Personal Finance

Employer switching from defined benefits to defined contribution pension plan. Advice appreciated!

  • Last Updated:
  • Jul 14th, 2019 4:44 pm
[OP]
Newbie
User avatar
Jul 9, 2010
84 posts
1 upvote

Employer switching from defined benefits to defined contribution pension plan. Advice appreciated!

Hi Everyone,

I’ve got a pension related question for you all today.

My dad is attending a pension info session with his employer, and I want him to get the most out of his session, so I’d like to prepare questions in advance.

What I’d like to know from you personal finance experts;

1. Advice on the following pension questions
2. Validation on my pension research

Context
My dad’s employer is ending their current Defined Benefit pension plan, and switching all employees to a Defined Contribution Plan by January 1st, 2020.
My dad is 57 so he's around 8 years out from retirement which will be in 2027. He's worked with the company for around 11 years, since 2008 on a Defined Benefit plan.

Questions
1.) One of the provisions in the pension document he received mentions that the employer will match contributions $1 for $1 up to 4% eligible pay.

But it also says he has the option to contribute up to 8% maximum.
Is it common to contribute more, as in 8% as opposed to 4%, when the employer is matching only up to 4%? What are the pros and cons of both?

2.) Are there any other questions you think I should tell my dad to ask his employer?

Pension Research and related pension questions
  • After January 1, 2020, my dad will have 2 pension plans;
  • One frozen Defined Benefits plan from when he started work till now (2008 – 2019)
  • One current Defined Contribution plan starting from 2020 – 20xx
  • Is a Defined Contribution plan basically like an RRSP?
  • If you already contribute to an RRSP, how does impact contributions to a defined contribution pension plans?
  • Tax free savings account is an investment option under the defined contribution pension plan, but if my dad has already maxed contributions to a personal Tax free savings account, how does that impact the contributions to the defined contribution pension plan?
  • Defined Contribution plans specify the amount the employer contributes to the plan vs. the amount they’ll pay out once the employee retires
  • Defined Benefit plans specify the amount the employee will receive from the employer
Thanks in advance for all your help everyone!
18 replies
Jr. Member
May 24, 2018
111 posts
57 upvotes
Ontario
Dostk wrote:
Jul 7th, 2019 12:37 pm
[*]Tax free savings account is an investment option under the defined contribution pension plan, but if my dad has already maxed contributions to a personal Tax free savings account, how does that impact the contributions to the defined contribution pension plan?
I have trouble understanding this ... do you mean there will be a TFSA (locked-in?) embedded within the DC pension plan ?
Last edited by hwyc2007 on Jul 7th, 2019 2:57 pm, edited 2 times in total.
Deal Addict
Dec 20, 2018
1637 posts
1240 upvotes
Doesn't seem like it's a choice so not sure what questions there are to ask when there's no choice

As for matching 4% and employee able to go upto 8%, that's normal for the crappier DC plans. My employer is lumpsum 15% pension contribution and matching is entirely upto employe

Your dad at min should contribute 4% to get the company match and anymore is upto him and his finances
Deal Addict
Mar 3, 2018
1003 posts
766 upvotes
GTA
Sorry to hear about the loss of the defined pension plan. All to common these days as corporations seek to increase profits. This will reduce his guaranteed retirement income.

A TFSA and a defined contribution plan (essentially an RRSP) are two different tax plans. They are never mixed. Could be the employer’s mutual fund firm pushing for additional TFSA contributions as they earn fees. Your Dad should just contribute what the employer is willing to match 4%. After that top up his own TFSA and RRSP.
Deal Expert
Aug 2, 2001
15932 posts
6120 upvotes
Dostk wrote:
Jul 7th, 2019 12:37 pm
Questions
1.) One of the provisions in the pension document he received mentions that the employer will match contributions $1 for $1 up to 4% eligible pay.

But it also says he has the option to contribute up to 8% maximum.
Is it common to contribute more, as in 8% as opposed to 4%, when the employer is matching only up to 4%? What are the pros and cons of both?
One of the reasons you would contribute more than is matched is because you want to take advantage of their DC plans being offered. I say this knowing that, for some, the DC plans offered by the employer, they are not a high performing option. But that would be one of the selling features of allowing an employee to contribute more to the plan - simplified investments (in a single plan) and the ability to access the DC plans that are "good".

From a more human perspective, one reason people might want to contribute more is because they are poor savers. You'll notice that when something is taken off your paycheck immediately you do not notice it "missing". It never touched your hands, and you might not even realize how much you contribute - the same as you do not realize how much tax you pay.


