by Andre Domise

I understand that sussing out the differences between workplace-sponsored retirement plans can feel like a pain.  I’ve been in the financial industry for the better part of 10 years, and even I get my definitions crossed at times. However, the effort is worthwhile, as some of these plans can be used to build a hefty nest-egg and even help you buy a home or retire early.

The Defined Contribution Pension Plan (DCPP) is the most common plan for private-sector, non-union employers. It’s called “defined contribution,” because the amount of money you’ll deposit into the plan is known ahead of time. Contained somewhere in the acres of paperwork and informational material, you should be able to find out the contribution and matching formula that determines how much you’ll pitch in, and how much your employer will match.  If this is difficult to locate or understand, just call your benefits provider and have a customer service representative explain it to you. They’re often very helpful – they want your business, after all.

In these plans, there is usually a base contribution you’re expected to make (ie. 2% of your gross salary), and your employer will likely match that amount dollar-for-dollar. Then, you might be able to kick in an optional amount that will also be matched (ie. up to 3% more of your gross salary, matched at 50% by the employer). Using the formula for a company I deal with fairly regularly, here is an example of how DCPP contributions work:

Employee gross salary: $75,000
Employer base contribution: 4% of gross salary
Employee base contribution: 2% of gross salary
Employee optional contribution: Up to 10%
Employer matched contribution: 100% of optional employee contributions
matched, up to 3%

Given that an amount equal to 6% of this employee’s salary is already being deposited into the DCPP (4% from the employer, 2% from the employee), she’s off to a good start. That’s $4,500 in the bank each year (or approximately $173 per paycheque – about $58 from the employee and $115 from the employer). If she decides to bump up her contributions by another 3% (because it’s matched by the employer), that’s an additional 6%, or $9000 per year and only $144 per paycheque coming from the employee.

Let’s say our employee is 40 years old, and plans on retiring at 65. Let’s also assume she made some smart investment choices, and averaged 6% growth per year. Her pension account would be worth over $520,000 by the time she’s ready to retire. Not bad!

When you’re ready to retire or leave your company, DCPP assets are usually moved into an account called a Locked-In Retirement Account, or LIRA (some provinces use a Locked-In RRSP or LRRSP, but they’re not much different). At this point, no more money can be added to the plan, and nothing can be withdrawn. You can choose the investments in the plan, but it’s otherwise off-limits. When you’re ready to collect an income from these locked-in accounts, they’re usually converted into a Life Income Fund, or LIF (Locked-In RRSPs are converted to Locked-In Retirement Income Funds, or LRIFs.  Again, not much different). The only downside for these pension plans is that pension varies by province.  For example, each province has a different retirement age (e.g. age 50 in Alberta, age 55 in Ontario), and different rules as to what can be done with this money at retirement. For
example, in Ontario, when you convert your LIRA into a LIF, 50% of those assets can be moved into a registered, non-locked-in account (ie. RRSP, RRIF) to be used as you wish, while in British Columbia, all of the DCPP assets stay locked-in (even if you are experiencing financial hardship).

That said, the downside of locking-in provisions is far exceeded by the upside of the tax deduction you receive for making the contributions, as well as the fact that employer money helping you grow your nest egg is free money. And by the way, only yourcontributions can be deducted; your employer’s contributions didn’t come out of your pocket, hence no deduction.

Next time around, we’ll look at Deferred Profit Sharing Plans.

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