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How well do you know your pension plan?

Money is only a tool. It will take you wherever you wish, but it will not replace you as the driver. – Ayn Rand

Recently, I read a great article by Rob Carrick in the Globe and Mail. It raised some major concerns about how both employees and employers perceive their Defined Contribution pension plans and the benefits they provide to members. It also stressed how important it is for employees and employers to understand how their plan works and what benefits they can expect it to provide at retirement.

Carrick’s observations mirror my own experiences of meeting with plan members and answering their questions over the phone and via email. Many plan members assume that being part of a pension plan assures them of a guaranteed income for life once they reach retirement age. Going hand in hand with this belief is the assumption that the amount they’re entitled to receive will be enough to replace their employment income in retirement. However, the reality of what they’re entitled to doesn’t always match those expectations.

If you are a member of a company pension plan, here are 5 questions that you should ask in order to understand your plan a little better:

1. Defined Benefit or Defined Contribution?

The two most common types of pension plan in Canada are Defined Benefit (DB) and Defined Contribution (DC) plans.

Defined Benefit plans provide a guaranteed income for life and the amount you are entitled to is usually calculated based on a formula that uses your years of service and highest average salary.

For DB plans, it is the benefit you receive in retirement that is defined. Your contributions and your employer’s contributions are an important part of accumulating that benefit but it’s the employer’s responsibility to make sure that the money inside the plan is invested in a way that will generate the guaranteed amount of retirement income for plan members. If interest rates fall or the stock market returns aren’t as high as expected, it’s the employer’s responsibility to fill the gap, not the members’. This can make DB plans a huge expense for employers and is one of the main reasons that many companies offer Defined Contribution plans instead.

With Defined Contribution plans, it’s the amount that is contributed by the employer and the plan members that is defined. Some plans don’t require members to contribute and are entirely funded by the employer but the most common plan design is for both the employer and the plan member to contribute.

The benefits members receive once they reach retirement age are entirely dependent on how much money was contributed to their pension account, how that money was invested and how those investments performed over time.

Related Article: Defined Benefit Pensions vs Defined Contribution Pensions

2. How Much is Being Contributed?

The most common misunderstanding that I get from DC plan members, is the belief that, because they’re part of a pension plan, they’re guaranteed an income in retirement that will be close to what they earned while they were working. They don’t realize that it’s the value of their pension account, not their years of service or salary that determines what their income will be.

Too many plan members assume that it’s their employer’s responsibility to make sure they have an acceptable amount of income once they reach retirement age and they don’t realize that, with a DC plan, that responsibility actually falls on them. Even with a DB plan, where you know how much you’ll receive in retirement, plan members still have a responsibility to make sure that amount (combined with their government benefits) will be enough and to save more on their own if it isn’t.

Even with a DB plan, where you know how much you’ll receive in retirement, plan members still have a responsibility to make sure that amount (combined with their government benefits) will be enough and to save more on their own if it isn’t.

Most personal finance experts suggest that we need to save at least 10% of our gross earnings throughout our working years in order to have enough in retirement. While ‘enough’ can vary dramatically in value from person to person, I’ve never heard anyone complain about saving too much which leads me to believe that 10% isn’t a bad benchmark to work with. However, if you have the ability to save more, then go for it!

Too often though, the amount that people contribute to their DC plans is based on the percentage that will be matched by their employer. If the employer will match 5% they’ll contribute 5% of their earnings but if the employer will only match 2% then they will also contribute 2%. In Canada, the average match offered by group retirement plans is 4%. Many plans offer a tiered match where employees have a lower matching rate in their early years of plan membership and are then entitled to a higher rate of matching as their years of service increase. Based on this information, it’s fair to assume that many DC plan members are contributing much less than they need to in order to create an acceptable amount of income in retirement.

If you’re a member of a DC plan, then you owe it to yourself to verify what percentage of your earnings is being contributed to the plan. If the total amount being contributed (your contributions + your employer’s) is less than 10% of your gross earnings, then you might want to consider either making additional voluntary contributions (if your plan permits this) or putting away extra in an RRSP to make sure you have enough in retirement.

