Retirement is supposed to be the best years of your life. Some call it the “golden years.” It can only be golden if you have enough money!
The cold, hard reality is most people need to save for retirement. Government benefits like Canada Pension Plan (CPP) and Old Age Security (OAS) are generally not enough. Combined CPP and OAS might be as much as $1,500 per month, but most people don’t qualify for the maximum benefit. The average is about $1,100 per month, and I don’t know many people who could live off that—even really frugal people.
Workplace savings plans are usually the best place to save for retirement. In fact, a 2011 survey by Fidelity Investments suggests that more than half (55%) of current participants say they would not be saving for retirement if their employer did not offer a savings program. The study also found that 19% of these participants have no retirement savings at all outside of their employer’s plan.
Let’s review the different workplace savings plans:
Group RRSPs are one of the most common workplace plans. They are very similar to individual RRSPs, except they are administered on a group basis by the employer. Employees make contributions to the Group RRSP directly from their paycheque, and the tax savings from the contribution can be applied immediately. Some employers even match a percentage of the employee’s contribution.
Defined Benefit Pension Plans
Defined Benefit (DB) Pension Plans pay employees a future retirement benefit that is known in advance, based on a formula that incorporates years of service, salary and a pension factor. In most cases, the contributions to the plan are shared by both the employee and the employer. These contribution amounts can change depending on whether the plan is sufficiently funded to meet its future obligations.
DB pension plans really reward long-term employees. People who retire with a defined benefit pension tend to have more stable, guaranteed income in retirement. Unfortunately, outside of the public sector there are fewer and fewer DB pension plans today, because they are costly to administer and the funding liability is shared by the employer.
Defined Contribution Pension Plans
Defined Contribution (DC) Pension Plans are becoming much more common than DB pensions because they are less costly and there is no funding liability on the employer. Under a DC plan, the future benefit is unknown: it depends on how much money is put into the plan and the rate of return earned on the investments—which means that employees bear the market risk.
What is “defined” in this plan is the amount of the contributions, usually expressed as a percentage of income. For example, an employee might contribute 5% and the employer will match that contribution for a total of 10%.
Deferred Profit Sharing Plans
Deferred Profit-Sharing Plans (DPSPs) are similar to DC pension plans, whereby an employer distributes a portion of pre-tax profits to selected employees. However, unlike a pension plan, employees do not contribute to the DPSP. DPSPs have become increasing popular in regions where pension plans have moved to immediate vesting because DPSPs still allow employers to put vesting periods on employer contributions
Pooled Registered Pension Plans
Pooled Registered Pension Plans (PRPPs) are the new kids on the block when it comes to workplace savings programs. The federal government introduced PRPPs in 2011 to address the concern that millions of Canadians do not have a workplace pension plan. PRPPs are a type of defined contribution pension plan designed to help smaller businesses and self-employed entrepreneurs save for retirement. The idea is that smaller employers can pool resources with other businesses to enjoy a cost-effective pension plan that is easily administered.