15 Must-Know Terms To Boost Your Financial Literacy

What are the two main types of employee pension plans in Canada?

Simply put, if your employer offers a pension plan to help you save for your retirement, it’s likely one of two main types of pension plans:

• A defined benefit pension plan, or
• A defined contribution pension plan.

What is a defined benefit pension plan?

A defined benefit pension plan provides retirement income based on a formula that may include your:

• years of service with your employer,
• salary, and
• age at retirement.

How does a defined benefit pension plan work?

Defined benefit pension plans pool the contributions from both you and your employer in a pension fund. Then, your employer invests the pension fund.

Your employer is responsible for paying your retirement income from the pension fund, based on the plan’s formula.

You’ll receive income each month or year, for the rest of your life. Some defined pension plans are indexed to inflation. That means your income can increase, if the cost of living rises.

What is a defined contribution pension plan?

Defined contribution pension plans provide retirement income, based on the savings you have in the plan. The amount of retirement income you get depends on:

• how much you contribute to the plan,
• how much your employer contributes, and
• how that money grows over time.

How does a defined contribution pension plan work?

There’s no set income level that will be paid. With a defined contribution pension plan, you and your employer pay a defined amount into the plan each year. Companies have mandatory employer contributions, and most have an optional employee component. In most cases, you control how you invest your money. You can usually select investments based on your own risk tolerance and goals. The investment performance determines what your retirement income will be.

What are the benefits of workplace pension plans?

There are many benefits to contributing to your company pension plan:

First, it’s like getting free money. There’s a requirement for employers to contribute to pension plans when they set them up. And, some employers have a matching program. Choosing not to join, or contribute to, your workplace pension plan is like saying no to free money. Remember that in most cases, the money in the pension plan is locked-in for retirement income only.

Second, your contributions are tax-deductible. This means you pay less income tax now. And, contribution and investment earnings are tax-deferred until you withdraw them.

Third, an employee pension plan is a great way to supplement other forms of retirement savings like:

• Canada Pension Plan or Quebec Pension Plan,
• Old Age Security, and
• personal RRSPs and other investments.

Understanding what your pension plan offers can help you make the most of your retirement savings options.

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