3. Who Makes the Investment Decisions?

Most Defined Contribution pension plans put the responsibility for making investment decisions on the plan

members rather than the employer. If members don’t give investment directions for their money, the contributions to their pension account are invested according to the default investment directions for the plan.

If the default investment is an asset allocation or target date fund, then your account is still likely to

generate a reasonable rate of return over time. However, if the default is a guaranteed interest account, a money market or a deposit fund then you should consider making a change. Many pension plans with these types of defaults, were set up when interest rates were much higher and cash accounts could earn 4-5% per year. However, as interest rates have fallen over the past few years, it’s not uncommon to see members earning less than 1% per year on their money.

This rate of return isn’t anywhere near enough to create a reasonable income in retirement and that is why recent pension reforms in Alberta and BC made it mandatory for pension plans to select a balanced fund or target date fund for the plan default. However, this isn’t the case for all plans in Canada and, even when a pension plan changes its default fund, the change often only applies to new money going into the plan, it doesn’t affect money invested prior to the change.

Related Article: Where are Interest Rates Going?

4. What’s My Rate of Return?

A Benefits Canada survey of 1,008 pension plan members, asked what rate of return plan members expected to see on their investments. The average rate of return that the surveyed members expected was 17.3%. This “disturbingly optimistic” expectation was, for me, the most worrying part of Carrick’s article. Even though the median expectation was 7% per year, if we assume that this is the net return (after investment fees are deducted) that still requires an average gross return of 9-10%. This isn’t impossible but it’s a long way from the net returns of 5-6% that many experts are currently projecting over the long-term.

When I run retirement income projections for plan members, I usually use a net return of 5% on the high end and 3% on the low end to give members an idea of what they can expect their account to be worth at age 60 or 65, assuming that they continue to make the same level of contributions until retirement. If the plan has low investment fees (less than 1.5%) I might run the projections using a 6% or 6.5% return on the high end but it’s always with the caveat that, if they leave their employer and/or move their savings to a plan with higher fees, they should expect less at retirement.

5. How Do I Find Out More?

If you want to know more about your pension plan, the easiest way to find out is to open your statement and take a look. This sounds obvious but I meet a LOT of people whose statements end up in a drawer or a shredder without ever being opened. If you’re a member of a group retirement plan, you owe it to yourself to open at least one statement per year to see how much has gone in, what you’re invested in, what your rate of return has been over 1, 3 and 5 years and who you have listed as your beneficiary(ies). It’s a 10-minute investment in your financial health that too few people are willing to do and yet it can have a huge impact on your retirement income.

Once you’ve checked your statement, if you have questions about your plan, you should talk to either someone in your HR department, a member of your plan provider’s client care team or your plan advisor (the contact information for these is usually listed on your statement). They will be able to answer your questions and help you make any changes to your contribution amount, investments, beneficiaries etc.

Written by Sarah Milton

Sarah Milton is currently stretching her professional wings in Edmonton, Alberta in a role that allows her to combine her talent for writing and speaking with her training in the financial services industry. She is passionate about inspiring people to get excited about their money and empowering them to take control of their financial future. You can follow Sarah on Twitter @5arahMilton

19 Responses to How well do you know your pension plan?

  1. My financial advisor (FA) has touted that a 4% return would be a safe number to use, and with the possibility in not so good years that it could be lower. I am having difficulty though seeing my account just sit there with really no return at all. My FA says it isn’t what my account is doing but where my money is being invested for my retirement income. Bonds, dividends, etc. If i was to take the 4% gain out at retirement my account, or principal amount, should not go down. At the rate I am going though, I will be drawing down my account much too rapidly. I understand this is my pension money and that it should be invested conservatively but to not have gains and to still have the FA taking her 1% just drives me crazy. I want to see my account grow. Any advice or recommendations? I am 59 years of age and am going to retire in no more than 2 years.

  2. Wow Sarah – great article! You’ve included enough detail to bring attention to the various concerns, without over-analyzing the issues.
    Keep up the good work.

