Example of a defined contribution pension plan (DCPP)
Let’s consider Cary, who opts to join the DCPP at the company they work for. They contribute $2,000 a year to the plan and the employer matches that contribution by 100%, so the total annual amount invested on Cary’s behalf becomes $4,000.
It’s Cary’s responsibility to contribute to the plan and choose how that money is invested. The employer only has to match Cary’s contribution up to the predefined limit.
If Cary leaves that employer after a few years and goes to another employer who offers a DCPP, they can move the amount from one plan to the other. Cary can continue building a retirement nest egg.
Cary’s investments stay in the DCPP until retirement. Let’s assume that they’ve totalled $450,000 by age 71. Cary can withdraw the amount in the plan then receive it in annuity payment, and/or invest it in a life income fund (LIF) or locked-in retirement income fund (LRIF).
Withdrawing from a DCPP
You can’t withdraw the money in a DCPP before you retire. The earliest retirement age depends on the plan provisions and is 10 years before the normal retirement age under the plan. If the normal retirement age is 65, the earliest you can retire from the plan is age 55.
Can you transfer a DCPP to an RRSP?
On your termination of employment, you can only transfer to:
- An locked-in retirement product allowed under pension legislation
- An insurance company to buy a deferred annuity
- Another employer’s pension plan
If you made voluntary contributions to your DCPP, or the amount qualifies as a small amount under pension legislation, you can transfer that money to an registered retirement savings plan (RRSP).
Can you withdraw from a DCPP due to an emergency?
In certain provinces you may be able to withdraw the funds due to financial hardship. You should speak with an advisor first. Other options may be available.
While you are employed, unless the pension legislation allows otherwise, you cannot withdraw from or “unlock” pension funds.
Some provinces and the federal government has reasons that permit you to unlock locked-in pension funds. Some of those reasons include:
- Low income
- Potential foreclosure
- Eviction for behind in rent
- First month’s rent and security deposit
- High medical or disability-related costs
- Shortened life expectancy
In addition, some jurisdictions let you unlock 50% of your locked-in funds, 1-time, if you’re 55 years of age or older. If you leave a job or retire, some jurisdictions also let you unlock if the balance of your funds is below a certain amount.
Check your pension documentation to confirm your options.
What’s the difference between a defined contribution plan and a defined benefits plan?
Defined contribution plan
Overview – You know how much is going into the plan.
Question #1: How is your retirement income determined?
Answer #1: It depends on the market and how much your investments have earned when you retire.
Question #2: What do you contribute?
Answer #2: It's usually a percent of your income (maximum 18%).
Question #3: What does your employer contribute?
Answer #3: It's usually a percent of the employee’s income (maximum 18%).
Question #4: How do taxes work?
Answer #4: The money you contribute is tax-deductible. The money you earn from investments won’t be taxed until you withdraw it.
Defined benefits plan
Overview – You know how much you’re going to get out of the plan.
Question #1: How is your retirement income determined?
Answer #1: It's determined by a formula, based on how long you’ve worked and your average earnings in your best years.
Question #2: What do you contribute?
Answer #2: You may or may not contribute – if you do, you’re usually required to pay less than half of the benefits.
Question #3: What does your employer contribute?
Question #3: The employer must usually contribute at least half of the benefits.
Question #4: How do taxes work?
Answer #4: The money you contribute is tax-deductible. The money you earn from investments won’t be taxed until you withdraw it.