In the past, the thought of retiring with a pension was very likely to raise images of a secure and steady retirement income after years of loyal service.
But times have changed.
Many pension plans used to be defined-benefit plans, in which the payments that you received from your employer were …well, defined.
Now, however, more and more companies are turning to what are called defined-contribution plans, in which contributions are made, and then interest rates and investment earnings affect the total value of the funds that have been contributed.
With a defined-contribution plan, you will have a choice of investments to which your money can be directed. These investments are the same investments available to the self-directed RRSP plan holder, and include stocks, bonds, mutual funds, and mortgage-backed securities (MBS), amongst others, though your employer will choose which investments will be offered. Usually the range of investments is quite limited.
Defined-contribution plans are becoming more popular with employers, because the employer is off the hook to provide a specified amount of pension; the amount of pension is a result of how you invest the contributions you make. Many employees fail to take advantage of the investment opportunities with which they are provided, and simply default to the money-market option as an investment vehicle. (A money-market fund is the most conservative type of mutual fund, in which net returns are equal to, or even slightly less than, a savings account, due to fees charged by the fund company.) This choice may provide an unwelcome surprise to retirees when they receive a pension that is much smaller than they expect.
If you are a member of a defined-contribution plan, you must be involved in the investment of the contributions to ensure they are correctly allocated for your retirement objectives, your risk tolerance, and your age.
Pensions paid by defined plans
All employees enrolled in an RPP receive an annual pension statement. This statement is frequently misinterpreted by the employee, who can be mistaken about what will be paid and when. It is important to analyze the statement with your financial advisor or plan administrator at work to understand how much you will receive—and when.
The pension statement will show the amount of pension earned as of the statement date and payable at the Normal Retirement Date. The Normal Retirement Date is the date when the pension will begin, according to the terms of the plan document. This is usually age 65.
The amount shown will be the pension that is payable either on an annual or a monthly basis. Be sure to understand the payment mode to avoid any confusion.
Often the statement will show the amount of pension that will be earned from the date of the statement to the Normal Retirement Date, based on assumptions about future earnings and assuming you remain in the plan until the Normal Retirement Date. The pension earned to the date of the statement, plus the pension to be earned, gives a conservative estimate of what your pension might be at the Normal Retirement Date.
Remember, though, if you have a defined-contribution plan, your investment choices and the attention you pay to your fund will have a direct impact on your life after retirement, just as if you were managing your own portfolio—because you are. Learn everything you can about your plan, ask questions, and make sure your pension investments are working for you!
Retirement Planning and Taxes for Canadians,
Oliver Publishing, 2008
www.oliverpublishing.ca
Copyright 2010 Stockhouse