Are you retiring in Canada this year, Pillar 3: Employer pension plans

Understanding your employer pension plan

The two main types of employer pension plans include: 

·         Defined benefit pension plan (DBP)

·         Defined contribution pension plan (DCP) 

The following table below compares the two. 

Characteristics	Defined contribution pension plan (DCP)	Defined benefit pension plan (DBP)
What is it?	·         DCPs are a form of savings for retirement where you and your employer contribute an established amount to your pension each year. ·         Your contribution is usually a percentage of your pay. ·         The value of the pension is based on the performance of the investments. ·         Amount of the pension is uncertain.	·         DBPs are an agreement where the employer promises to pay a certain amount of money each year after retirement. ·         Employees often but do not always make contributions in addition to their employer’s contribution. ·         How much you receive depends on a formula, generally based on your income and years worked.
How is it managed?	·         Generally, you have to choose how your contributions are invested. ·         Consider the level of risk and time frame when making investment choices.	·         Your contributions are pooled into a retirement fund and managed by your employer or pension plan administrator/sponsor. ·         Investment results affect the amount of the employer’s contributions.
Advantages	·         You have more control. ·         You can invest in a way that suits your goals and risk tolerance. A financial professional can help you understand the risks of various investments. ·         You have the possibility of benefiting from higher returns if your investments perform well.	·         The amount of your pension is set primarily on a set formula often based on your career earnings and years of service and is therefore generally less sensitive to annual returns in the stock market.  ·         Funds are professionally managed and you are not required to make any additional investment decisions. ·         Your investment risks are pooled across time and different individuals, so that investments have time to recover from really bad years and/or benefit from years with really good returns.
Disadvantages	·         The amount of retirement income is not guaranteed. If your investments do not perform well, you have to deal with it yourself. It could be affected by the ups and downs of the stock market. ·         Some people are not comfortable managing their own retirement fund or investments. ·         Because of the limited advice available, obtaining separate financial advice may involve additional costs. ·         You may not be able to invest exactly the way you want as the employer may offer only a limited number of investment options within the plan.	·         The risk that the fund is not managed properly or that your employer experiences financial troubles or even bankruptcy can affect the amount of your pension. ·         You are not able to directly benefit from high stock market returns. These are passed along to all members in various ways (often in terms of lower contributions or increased benefits).

Both DCPs and DBPs have advantages and disadvantages, but ultimately you won’t have a choice over which type of pension plan your employer has in place. What’s most important is that you fully understand how your pension plan works.

Your pension will likely be a cornerstone of your retirement income, so if you don’t know how your pension works, be sure to speak to your human resources staff member, union representative or pension plan manager to find out.

Group Registered Retirement Savings Plan (Group RRSP)

A Group RRSP is an employer-sponsored retirement savings plan, similar to an individual RRSP, but administered as a group by your employer. Your contributions are made through regular pay-roll deductions on a pre-tax basis.

While Group RRSPs function similar to individual RRSPs, the details of the plan often vary by the employer. For more detailed information on your Group RRSP, consult your human resources, union, or pension plan representative.

Pooled Registered Pension Plan (PRPP)

Pooled registered pension plans (PRPPs) are a new type of pension plan to help Canadians save for retirement. PRPPs are designed mainly for people who do not have access to a workplace pension, such as employees of small-sized and medium-sized businesses, and self-employed individuals.

The federal Pooled Registered Pension Plans Act (the federal PRPP Act) and the Pooled Registered Pension Plans Regulations (the Regulations) came into force on December 14, 2012. 

How do PRPPs work? 

PRPPs are defined contribution (DC) pension plans. In a DC plan, you and your employer contribute a certain amount to your pension each year. In the case of PRPPs, employer contributions are optional. DC plans do not guarantee how much you will receive when you retire. Your pension income depends on how well the investments held in your DC plan perform.

Employer participation in PRPPs is voluntary. To set up a PRPP, an employer must enter into a contract with a PRPP administrator. PRPPs are administered by licensed third parties such as banks or insurance companies, not employers.

