10,000) x (50% of 10%) = $5,000] = $15,000 Contributions within a DC pension grow tax-deferred, and there are limits set on annual contributions. These limits include both employee and employer contributions. A defined contribution plan may be known as a group RRSP, but it is superior to an RRSP due to matching employee contributions. This contribution match is like receiving free money or an instant return on your investment. You may think that you could invest your money outside of the plan and get a better return. But that return would have to be better than the return you are getting in the plan and the contribution match. And this is highly unlikely. Benefits of a defined contribution pension
Disadvantages of defined contribution pensions
So, what is the best pension? Whether it's a DB plan or a DC plan, you are winning if you have access to a company pension. While not all programs have mandatory or automatic enrollment, you will want to make sure you enroll as soon as possible. By doing so, you are opting in for free money. It is also important to note that having a company pension plan does not let you double dip with your RRSP contributions. Your RRSP contributions will decrease in relation to your pension amount. This is so that there is not an unfair advantage created for someone with a company plan. I would argue that if you have any form of company pension, you already have an advantage in your retirement plans compared to someone who doesn't. Regardless of the impact it has on your RRSP contribution room. In the end, the defined benefit vs. defined contribution debate really doesn't matter. The fact that you have a pension makes all the difference, not which type it is. This article was written by Maria Smith from MapleMoney and was legally licensed through the Industry Dive publisher network. Please direct all licensing questions to [email protected]. What is the main difference between a defined benefit plan and a defined contribution plan?The benefits in most traditional defined benefit plans are protected, within certain limitations, by federal insurance provided through the Pension Benefit Guaranty Corporation (PBGC). A defined contribution plan, on the other hand, does not promise a specific amount of benefits at retirement.
What's the difference between defined benefit and defined contribution?Private pension schemes are ways for you or your employer to save money for later in your life. There are 2 main types: defined contribution - a pension pot based on how much is paid in. defined benefit - usually a workplace pension based on your salary and how long you've worked for your employer.
What is the difference between a defined benefit pension plan and defined contribution plan is a matter of risk?Defined Benefit scheme vs Defined Contribution scheme
The main difference between a defined benefit scheme and a defined contribution scheme is that the former promises a specific income and the latter depends on factors such as the amount you pay into the pension and the fund's investment performance.
Can you have both a defined benefit plan and a defined contribution plan?It is important to have a retirement plan that works for you. Combination plans offer a solution that allows companies to combine some of the most powerful investment vehicles: a defined benefit plan and a defined contribution plan.
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