07: Understanding Your Defined Benefit Pension Plan

If you’re one of the increasingly rare people who have a defined benefit pension plan, this episode is for you. Today, we’re going to find out everything you need to know about this endangered species of an employee benefit…or, at minimum, we’ll find out how to find it all out. 

But first! Terminology!

First things first: A defined benefit pension plan is one where both you and your employer make tax-deductible contributions to a huge investment account that is kept in trust and separate from the rest of your employer’s assets, and it’s your employer, not you, who decides how it’s invested. 

It’s also your employer who’s responsible for hiring an actuary every few years to make sure (with the power of complicated and very fun math!) that there’s enough money in the plan to pay out the future pensions of every member (aka. the “funded status” of the plan), and for reporting to the regulator and to you and the other members. If the funded status isn’t up to scratch, your employer might need to increase the amount they (or you and they) contribute.

Defined benefit plans are ones where the amount of money you receive in the future is governed by a formula, not on how well (or poorly) the investments do, so it’s pretty important that the investments and contributions are managed carefully so your employer can actually pay out what it promised to.

The formula is usually based on some combination of the length of time you participated in the plan (aka your “years of service”), the average amount of money you earned each year (aka your “average earnings”), either over the last few years of work or over your total years of service, and a benefit amount, which can be a flat dollar amount or a percent of your earnings.

Sometimes, there are other little treats that come with your pension, like a guarantee that your pension income will increase, at least in part, as the cost of living does, or an age at which you’re eligible for early retirement without a reduction in your pension. If you have a spouse, your pension plan can reduce the amount you receive so that your spouse will keep receiving a pension if you die first. 

The amount you and your employer contribute is usually a percent of your income, and can sometimes be two different numbers: a certain percent of your earnings up to the amount where you stop having to pay into the Canada Pension Plan, and a different (usually higher) percent of any earnings above the CPP threshold (aka the “Years Maximum Pensionable Earnings”). 

This double calculation is designed to recognize the fact that you’re already contributing 5.95% of your earnings up to this threshold to another defined benefit pension plan - the Canada Pension Plan! Lots of pensions pay a small extra benefit if you retire earlier than age 65, called a bridge benefit, to tide you over until CPP starts. 

Answering the Four Important Questions 

Okay, that’s the definitions out of the way. The most important thing for you to know is the answer to four questions: 

  • When can you start getting your pension?

  • How much will you get?

  • Will the amount you get increase with the cost of living?

  • What happens to your pension if you leave?

All of this information should be reported to you in one of two places: your annual pension statement and your pension booklet. If you’re lucky, you might have an online portal where you can access this information easily. If you’re really, really lucky, you might even have a calculator that’s connected to your years of service, marital status, and earnings history and can spit out a hypothetical pension amount and bridge benefit depending on when you tell it you’re going to retire. 

One thing this calculator won’t estimate is the amount of money you’d receive if you leave your job and want cash instead of the lifetime pension (aka the “commuted value”). Actuaries always have to get involved in that kind of fun and special math. 

If you can’t find the information you need to answer those four questions, it’s time to call your pension administrator. Those of you with the shiny online portals should be able to find the “contact us” page without too much trouble. For everyone else, start in one of three places:

  • The contact information on your most recent pension statement

  • Your HR department, if you work for a company that has one

  • Your immediate supervisor, if you work for a company that doesn’t

It’s best if you ask for the answers to your questions in writing. Your pension administrator is absolutely required to answer your questions, and is probably starving for contact from the outside world, so do them a favour and give them an easy job. 

You’ll be doing them and yourself a favour - they’re getting to talk to someone who’s not an actuary and you’re getting critical information about your future income that you can use to plan your escape from labour.

RESOURCES

For pension plans regulated by: 

Contacting your pension plan administrator for information

General Information: How defined benefit pension plans work | GetSmarterAboutMoney.ca

Ontario only: Pension Benefits Guarantee Fund

Ready Set MoneySandi MartinComment