Once an employer enters into a contract, employees are automatically be enrolled as members unless an employee chooses to opt out. Members’ contributions to the pension plan will be made through deductions from their pay.

Who can join a PRPP under the federal PRPP Act and Regulations?  

You can join a PRPP offered by your employer if: 

·         you are employed in a federally regulated business or industry (such as banks, telecommunications companies, interprovincial transportation sectors, etc.) anywhere in Canada and your employer offers PRPPs

·         you are employed in any type of work in the Yukon, the Northwest Territories or Nunavut. 

You can join a PRPP on your own if: 

·         you are employed in any type of work in the Yukon, the Northwest Territories or Nunavut and your employer does not offer PRPPs

·         you are self-employed in the Yukon, the Northwest Territories or Nunavut. 

Note: The availability of PRPPs for provincially regulated employers, employees and self-employed individuals will depend on provincial government decisions on whether to put in place similar provincial legislation. 

Provinces  

Quebec: Voluntary Retirement Savings Plans

In 2013 the Quebec Government introduced the Voluntary Retirement Savings Plans Act for employers with businesses in Quebec – Voluntary Retirement Savings Plans (VRSPs) are Quebec’s version of PRPPs.

VRSPs and PRPPs are similar in many ways.  However, one of the main differences is that employers with businesses in Quebec with more than five employees must offer their employees a VRSP, a Tax-Free Savings Account, or another retirement savings plan, however, employees have the right to opt-out. 

For more information on VRSPs visit the VRSP section of the Régie des rentes du Québec website and for more detailed information on eligibility see section 45 of the Voluntary Retirement Savings Plan Act. 

More key facts about PRPPs 

·         PRPPs must be low-cost. This means that the costs charged to plan members must be at or below those charged to members of defined contribution pension plans that provide investment options to groups of 500 or more members.

·         Costs include all fees, levies or other charges that reduce a member’s return on investment, other than those triggered by the actions of a member, such as requesting copies of documents.

·         Under the federal PRPP Act, the Office of the Superintendent of Financial Institutions issues licenses for administrators to offer PRPPs.

A few things to keep in mind about employer pension plans 

If you have a defined contribution pension plan, contributing at least the amount your employer will match will enable you to fully benefit from your employer’s contributions. 

Many people switch jobs and careers throughout their working lives, which means many people might have two or more smaller pensions from different employers. 

If this is the case for you, be sure to investigate what’s best for you. Are you able to transfer your old pension to your new plan? Talk to a financial professional or your human resource advisor to better understand your options.

Are you retiring in Canada this year, Pillar 2: Canada Pension Plan (CPP)

The CPP operates throughout Canada, except in Quebec. Quebec has its own program called the Quebec Pension Plan (QPP) for workers in Quebec.

The CPP retirement pension is a monthly benefit paid to those who have contributed to the Canada Pension Plan. All Canadians over the age of 18 who earn $3,500 or more per year have to pay into the CPP. The amount you pay depends on how much you earn.

The Plan is designed to replace approximately 25 percent of the earnings on which your contributions were based over your working life. You make contributions only on your annual earnings between a minimum and a maximum amount (these are called your pensionable earnings). 

The minimum amount is frozen at $3,500. The maximum amount is set each January, based on increases in the average wage in Canada. In 2014, the maximum amount is $52,500. The contribution rate on these pensionable earnings is 9.9 percent, split equally between you and your employer. If you are self-employed, you pay the full 9.9 percent.

The average monthly payment in October 2013 was $534.51 among all beneficiaries and $594.19 among new beneficiaries aged 65. You have to apply for CPP benefits. 

The amount of your CPP benefits will depend on several factors, including how long you contributed to the plan, how much you contributed, and finally, the age at which you choose to begin receiving your CPP retirement pension. You can choose to begin collecting your CPP benefits at any time between ages 60 and 70. 

