Pension plans can vary
greatly in terms of their structure and the benefits they provide. The two most common
types of pension plans are the defined benefit plan and the defined contribution (or money
purchase) plan. Some employers offer a combination of the two types of plans - known as
"hybrid" or "combination" plans.
Defined Benefit Pension Plans
Defined benefit plans are designed to provide you with a
specified amount of pension benefit when you retire based on a formula. Generally, this
formula depends on factors like years of service and earnings and is described in the
pension plan documents provided to members. Members of this type of plan are advised
annually of the amount of pension benefit they have earned or "accrued" up to
that point.
There are three types of benefit formulae commonly used to
determine a member's pension:
- final or best average earnings formula:
For each year of service, the formula provides a fixed
percentage of your final earnings from employment or of an average of your earnings over a
fixed period of time. In other words your pension adjusts in step with your wages. For
example:
1.6% of your average earnings over the best 5 years of
earnings x your total years of service
- career average earnings formula:
Your annual pension benefit is a fixed percentage of your
annual earnings while a member of the plan. For example:
1.2% of your annual earnings
Your annual pension benefit is a fixed dollar amount per
year of service. For example:
$32 per month per year of service
Defined Contribution Pension Plans
In a defined contribution or money purchase pension plan, a
specified amount of money is contributed regularly for you. This money is placed in an
investment account in your name. At retirement, these contributions - plus interest - are
used to purchase a pension. You will not know the amount of pension you will receive until
you retire.
Some defined contribution plans permit employees to make
their own investment choices, while others provide that the employer or a board of
trustees is responsible for all investment decisions.
Ultimately, the size of your pension depends on the amount
of the contributions made by, or on behalf of you. It will also vary due to the return on
the investment of those contributions. Annuity rates (i.e., long-term interest rates) at
the time of retirement also may be a factor.
The traditional form of pension is the life annuity.
Typically with a life annuity, your locked-in pension money is paid to a life insurance
company that guarantees the payment of a fixed amount for your lifetime. Pension
legislation has introduced the following alternatives to the life annuity:
- A Registered Retirement
Income Fund (RRIF) will allow you to determine your level of income, as well as manage your
pension capital to take advantage of continued capital growth from investment earnings,
and to have more flexibility for tax and income planning purposes.
- A Variable Benefit, which is
similar in nature to the above RRIF may be offered by a defined
contribution plan. Check with the administrator of your
plan to see if this is a retirement option under your plan.
