The Gold Plated Pension

Pension Piggy BankBack in March 2012, I wrote a post titled Building My Portfolio for Retirement, with Dividends and Bonds. In that post I discussed that I was one of the fortunate ones to have a defined benefit pension plan through my employer. My pension is an additional source of monthly income, along with my investments, to help me in retirement.

I think it is critically important to understand the foundation of your retirement, the pensions you are entitled to receive, and how much monthly income you can expect your investments to spin-off. I pointed this out in my most popular article – Can You Live Off Your Dividends?  When you put it all together, pensions are an important component of that monthly income.

Here is how the basic pension plans work in Canada, both government and employer sponsored:

1. Canada Pension Plan (CPP)

All Canadians who have contributed to the Canada Pension Plan (CPP) during their working years can apply. This is a government benefit. Canadians can apply as early as age 60. The full monthly benefit is available at age 65, with a 0.5 per cent reduction in the pension payout for each month before age 65 that someone begins receiving it. The total reduction is approximately 30% if you collect CPP at age 60, so in effect the government is penalizing you for taking early retirement.

The Canada Pension Plan is a contributory plan. This means your benefit is based on how much you contributed to the plan while working. The maximum CPP benefit rate is currently $986 per month.

2. Old Age Security (OAS)

The Old Age Security (OAS) Pension is a monthly benefit available to most Canadians 65 years of age or older who have lived in Canada for at least 10 years. This is a government benefit. Eligibility for OAS is based on residency and has nothing to do with employment history. The current maximum OAS monthly payment is $544.

From an investor’s point of view OAS can present a problem because OAS is based on income. RRSP withdrawals are counted as taxable income. Therefore, RRSP withdrawals can result in claw-backs to your OAS pension amount and/or entitlement, if your retirement income is over 69K. For most Canadians that will likely not be an issue, but for those living off their investment income it may well be. Canadian finance guru Jim Yih provides an excellent article on Minimizing OAS Clawbacks.

3. Defined Benefit Plan (DBP)

In Canada, government and public service workers, as well as some private sector employees, are able to sign up for a defined benefit pension plan. This is the granddaddy of all the pension plans, and usually involves mandatory enrolment as a public service employee. But enrolment is well worth it!

For every dollar you contribute to your defined benefit plan, your employer also makes a contribution, and in my case my employer matches it. The key point with a Defined Benefit Pension Plan, is that the amount of your monthly pension payment in retirement is fixed and guaranteed, and in most cases for life. Payment is primarily based on years of pensionable service, and your age at retirement. The Defined Benefit Plan is worth gold, because your monthly payment is fixed and guaranteed at retirement.

4. Defined Contribution Plan (DCP)

For those in the private sector, the alternative is a defined contribution plan, assuming your employer offers one. Rather than a guaranteed benefit amount at retirement, your employer simply makes a contribution as you contribute to the plan. In most cases the employer will match your contribution. Most Defined Contribution Plans rely on managed investments such as mutual funds through life insurance companies.

However, you are not guaranteed any defined benefit. All you are guaranteed is that your employer will contribute to the plan. This usually means you are relying on the value of your portfolio when you retire, how well the investments in your plan performed over the years, and the market value of your investments at retirement. However, when you consider for every dollar you contribute, your employer usually contributes another dollar, that is still a pretty good deal.

Why Employers Prefer Contribution Plans

The Defined Benefit Pension Plan is becoming an expensive overhead that many employers are not willing to bear. Many employers are scrapping the coveted Defined Benefit Pension Plan, and opting for the less costly Defined Contribution Plan. A major reason is that defined contribution plans are not linked to a specific benefit formula based on age and years of service. Employees simply receive the amount that they have been able to save with employer including matching contributions. In addition, defined contribution plan funding requirements are lower than the funding required for defined benefit plans. Simply put, there is less obligation and less cost for the employer with a contribution plan.

The Defined Pension is Worth Gold (if you have one)

The Defined Benefit Pension Plan (DBP) is considered the Gold Plated Pension for working Canadians.  But less and less employees will be able to collect Defined Benefit Pension plans. More private sector employers will be converting and/or offering their employees Defined Contribution Plans. The Defined Benefit Pension Plan in Canada may indeed become a scarce commodity for retired workers. The DBP is worth gold if you have one.

Reader’s do you have a defined benefit or defined contribution plan through your employer? What do you think of your defined benefit or contribution plan?

15 Responses to “The Gold Plated Pension”

  1. TM @ Young and Thrifty

    Jul 25. 2012

    The one unfortunate side effect of the DPP that I have seen in the world of education is that they are such an enticing piece of compensation that it keeps people around for the wrong reasons (namely gold-plated reasons). When people are staying around crossing days off of the calendar just because of the compensation package that leads to all kind of problems. That being said, it is a pretty nice thing to have. Teachers retiring today in my province would get around 55-58K a year, indexed to inflation for the rest of their life. You would need one heck of a dividend portfolio to generate those returns!

