Is my pension… a pension?
“I have a pension through my employer,” says Tim*, in a recent call. “But I don’t understand it.”
If you’re like Tim, you’re not alone. In Canada, we have many different potential sources for retirement income, with all kinds of different names. Pensions can be particularly confusing, because they all behave differently, depending on how they’re structured.
Canada’s government provides several different pensions for seniors, all of which come with different sets of rules. Here are (very short, simplistic, and limited) summaries of each:
Canada Pension Plan (CPP)
The CPP is the the pension plan you likely read the most about. It’s the one you contribute to directly, with deductions from your paycheque or your self-employed income. Its primary focus is on retirement income, but it also provides some disability and death benefits.
You contribute to the CPP throughout your working years. “Normal” retirement under this pension is age 65, but you have the option to take it as early as age 60, or delay it to age 70. Your monthly benefit will be based upon your contributions throughout your working years, with adjustments based on when you take it, if you reduced your contributions when you had children, and more. This pension is adjusted annually for inflation, using the Consumer Price Index (CPI). For more information on the CPP, click here.
Old Age Security (OAS)
The OAS is funded out of Canada’s general revenues – which means you do not pay into it directly. It provides a monthly benefit to people age 65 and over who have lived in Canada a minimum of 10 years. The benefit is based upon your previous year’s income. If your income exceeds the “minimum recovery threshold,” your OAS pension will be reduced (commonly referred to as a “clawback”). If your income hits the “maximum recovery threshold,” your OAS pension will be eliminated.
This pension is adjusted quarterly for inflation, using the CPI. There are no death or disability benefits associated with this pension. For more information on the OAS click here.
Guaranteed Income Supplement (GIS)
The GIS provides a monthly, non-taxable benefit to low-income recipients of OAS. Like the OAS, this pension is funded out of Canada’s general revenues. Income eligibility for this pension is very low. For more information on the GIS, click here.
The Allowance is a benefit for spouses/common-law partners of GIS recipients who are aged 60-64 (and therefore not eligible for OAS or GIS on their own). This pension is funded out of Canada’s general revenues, and income eligibility is very low. For more information on the Allowance, click here.
Employer pensions fall into two main camps: Defined Benefit Pensions and Defined Contribution Pensions. These are structured very differently.
Defined Benefit Pension Plan (DBPP)
A defined benefit pension plan is the type of pension that most people are familiar with as “a pension.” You and your employer contribute to it during your working years. Your employer manages the funds, and when you retire, you receive a payout based on a fixed formula. Typically, the formula is based on your years of service and a percentage of your average salary. It’s important to note that each employer pension has its own rules around this formula.
Once you are retired, that payout is usually guaranteed for the rest of your life. You may have several options for payout, which may include some protection for your spouse, and some protection if you pass away before a specified number of years.
Most government-employee pensions come with inflation protection, which increases your benefit based on the CPI, like public government pensions. Many non-government employee pensions do not come with inflation protection.
Many pensions also come with access to group benefits, including extended health and dental. Yes, you’ll likely have to pay the premium out of pocket, but it’s often less expensive than an individual plan and rarely has limitations on pre-existing conditions.
Defined Contribution Pension Plan (DCPP)
A defined contribution pension plan is the one where people get confused. It’s a pension, which makes you think of the Defined Benefit program above, but it acts much in the same way as an RRSP. You make contributions, you choose your investments, you hope that it does very well. How is this different than an RRSP?
A very good question. In many ways, they are the same. The major differences are really in the way they are administered by Canada Revenue Agency.
Your employer’s contributions to a Group RRSP are considered income, and added to your T4 slip under box 14. So if you earn $60,000 per year in salary and your employer contributes $2,400 on your behalf, your income will show as $62,400.
Your employer’s contributions to a Defined Contribution Pension Plan are treated the same way as contributions to a Defined Benefit Pension Plan. They are reported as a Pension Adjustment, on your T4 slip under box 52.
RRSP contribution room is calculated as 18% of last year’s income. So if you earned $58,000 last year, rather than the $60,000 you earned this year, your contribution room will be (58,000 X 18%) = $10,440.
DCPP contribution room is calculated as 18% of this year’s income. So in that same scenario, your calculation would be (60,000 X 18%) = $10,800.
Your DCPP must also abide by pension legislation, rather than RRSP rules. This means a few additional document filings by your employer. It also means that if you leave your employer and transfer your DCPP out, you can’t transfer it into a regular RRSP. You must transfer it into a Locked-In RRSP, which has rules and restrictions around contributions and withdrawals.
An RRSP is not a pension in that it is not governed by pension legislation. However, when it was created in 1957, the intention was to provide Canadians who did not have access to employer pensions with an opportunity to save for retirement.
Group RRSPs are those plans administered by your employer. Usually, your employer contributes an amount to it, or matches your contribution. There may be vesting rules (i.e. how long you must be with the employer in order to keep that contribution), and there may be some company-specific restrictions around withdrawals and contributions.
RRSPs are those plans you open at your local financial institution, which you contribute to directly out of pocket.
Locked-In RRSPs are those plans that used to be employer pensions, but were moved to another institution when the employee left the plan. They are “locked” in so that you cannot make further contributions to them, and they are governed by pension legislation. Note that the pension legislation that governs the plan (provincial, federal) depends on the source of the pension itself, rather than where you’re living at any given time.
Clear as mud? It’s not the most thorough summary but hopefully it’s enough to help you determine the difference between your various sources of retirement income, which should then help you plan for your prosperous retirement future.
*He wasn’t named Tim. He wasn’t even a he. We’re super good at keeping secrets.