Pension Plans Part 1: What are they and how do they work?

Many staff pharmacists and hospital pharmacists work for employers who offer a group pension plan.

A lot of you may know what a pension plan is but many still scratch your heads wondering how they actually work, what the benefits are, or what the difference is between a defined benefit or defined contribution plan.

This is part 1 of a 5 part series about pension plans to help answer these questions.

Introduction to Pension Plans

• The goal of a pension plan is to provide you income at retirement
• You can participate only if you receive a salary, i.e. you get a T4 tax slip every year
• Your employer is called the plan sponsor and you, the employee, called a member
• There are two main types: defined benefit (DB) plan and defined contribution (DC) plan

How Pension Plans Operate

• Employee contributions are tax deductions claimed in your personal tax return
• Employer contributions are tax deductions claimed in your company’s tax return
• The amount you can contribute depends on how much you make, age, and years of service at the company (more about this in Pension Plans Part 2)
• Contributions are invested using an investment company chosen by your employer, e.g. Manulife mutual funds, at a cost that is typically lower compared to a traditional financial advisor
• Contributions grow tax-sheltered over time (like an RRSP)
• Administration and safekeeping of assets is usually managed by an outside trust company
• You cannot access the funds until retirement at age 65

When Do My Payments Start?

Payments do not start until retirement at age 65 (only under very stringent financial hardship rules you able to access your pension sooner than that). Usually about 12 months before retirement, you will receive a package outlining your options:

• How much your payments will be
• Selecting frequency of your payments: monthly, annual, etc.
• How much tax to deduct from each payment
• If you would like to include options such as a survivor benefit, inflation protection, disability benefits

Yes, the amount you receive from a pension is taxable and is reported on a T4A tax slip. Hate that you have to pay tax on this? Don’t be, because:

• You benefit from employer contributions (money you would not have otherwise have received)
• In most cases, you benefit from a lower tax bracket in retirement (you pay less tax on this income in retirement versus if you had received it during your working days – this is called tax deferral)

What Happens if I leave my employer?

If you are considered “vested” – a term used if you have been in the pension plan for a certain period of time, typically 2 years – then you are able to receive benefits. If you are not considered to be “vested” then you are entitled to a refund of your own contributions but not your employer contributions.

If you are “vested” and leave your employer, there are a number of options:

• Leave the assets in the pension plan; the plan sponsor will notify you how much retirement income to expect at age 65
• Transfer to another pension plan, if you’re joining one at your new employment
• Transfer some or all assets to an RRSP
• Transfer a lump-sum (called commuted value) into a locked-in retirement account, where you control the investments but cannot access until age 65

The plan sponsor will let you know what options you have if you leave your employer. If you are in this situation and unsure what option is best for you, talk to your accountant or financial advisor who can give you proper advice.

Conclusion:

Pension plans are a great way to save for retirement. If your employer offers a pension plan, don’t think twice about joining. Not only will you benefit from employer contributions, pension plans are a great way to pay less tax because you can defer tax to retirement when your tax bracket is likely to be lower than during your working years.

If you have questions about your pension plan or are considering to join one with your employer, do not hesitate to ask us for advice. We offer a free consultation at your office or one of ours. Our aim is to educate Pharmacists in all aspects of wealth management.

In part 2 of this series, we explain the difference between the two main types of pension plans: defined benefit vs defined contribution.