The age at which you begin receiving your CPP benefits will have a major impact on the payments you will get for the rest of your life.  There are other types of benefits that are available within the CPP:

1.  CPP Post-Retirement Benefit is a new cumulative monthly benefit paid to individuals who worked and made CPP contributions while receiving the CPP retirement pension.

2.  CPP Disability Pension is a monthly benefit available to people who have made enough contributions to the CPP and whose disability prevents them from working at any job on a regular basis. A disability pension converts to a CPP retirement pension at age 65. The average monthly benefit in October 2013 was $855.49.

3.  CPP Survivor’s Pension is a monthly pension paid to the legal spouse or common-law partner of a deceased contributor to the CPP. The average monthly benefit in October 2013 was $325.69.

4.  CPP Death Benefit is a one-time, lump-sum payment made to, or on behalf of, the estate of a deceased CPP contributor. The average one-time payment in October 2013 was $2,286.03.

For more detailed information on the CPP, visit the Service Canada website.

Canada Pension Plan Investment Board (CPPIB)

The Canada Pension Plan Investment Board (CPPIB) is a crown corporation that was created to help manage and grow the money in the Canada Pension Plan (CPP).

The CPPIB takes the money that is left in the CPP after all benefits have been paid out and invests it in a number of different assets. To learn more, view CPPIB’s infographic An Introduction to Canada Pension Plan Investment Board (CPPIB).

Quebec Pension Plan (QPP)

The QPP is a mandatory public insurance plan for those who work, or who have worked in Quebec. It provides them and their families with basic financial protection in the event of retirement, disability or death. The QPP works similarly to CPP as it is funded by contributions from Quebec workers.

Similar to CPP, the amount of your QPP payments will depend on several factors, such as how much you contributed, how long you contributed and when you chose to start collecting the benefit. For more information on the QPP, visit the Régie de Rentes du Quebec website.

Note: Pension plan benefits (such as Old Age Security, and the Canada Pension Plan are protected against inflation because they are indexed to the Consumer Price Index. This means that if the cost of living goes up, the value of the benefit goes up accordingly.

However, personal savings and investments, such as mutual funds or GICs, are generally not protected against inflatio

Are you retiring in Canada this year, Pillar 1: Canada’s public pension system

Many more people are retiring this year, so I want to take a look at the three pillars of the Canadian Pension System over the next few posts. 

Pillar 1: Canada’s public pension system

The majority of today’s Canadian seniors receive income from Canada’s public pension system. The two main pension programs that provide benefits are the Old Age Security program (OAS) and the Canada Pension Plan (CPP) or Quebec Pension Plan (QPP). Keep in mind that these benefits are taxable income. Old Age Security (OAS)

If you are a Canadian citizen or legal resident, have lived in Canada for more than 10 years after turning 18 and are 65 or older, you may be eligible to receive OAS. OAS is not tied to contributions you have made, and whether you qualify for a full pension or a partial pension depends on how long you have lived in Canada. For further information concerning  OAS eligibility, visit Service Canada.

Note: OAS benefits do not necessarily begin automatically. You may have to apply for OAS benefits.  There are four types of benefits available within the OAS program:

1.  The Old Age Security pension—a monthly benefit available to all Canadians 65 years of age and over who meet the legal status and residence requirements. (The average monthly payment in October 2013 was $520.10).

2.  The Guaranteed Income Supplement (GIS)—a monthly benefit available to Canadian seniors who receive an OAS pension and have little or no other income. (The average monthly payment in October 2013 was $500.56 for single individuals).

3.  The Allowance—the monthly benefit available to eligible low-income Canadians who are between 60 and 64 and have a spouse or common-law partner who is receiving the GIS. (The average monthly payment in October 2013 was $433.73).

4.  The Allowance for the Survivor—a monthly benefit available to eligible low-income Canadians who are between 60 and 64 and are widows or widowers. (The average monthly payment in October 2013 was $641.87).

Automatic enrolment

Proactive enrolment of OAS benefits was announced in Budget 2012 and is being phased in, starting in 2013. Individuals who do not receive a notification letter indicating that they will be automatically enrolled for the OAS pension are required to apply for their OAS pension. 

