What is a defined benefit pension plan?
There are 2 main types of pension plans in Canada: defined contribution plans and defined benefit plans.
Canada Life only offers defined contribution pension plans, but you may have a defined benefit pension plan from another provider or an older plan.
A defined benefit pension plan (or DB pension plan) guarantees you a certain amount of monthly retirement income. Defined benefit pension plans can be complicated, but here are the basics.
Defined benefit pension plan contributions
Most employers calculate and deduct your pension plan contributions from your pay each pay period.
- Contributions are generally based on a percentage of your pay.
- You can deduct these contributions from your income tax.
- An employer may change the amount employees contribute depending on the terms of the plan and the funding requirements which are determined by actuaries who review the plan, usually every 3 years.
- The employer must contribute at least 50% of the pension benefits you earn.
Some plans require you to be a plan member for a specific amount of time before you’re entitled to benefits (also called vesting). Vesting time varies by province. If you leave the plan before being vested, your contributions will be returned to you with interest.
Defined benefit pension plan example calculations
With a defined benefit pension plan, your retirement income is calculated using 1 of 3 formulas:
Final average earnings
This example uses 2% multiplied by your average salary in the 5 years before retirement, then multiplied by your years as a plan member. If your average salary was $60,000 and you participated in the plan for 30 years your pension would be:
- Benefit percentage: 2%
- Average salary: $60,000
- Years of plan membership: 30
- Calculation: $60,000 x 2% x 30
- Annual pension: $36,000
Career average earnings
This example uses your average earnings during the entire period you were a member of the plan. If your average salary was $40,000 and you participated in the plan for 30 years your pension would be:
- Benefit percentage: 2%
- Average salary: $40,000
- Years of plan membership: 30
- Calculation: $40,000 x 2% x 30
- Annual pension: $24,000
The annual pension amount is lower in this example because the career average salary is less than the final average salary.
Flat benefit
This example uses a fixed dollar amount ($100 per month x 12 months = $1,200) for each year you are a member of the plan multiplied by your years as a plan member (30 years).
- Benefit amount: $100
- Years of plan membership: 30
- Calculation: $1200 x 30
- Annual pension: $36,000
What happens to your DB pension plan if you leave your employer before you retire?
Depending on the province or territory in which you live, you may have 3 options when you leave your defined benefit pension plan before retirement.
- Leave your pension in your plan and start receiving it when you retire (also known as a deferred pension).
- Transfer the commuted value of your pension to your new employer’s plan if they will accept it. A commuted value represents the lump sum present value of the pension you’d otherwise receive as a monthly payment for your lifetime upon retirement.
- Transfer the commuted value of your pension to a locked-in retirement account (LIRA) (usually only available if you’re under age 55 at the time of transfer). A LIRA keeps the money in your old pension plan set aside until you retire.
This is different than if you leave your defined contribution pension plan before retirement. In this situation, depending on where you live, you may also have 3 options:
- Transfer the commuted value of your pension to an individual locked-in retirement account (LIRA)
- Use the money to buy a deferred annuity that guarantees to pay you an income for life
- Transfer the commuted value of your pension to your new employer’s plan if they will accept it