    Reply to this comment
    • The Dividend Ninja

      Jul 25. 2012

      Hey TM, I am certainly looking forward to the DBP. While I do like my job, the pension is a nice benefit I am looking forward to. It gives me more options and resources – like running my multi-million dollar web empire and some travel. Freedom 55! :)

      Unfortunately many people don’t like their work whether they are in the public or private sector, or entitled to a pension or not. There isn’t much we can do about that one. ;) Some people don’t want to retire and continue to work. When I consider the pension plus my investment income at that time, early retirement is looking pretty good for me! I want to enjoy the quality of life as much as possible, somehow working when I’m 60 doesn’t seem like part of that plan.

      Cheers

      Reply to this comment
  2. Rob

    Jul 27. 2012

    Hey Ninja,

    Great post! First off, congratulations of being one of those lucky few who have a DBP. They are becoming increasingly rare in today’s world.

    I’m in my early 30’s so I still have loads of time for my investments to grow before I begin to draw on them. However, being the skeptic that I am, dispite assurances to the contrary I’m not convinced CPP and OAS will even exist 30+ years from now.

    I base my retirement income calculations without CPP nor OAS included. Though to be fair, we actually had a bank rep come into our office a few weeks ago to speak about our group RRSP, and he assured us at that time that CPP and OAS are fully funded for the next 50 years. If that is indeed true, it’s nice to have your post with everything presented to help me revise my calculations.

    Reply to this comment
    • The Dividend Ninja

      Jul 27. 2012

      Rob, you can assume that OAS and CPP will still be around when you retire, since the government backs them. It may not be in the same level of funding, you may not be entitled to early enrolment, or it may even be merged into a new plan. But there will still be some type of pension available for Canadians.

      What I do think, is you don’t want to rely on the government for your future – hence starting on your investments early as you are, makes good sense. ;)

      Cheers

      Reply to this comment
  3. My Own Advisor

    Jul 28. 2012

    Good post Ninja!

    I’m fortunate to have a DB plan at work….about 12 years into it. If I “hold on” at work for another 20 years, or they hold on to me that is, I should be in great shape.

    Add the $30,000 in dividend income per year to that, and hopefully things will be fine :)

    It would be great if I don’t have to use OAS in retirement. I’m dreaming a bit, but it feels good to dream!

    Cheers,
    Mark

    Reply to this comment
  4. spbrunner

    Aug 05. 2012

    The defined benefit plan is great if you work for a company for many years and retire from that company. However, if you quit, are layoff or your employment is stopped for any reason you get very little from these plans. This is because you get a discounted value of the value it would be at retirement and often a very high rate is used for this discount. (I have had this happened a couple of times to me.)

    That was why, when I was working at Manulife and they were offering a change from their defined benefit plan to a defined contribution plan I made the change. I was planning on leaving and they offered a good deal for people who changed.

    If you do not plan to be at the same employer until retirement, you are better off with a defined contribution plan.

    You are also better off with the defined contribution plan if your company goes bankrupt. A lot of times if a company goes bankrupt, the pension plan is underwater. Sometimes the government will step in and help, but they do not have to.

    I am just saying that the defined benefit plan may not be as gold plated as you expect.

    Reply to this comment
    • The Dividend Ninja

      Aug 05. 2012

      Susan, a very well thought out comment, and greatly appreciated. ;)

      A few years after I started working in the Healthcare sector in B.C. I’ve seen nothing but changes. I’ve seen entire departments privatized, and I know many companies are moving from defined into less costly contribution plans. I’ve always lived with an umbrella of uncertainty in my workplace. I’m not taking anything for granted, but I’ll be thankful for whatever pension I receive when I retire (assuming the plan is still in place).

      My pension plan mails out a statement every year of what I’m entitled to based on various scenarios. So if I take early retirement, or quit etc. I have an exact statement of my retirment income. It’s complicated but quite transperant actually. ;)

      Cheers!

      Reply to this comment
  5. The Dividend Ninja

    Jul 25. 2012

    Dave thanx for the update and letting me know! A 36% reduction is worse than 30%!! Please feel free to update me on the other number you know is incorrect, and I’ll verify and edit the post accordingly.

    Cheers and Thanx!

    Reply to this comment
  6. RICHARD

    Aug 06. 2012

    It is neither 5% nor 6% at present. It will be 6% in a few years as it is ramped up – depending on your present age.
    Very easy to check out the Gov website for the rate increases.

    Reply to this comment

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