What is a Defined Contribution Pension Plan? 

Many Canadian employers offer defined contribution pension plans as part of their employee benefit package. Defined contribution pension plans involve fixed contributions from both employees and employers. The retirement amount depends on investment performance, and participants have control over their investment choices.

Under this plan, a certain guaranteed amount is put towards your retirement savings, but it is up to you how you invest this money. Aside from flexibility in investment choices, a defined contribution plan offers benefits such as tax deductions on contributions, employer matching contributions, and portability between jobs.

What is a Defined Contribution Pension Plan (DCPP)?

A defined contribution plan helps you build a pot of money that you can use to provide income during retirement, functioning as a retirement savings plan. During your working years, both you and your employer can contribute a specific percentage of your salary or a fixed amount every year into the plan. Your employer may fully or partially match your contribution to a set percentage of your salary to boost your savings.

The money in your DCPP is then invested, and investment earnings are tax-sheltered until withdrawn. You can access the DCPP funds as early as age 55 or as late as December 31st of the year you turn 71.

With a DCPP plan, there’s no promise of a specific amount of benefits. This is because contribution levels can change, and the investment return can vary yearly.

Key points to keep in mind are:

• A defined contribution plan is primarily funded by you (the employee) — not the employer
• The money you put in a DCPP account and the investment gains grow tax-deferred, meaning you’ll pay tax only when you withdraw it
• Your eventual pot is not guaranteed and depends on how much money is put into it and how your investments perform
• When you retire, you can put the money that you’ve amassed in your DCPP in an annuity, a locked-in RRSP or RRIF, or both
• Registered private pension plans are classified either as  defined benefit plans. It is important that you determine which type of plan you have, since this affects the kind of pension benefits you will receive.
• Understanding your pension plan Private pension plans provide an important source of retirement income for members and their families.

Employer Pension Plan Basics

An employer pension plan is a registered plan that provides a source of income during retirement. Also known as an employer-sponsored pension plan, it involves contributions from the employer or both the employer and employee. When you retire, you’ll receive an income from the plan.

There are two main types of employer pension plans: defined benefit and contribution. Understanding how your specific plan works is crucial, so speak to a human resources advisor or pension plan manager for details. If you’ve switched jobs during your career, you might have multiple pensions from different employers. In such cases, you may be able to transfer your old pension to your new plan, consolidating your retirement savings.

How does it work?

The idea of a DCPP is that you make regular contributions during your working years to build up a pension pot gradually, contributing to your retirement savings. Both you and your employer contribute to this plan, with your employer potentially matching your donations to help you enjoy a comfortable retirement.

Typically, there are two ways in which your employer may match your contributions:

• It may match a percentage — 25%, 50%, or even 100% — of your contribution up to a set percentage of your salary
• It may match your contributions up to a certain dollar amount, irrespective of your salary

The maximum contribution limit for a DCPP in 2024 is the lesser of 18% of annual salary or $32,490.

Typically, you can choose how your contributions are allocated among the various investment options your plan provider provides. This allows you to create a portfolio suited to your risk tolerance and investment goals.

Investment options include:

• Canadian bond funds
• Guaranteed investment funds
• Canadian balanced funds
• Segregated funds
• Canadian equity funds
• Global equity funds

You can withdraw DCPP funds upon reaching the minimum retirement age, typically 10 years before the standard retirement age. Since 65 is the standard retirement age in Canada, the earliest you can access the money is at age 55.

The amount you’ll receive when you retire depends on the amount you pay in, the performance of your investments, and the withdrawal option.

Upon retirement, you can transfer DCPP assets to:

• A locked-in retirement product such as RRSP
• An insurance carrier to purchase a deferred annuity
• Another employer’s pension plan

Defined Contributions vs Defined Benefits

Registered pension plans typically come in two flavors: Defined contribution and defined benefit, both offering different types of retirement benefits. While both help you accumulate retirement savings, they differ significantly in various aspects. Unlike defined benefit plans, defined contribution plans do not guarantee a specific retirement amount. The eventual retirement payout is contingent upon the contributions made and the performance of the investments chosen.

Managing Your Retirement Savings

Managing your retirement savings is crucial to ensure a comfortable retirement. A defined contribution pension plan allows both you and your employer to contribute a percentage of your salary, which is then invested to create retirement income. The amount of retirement income you’ll receive depends on several factors, including the contributions made and the performance of your investments.

You can choose from various investment options, such as stocks, bonds, and mutual funds. Reviewing and adjusting your investment choices regularly is essential to ensure they align with your retirement goals. Consider consulting a financial advisor like Dundas Life to help you make informed decisions about your retirement savings and optimize your investment strategy.

When can you access funds in defined contribution plans? 

You can withdraw money from a DCPP only upon retirement, but some exceptions exist within the retirement plan. The earliest retirement age is 10 years before the standard retirement age. If the standard retirement age is 65, you can access DCPP funds at age 55 or later.

However, it’s possible to access DCPP funds early in certain instances. For example, some jurisdictions allow account holders to withdraw a portion of their locked-in DCPP funds if they:

• Have low income
• Have high disability-related or medical costs
• Have a shortened life expectancy
• Are 55 years of age or older, and the balance of their DCPP funds is below a specific amount

Read the pension document or speak with the plan administrator to confirm your early withdrawal options.

