Understanding your pension

If you lost your job tomorrow, do you know what to expect from your company pension plan? What if you were forced to retire? How would your pension money fit into the scheme of things?If you’re like most people, your company pension plan is probably the part of your retirement strategy you least understand.

People who neglect their pension plans tend to short-change themselves. Some even wind up in downright frightening situations later in life. Take the case of New Brunswick resident Ray Comeau. By the time he retired from his job in 1996, after prolonged leave for illness and stress, he was in no shape to pay proper attention to his financial affairs.

A bad investment decision saw his various severance payments locked into a term deposit within his RRSP. Mounting health costs – coupled with a giant tax bill for the year he retired-left Comeau with a crippling debt. He found he couldn’t even use his RRSP as collateral for a loan because of Finance Canada’s rule forbidding this practice. 

Bitter disputes
Comeau is far from alone. Recently, pensions have been at the heart of some bitter disputes between unhappy retirees acrs Canada and their former employers. The discontented include lawsuits brought by former or retired employees of these prominent companies:

  • Royal Trust, part of the Royal Bank group 
  • National Trust, taken over by Scotiabank
  • Air Canada employees

The arguments vary. But at the heart of each dispute is the contention by retired employees that the pensions being paid to retirees are inadequate or unfair.

A group of retired women professors from the University of Toronto is suing over claims that pay equity changes were introduced too late to give them proper pensions. Others claim that pensioners are living in poverty while their former employers get the benefit of surplus pension fund assets.

Billions invested
These problems represent the tip of the iceberg when it comes to pension rights. In 1998, 5.1 million people belonged to private pension plans-almost all of which are employer-sponsored-compared with 6.1 million who contributed to an RRSP.

Statistics Canada also reports assets in these plans increased 22 per cent to an estimated $644 billion dollars between 1996 and 1998. This reflects faster growth than any other major retirement income program, including RRSPs and the Canada/Quebec Pension Plans.

Common questions
Despite this huge stake, many Canadians have limited knowledge of their pensions. Improving understanding now is the best way to get the most from our plans and avoid any nasty surprises down the line.

Here are answers to some common questions about pension plans:

Are there different types of pension plans?
If you belong to a company pension plan, it’s likely one of two types:

1) Defined benefit plan:
Your contributions and benefits are determined by a formula that’s laid out in the pension document. This formula usually takes into account years of service and earnings. Your employer is responsible for ensuring that the plan will pay the promised benefit.

2) Defined contribution plan:
This is also known as a money purchase plan. It specifies the rates of contributions you and your employer must make, but doesn’t set a pre-determined rate of benefits.

If you’re in one of these plans, you may be responsible for making some of the investment decisions. Your retirement income will depend on how your investments perform.

“The defined benefit pension plan has always been considered the Cadillac of pension plans,” says financial expert Sandra Foster. Once the most common type of retirement plan for working Canadians, the number of defined benefit plans has declined in recent years. Defined contribution arrangements now account for approximately 80 per cent of all employer-sponsored retirement plans in Canada.

According to a study by William M. Mercer Ltd., this growing popularity is based on the relative ease with which defined contribution plans can be set up and administered as well as reflecting changes in the work environment.

Nowadays, employees change jobs more frequently than in the past. Since years of service figure prominently in calculating the benefit in defined benefit plans, these types of plans are less attractive to these workers.
How does belonging to my company’s pension plan differ from contributing to an RRSP?
As far as the government is concerned, these plans have a shared driving principle: encouraging people to save for retirement through tax incentives. In the long run, this should reduce reliance on government programs later. Like contributions to your RRSP, pension contributions are deductible from taxable income.

Pension contributions affect your RRSP room. The approximate value of your pension-plan accrual each year, known as a pension adjustment (PA), determines the exact reduction to your RRSP contribution room.

The PA is designed to give all working Canadians the same opportunities to save for retirement-with or without the benefit of a company pension plan.

Who is responsible for the investments in my pension fund?
In a defined benefit plan, your employer or the plan administrator appoints professional investment managers. Your employer also assumes the risk for the pension fund’s investment performance, since the benefits defined in the pension contract must be paid regardless of how investments perform. 

Defined contribution plans assign investment risk to the plan members. The level of your benefits is related to how your investments perform and, although your employer may be responsible for administering the assets, you have a say in how these assets are invested. In most cases, your options are limited to a choice of selected mutual funds or other investments. 

Since benefits are tied directly to performance, there are no shortfalls with defined contribution plans. 

With a defined benefit plan, a pension surplus can arise when financial markets are performing well. Such surpluses are at the heart of many of the prominent legal battles currently being waged between pensioners and their former employers. In a defined contribution plan, there is no surplus.

What happens to my pension assets when I leave my employer?
Your accrued pension benefits may remain in the plan or be transferred to a locked-in RRSP. Staying in the plan offers the advantage of professional investment management. Your pension assets will continue to be managed on your behalf and you’re guaranteed a lifetime income down the road.

On the other hand, a locked-in RRSP gives you the flexibility to manage your own investments. In some cases, pension plans allow for early retirement (usually at age 55) with pension benefits payable from this time.

Why is my access to my pension assets restricted?
Accrued pension benefits can be converted to a locked-in RRSP, and later, a life income fund (LIF) or locked-in retirement income fund (LRIF). Your options depend on the plan’s jurisdiction, which may be federal or provincial. 

These rules ensure that your pension plan serves its intended purpose, that is, to provide a stream of income over your retirement lifetime.

Recently, some provinces have allowed individuals to greater access to locked-in pension assets. For example, in Ontario, legislation passed in early 2000 allows people experiencing financial hardship or with shortened life expectancy to withdraw previously locked-in assets.

How do I know which rules apply to my pension plan?
All pension plans must comply with the registration requirements of the federal Income Tax Act, and most also fall under provincial jurisdiction according to where they are registered.

However, all provinces except Prince Edward Island, are part of a multilateral reciprocal agreement and the province in which you report to work determines the rules for the pension benefits you earn there.

Exceptions are plans in industries regulated by the federal government – such as banks, airlines and broadcasting. These fall under federal jurisdiction no matter where you work.

So, for example, if you work in Nova Scotia, the Nova Scotia Pension Benefits Act would apply to your pension benefits – even if your plan were registered in another province.

How can I learn more about my pension plan?
The plan administrator is required to make sure that plan members are informed about the plan. If you want to understand your pension plan better, get your hands on anything and everything the company or the administrator is willing to give you, advises Purcell.

A current pension benefit statement, issued to members annually, and a copy of the employee handbook outlining your pension plan and explaining pension terms are good first steps.

It’s crucial to learn all you can about your pension plan. The more you know, the more likely you are to make the right decisions.