For more detailed information about Old Age Security, visit Service Canada.

Do you worry about your investments?

I used to review my investment portfolio at least once or twice a week and when it fell, I became concerned about losing money, and when it gained, I was happy about making money. A conversation with my advisor helped me understand that I was investing for the long term, not the short term, and that the market today is volatile. 

I am not alone in my obsession with my investments. One of the greatest challenges retirement planners face is relieving the anxiety their retired clients experience during market drops and other events that may affect their portfolios and potentially their income.

Because I understand that markets can be volatile, and I am investing for the longer term, I do not react with panic when the market goes down. Market volatility is the primary catalyst behind many bad financial behaviors retired investors engage in under stress, such as buying high and selling low, or divesting a portion of their equities to invest in stocks.

Understanding behavioral and cognitive psychological theory and conventional economics, we can use behavioral finance strategies to identify triggers that cause individuals to make certain—usually bad—financial decisions, and recognize past financial mistakes in order to avoid repeating them and putting their retirement income at risk. Here are some behavioral finance behaviors that you should be aware of as you think about your investments

·      People tend to view the possibility of recouping a loss as more important than the possibility of greater gain.

·      Investors tend to place too much worth on judgments derived from small samples of data or from single sources. For instance, investors are known to attribute skill rather than luck to an analyst that picks a winning stock

·      We have the tendency to attach or "anchor" our thoughts to a reference point - even though it may have no logical relevance to the decision at hand. For example, some investors invest in the stocks of companies that have fallen considerably in a very short amount of time. In this case, the investor is anchoring on a recent "high" that the stock has achieved and consequently believes that the drop in price provides an opportunity to buy the stock at a discount

·      We use mental accounting. Mental accounting refers to the tendency for people to separate our money into separate accounts based on a variety of subjective criteria, like the source of the money and intent for each account. According to the theory, individuals assign different functions to each asset group, which has an often irrational and detrimental effect on their consumption decisions and other behaviors.

·      Although many people use mental accounting, they may not realize how illogical this line of thinking really is. For example, people often have a special "money jar" or fund set aside for a vacation or a new home, while still carrying substantial credit card debt

·      The reason we do this lies with the personal value that people place on particular assets. For instance, people may feel that money saved for a new house or their children's college fund is too "important" to relinquish. As a result, this "important" account may not be touched at all, even if doing so would provide added financial benefit.

As we age, we should be seeking less risking investments, so that we can generate income, because having high risk investments, may be destructive in the long term

I know that I am uneasy when my investments earn low or show no gains in a flat economy, which can activate some of my behavioral finance actions (see above) that may also lead to bad financial behaviors. My advisor suggested to me that I could minimize losses by merely staying the course and resisting the compulsion to take on risk.

I assume that all of us who are retired experience heightened anxiety over their financial security at one time or another. A recent American College survey (pdf file) showed that more than 60 percent of us are concerned with market volatility significantly impacting their retirement income stream.

In a discussion with another investment consultant, I was told that the biggest problem faced by retired people is that many of us often over-estimate how far into retirement their savings will last, and don’t plan for unexpected expenses such medical care that accompany retirement. Minimizing risk and establishing a financial plan that meets one’s retirement goals without draining their savings prematurely requires planning and flexibility, as this is not always an easy transition for retirees

It is important to understand that until we begin withdrawing money from our savings, there is no impact on our portfolio. However, selling stocks right after a significant market downturn can lock in lower returns, which can negatively impact the longevity of a retirement portfolio.

If flexibility with retirement income is not possible, you can consider securing enough guaranteed income sources to cover your basic retirement needs—a strategy often referred to as flooring, which is usually accomplished through a combination of investments and insurance products such as bonds and annuities that can help provide a predictable amount of income each month in retirement to meet expenses.

Coordinating annuity or bond purchases with other consistent income sources, such as pensions, Social Security, or rental income can help provide reassurance during volatile markets, and allow retirees to focus on enjoying their golden years instead of worrying about meeting expenses.