  3. Hola Jim,
    Anastasia and I have worked on commission our entire careers… the only thing we had was CPP and OAP from the government. Our only choice was cut our lifestyles way back to live in Canada but up until I made a trip here to this place in Mexico… the rewards for a lifetime’s work seemed pretty bleak.

    The fact that I stopped spending about $40,000 per year by quitting drinking and smoking was a huge contributing factors in those were net after tax dollars. I did those things in 1999 (booze) and 2000 (cigarettes). By the time I retired in 2007 at 65 there was about $300,000 unspent dollars and that would (and did continue) until this day.

    It was one thing to have equity in our condo in Edmonton but in that there are no mortgages in Mexico we have 100% equity. We bought a 2,000 square foot one level home, fully furnished, with a swimming pool in a preferable gated community for $140,000 was great but when we could support the home (property taxes, utilities, housekeeper, gardener, pool attendant, telephone (with 1,000 free minutes a month), wifi, etc for about $400 per month (the same as our condo fee alone in Edmonton) was huge.

    I did a budget (we’ve never lived with one) which included eating 2 meals out a day (there are hundreds of good restaurants down here), two vehicles (we’ve always had that) and a well above average social life and including my Masonic and Shrine activities and my music endeavours… all was well and we live happily ever after so to speak.

    Many things such as gasoline are the same or higher than Canada… but consumption is much lower. Things like (as this very week) having an addition done on our house for less than $3,000 dollars.

    At the same time, should I or we have to look at senior’s lodging… a first class facility down here with meals and your own space runs $1,000 to $1,400 depending on your requirements… not a chance of anything even close in Canada.

    Automatically when we bought our house our 3 boys are heirs to the home and that’s right on the deed.

    I know an awful lot of people it seems only work to get a pension and live like a dog thereafter which is completely foreign to us. We didn’t plan this move ever or even imagined that we’d be living in a place like this in our later years after watching our parents and grandparents “live” a pretty meager existence in what is referred to as their Golden Years.

    We had many friends over the years that bought “winter get-aways” in Phoenix, Palm Springs, Las Vegas (or as some did… a mobile home in Mesa) but have found they can’t retire there because of the super hot summers… they also find that without cash flow they can’t afford both abodes.

    We live in the second best climate on Earth at a very moderate cost with an excellent (and really free) healthcare system and we have a higher lifestyle than when we were working in Edmonton.

    I see down here now (and I am sure many other places) younger people are coming and setting things up for their eventual retirement. Some are even coming down here in their late 40’s to early 50’s complete with kids and doing great things they never did in the US or Canada and the kids are going to school with the bonus of learning another language. It is great to see indeed.

    For us, it was very good luck but for many it should be an offered option to plan how much money they might have but how, when and where they are going to spend it. The best plan we can see is to have a clear title home to sell and live happily ever after!

    Anything we can do to be of assistance to our good friend Jim, his wonderful family or his clientele… would be our extreme pleasure or we say here in Mexico… mucho gusto!

      • We are retired at Lake Chapala in Jalisco, Mexico about 35 Kms. south of Guadalajara. The area is on about 25 Kms. on the northwest shore of the lake from Chapala to Jocotepec. The “jewel” of the area is Ajijic (pronounced Ah-Hee-Heek) and we are in a gated community called Mirasol in San Antonio Tlayacapan just east of Ajijic.

        This area is said by National Geographic to have the second best climate on Earth… we are very happy with that after spending our lives in Canada! The climate is temperate all year around… no need of a furnace or an air conditioner.

        The cost of living here is ¼ to ⅓ that of Canada or the US… needless to say we enjoy that big time! My wife Anastasia has continued her Real Estate career down here and her web site is at: http://www.anastasiaboyd.com for your interest.