What are the benefits of a defined contribution pension plan?

Some of the main benefits are:

• Tax advantages: Employee contributions to DCPP are tax deductible, meaning you pay less tax on your current income. In addition, the DCPP funds in your plan grow tax-deferred until you retire.
• Investment control:  You can choose how your DCPP funds are allocated from the pool of investment options the plan provider offers. This allows you to set up an individual portfolio suited to your investment goals and tolerance for risk.
• Employer matching: Many Canadian employers match some of their employees’ contributions. Your employer contribution is, in essence, free money towards your retirement savings.
• Portability: You can carry a DCPP plan when you switch jobs.

Retirement Options

When you retire, you have several options for your defined contribution plan. You can leave the money in the plan, transfer it to a locked-in retirement account (LIRA), or transfer it to a registered retirement savings plan (RRSP).

You can also combine these options to suit your needs. For instance, you might use some of your money to buy an annuity, which provides a guaranteed income stream, and transfer the rest to a LIRA. Additionally, you can use LIF savings to buy an annuity at any time in the future, especially if your need for guaranteed income increases as you get older. These flexible options allow you to tailor your retirement strategy to your personal circumstances.

What’s the difference between a DCPP and RRSP?

Both DCPP and RRSP are financial tools that provide an income stream during retirement, but they work differently. A registered retirement savings plan (RRSP) can also be offered as a group RRSP, which is a retirement savings option sponsored by employers. In a group RRSP, contributions are made through payroll deductions, and there is often the possibility of employer contributions. The details of a group RRSP can vary based on different employers.

Withdrawals

You can’t withdraw DCPP funds before you retire (age 55 or older), but you can access your RRSP funds at any time, though early withdrawals can lead to significant penalties and affect your retirement income.

In contrast, you can withdraw RRSP funds at any time, though early withdrawals can lead to significant penalties.

Contribution Limits

DCPP contribution limits are determined by the employee’s salary, with the overall contribution limits comprising the employee’s and employer’s contributions within the retirement savings plan. In the case of RRSPs, contribution limits are related to your salary or a set maximum.

Employer Contribution

In a DCPP, employers must contribute at least 1% of an employee’s salary, enhancing the employee's retirement savings. On the other hand, with a Group RRSP, the employer can decide whether to contribute and determine the specific contribution amount if they choose to do so.

A pooled registered pension plan (PRPP) is another defined contribution pension option designed for individuals who lack access to workplace pension plans. PRPPs cater to both employed and self-employed individuals, particularly those in small to medium-sized businesses. Employer contributions to PRPPs are voluntary, and the investment structure of these plans significantly influences retirement outcomes.

Protecting Your Retirement Savings

Your defined contribution pension plan is protected by law, ensuring that all contributions made to your plan account (both yours and your employer’s) are secure. The plan administrator, typically an insurance company or other financial institution, holds the money in your plan account and invests it according to your instructions.

This money is held in trust and cannot be accessed by your employer, even if they face financial difficulties. Defined contribution plans are a common type of pension plan, guaranteeing a contribution amount. However, the amount you receive in retirement depends on the growth of your savings, which is influenced by your investment choices and market performance.

Tax Implications

Contributions to a retirement plan are tax-deductible, allowing you to keep more of your income by reducing your taxable income. Additionally, investment earnings in a retirement plan are tax-deferred, meaning you won’t pay tax on these earnings until you withdraw them.

This tax-deferred growth can significantly enhance your savings over time. Employer contributions are a key component of retirement savings, supplementing your own contributions and boosting your retirement fund. When you retire, you’ll pay tax on the income you receive from your plan. To fully understand the tax implications of your retirement savings and make the most of tax benefits, consider consulting a tax professional.

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Conclusion 

A defined contribution pension plan offers a flexible and tax-efficient way to save for retirement, contributing significantly to your retirement savings. Your employer typically deducts your contributions from your salary before taxing it and may match a portion of your contribution. You can choose to invest the money in a variety of investment options. When you retire, the amount you will receive will depend on your contributions and the performance of your investments.

Have more questions about retirement plans for your company? Book a call with a Dundas Life licensed advisor today.

Frequently Asked Questions - FAQs

Can anyone enroll in a defined contribution plan?

Participation in a defined contribution pension plan is contingent upon the specific employer and plan provisions. Many Canadian employers require full-time employees to enroll in their DCPP plan. This can happen at the time of joining or after you’ve worked for a certain period. Some other employers let you decide whether you want to enroll or not. 

If you work part-time, you may still be able to join your company’s plan. Speak with your plan administrator to find out. 

What happens to my defined contribution plan if I change jobs?

Individuals with a defined-benefit (DB) pension generally have two options: maintaining the retirement with their current provider or transferring it to their new employer’s plan. 

Are there any restrictions on how much I can contribute to a defined contribution plan?

Employees can contribute up to 18% of their annual employment income. Employers must contribute 1% of an employee’s salary at the minimum, but they can contribute up to 18%. The combined contribution of the employee and employer cannot exceed 18% of employment income or the money purchase limit of that year. For 2024, this limit is $32,490.