        Also there is an Entertainment button in the upper right that I write and distribute to 1,600+ in the area… there are scads of great restaurants with any cuisine you fancy from Thai to German and every where else you can imagine… plus a few with Mexican food too! lol

        We use to sell people winter get-aways in the US southwest but those places are useless because of the summers so hot… a lot of Snowbirds come here and purchase homes and come down until they retire… then they move here and visit back there (not in the winter!). lol

        There is no bad time to come here… lovely all year around! There is a rainy season from about mid-June to late September but it rains mostly at night… beautiful!

    • Hi Frances and Anastasia , Where in Mexico did you buy a place please? Sounds very interesting! Thanks for any information about this place? Kind Regards, Rita Sept.2,2017

  4. For those with DB plans, one other thing to check is whether it is fully indexed to inflation, or partially indexed, or not indexed at all. Inflation has the potential to erode benefits and the implications can be significant over a long retirement.

  5. Sarah,

    This is a topic I know nothing about as the companies I worked for – including self-employment – didn’t offer one. I have relatives who have taxpayer funded pension plans as they work or have worked for governments providing services, and a few relatives who have corporate pension plans.

    I’m one of the 60% of Canadians who have had to fend for themselves, and simultaneously fund government employee plans via income taxes as well as fund corporate plans because corporations get their contributions from their profits which eventually affect the price of consumer goods and sales taxes.

    I have relatives in both categories who are retired and when we talk about finances, their biggest complaint is how much they have to pay in income tax; I’ve paid less than 8% since 2006, 11 years ago.

    I have investment expenses but pay very little in income tax as most of my income is tax advantaged and 17% is tax free from my TFSA. My largest investment expense is interest. But the interest is 100% tax-deductible which wipes out most of my CPP and OAS benefits while providing about 50% of my tax advantaged income.

    I index my monthly income from my portfolio by automatically re-investing a portion of my income in additional income generating stocks and funds. Since CPP & OAS index at a fake rate lower than 2%, you’re promptly behind the 8 ball if you don’t address inflation personally.

    Until I approached 60, I had no clue about CPP and OAS or GIS benefits. That’s when I realized that CPP is a pension plan supplement, OAS and GIS are a necessity when you don’t have a Personal Pension Plan.

  6. Claude

    Could you please elaborate…”But the interest is 100% tax-deductible which wipes out most of my CPP and OAS benefits while providing about 50% of my tax advantaged income.”.

    Thanks in advance. I understand that margin interest is tax deductible.

    • Dave,

      By borrowing using my Margin account, I have more income.

      Example.
      My $100,000 pays me 12% in tax advantaged monthly income that I can use or re-invest (TMXMONEY screener for dividends).

      I automatically borrow $50,000 (or more) against my capital @ 5% and invest it also at 12% in tax advantaged monthly income that I can use or re-invest.

      CPP is 100% taxable. My Margin interest is 100% tax-deductible.

      Only my money: $12,000 income
      Borrowed money: $6,000 income
      Margin cost: $2,500 expense

      Pre-tax income on my money: $15,500 or 15.5%

      On the CRA website you’ll find that you can earn $50,000+ in dividends tax-free.

      If you re-invest the 15.5%, you will double your money in 4.65 years (Rule of 72); your income tax bill will be negligible.

      If you use the cash, your income tax bill will be negligible.

      When you’re retired, what matters most is disposable income. How much capital you have when you die is inconsequential.

  7. Thanks Claude.
    I’ve done lots of buying dividend payers on margin over the years but nothing paying 12%.!

    Most recently paying 3% (td direct) interest and usually buying something paying about 5% div. My tax situation is now such that I save 39% on the interest but have to pay about 21% on new dividend income.

    I very much agree, after tax monthly income is what is relevant in retirement not total capital.

    I use the calculators at. Taxtips.ca. to do a lot of “what ifs”

  8. Excellent read. As a retired guy with a DB Pension, the best thing I did in my 20’s was finding out & understanding how my DB would work if I did the time. It really helped to get a grip on the total life plan by understanding different plan options. Mine was not indexed, so needed to factor in some what ifs. Health care, drugs & dental as part of your retirement package or not can be a big factor. Pass this article on if you have have children, because many don’t look at any numbers until it is too late to make anything work. Bob

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