What I assume they will cover is what the parameters of the DC plan are. Who supplies the funds, what to choose from, etc. This is important to understand, but truthfully, the only thing this will impact is whether you contribute more than 4%. I think it would be rare that turning down their 4% match is a good idea, so I assume your father will take advantage of that at a minimum.
Deal Addict
User avatar
Feb 1, 2012
1022 posts
1125 upvotes
Thunder Bay, ON
Here is a link to a roadmap for options available for retirement accounts including DCPP:
http://www.avrexmoney.com/retirement/lo ... -road-map/

Re contributing extra above 4%: Does your dad need to contribute more to meet his retirement needs? That's not an easy question to answer without a financial plan. If he does need to save more, is contributing extra to the DCPP a good choice? If he does not want to manage his own savings, then extra contributions to the DCPP may be a good idea. And if he is currently saving in high-cost mutual funds, the DCPP may have better low-cost fund options. Look at the funds available in the plan and what the MERs are compared to what he is investing in now.

DCPP contributions eat up RRSP contribution room on a dollar-for dollar basis. Both are tax-deferred saving plans. (DB pension contributions by both employee and employer also eat up RRSP room in the form of a Pension Adjustment but it's a more complicated formula than for DCPP.)

Re the TFSA option. It is probably just TFSA contributions via payroll deduction. If he does not want to manage his own TFSA, and payroll deductions work well for him, and the saving options are good and low cost then consider it. I doubt if the TFSA option is at all related to the DCPP except for offering the same funds.

DCPPs will be something like a RRSP, except there are more restrictions on how much and when the funds can be withdrawn. With an RRSP, the funds can be withdrawn at any time. Then no later than the end of the year he turns 71 it must be converted to a RRIF which has minimum mandatory annual withdrawals. If he leaves the company or retires, the DCPP must be converted to a locked-in retirement account, then to withdraw money it must be converted into a Life Income Fund (LIF), and no later than the end of the year he turns 71. Where a RRIF has minimum annual withdrawal, a LIF has both minimum and maximum annual withdrawal because it is designed to last a lifetime.

Other questions to ask are what are the fund choices and MERs in the DCPP? How often can he change his fund choices and contribution level (i.e. the amount over 4%)?
Invest your time actively and your money passively.
Jr. Member
May 2, 2019
109 posts
75 upvotes
Vancouver
Dostk wrote:
Jul 7th, 2019 12:37 pm
My dad’s employer is ending their current Defined Benefit pension plan, and switching all employees to a Defined Contribution Plan by January 1st, 2020.
Does your dad have a copy of his employment contract? My first question is if the employer are even allowed to end the current plan. Depending on the wording (which may be different from other employees), the parameters of the pension plan might be mentioned in the contract. It may be worthwhile to talk to an employment lawyer. I'd recommend not to sign anything without investigating this. Just in case it's a trick from the employers to "voluntarily" push people to the new pension plan. If there's really no choice, there should be nothing to sign.
Dostk wrote:
Jul 7th, 2019 12:37 pm
1.) One of the provisions in the pension document he received mentions that the employer will match contributions $1 for $1 up to 4% eligible pay.

But it also says he has the option to contribute up to 8% maximum.
Is it common to contribute more, as in 8% as opposed to 4%, when the employer is matching only up to 4%?
If a 4% contribution draws the maximum 4% employer's match, then contribute 4% and not more. Almost all of these plans are rip-offs in terms of huge management fees, nobody should put their money there other than to get a match. If there are more money to save, put the extra to RRSP or TFSA, not the employer's DC plan.
Dostk wrote:
Jul 7th, 2019 12:37 pm
2.) Are there any other questions you think I should tell my dad to ask his employer?
What are investment options for the plan? Can they provide prospectuses with details (assuming the investment options are similar to mutual funds)?
The main thing to watch are costs - MER(Management Expense Ratio of the funds), but they may be hiding extra fees (called Trading Expenses or whatever). Be prepared they try to mislead you about the full costs they are charging. E.g. the investment option may be called "Balanced fund" and MER is 1.5%, but this "Balanced Fund" may be a combination of few others: "Canadian Equity" etc. with every one having it's own 2.5% MER. The pension company may claim the MER of "Balanced Fund" is 1.5% (still not ideal), but reality can be a horrendous 4% (1.5%+2.5%) fee quietly taken from the investment every year. It's such a large-scale scam.
Dostk wrote:
Jul 7th, 2019 12:37 pm
[*]Is a Defined Contribution plan basically like an RRSP?
The main difference is that RRSP money is easy to access to. The holder can withdraw from RRSP at any time (taxable). Check the pension plan terms, but usually there is no way to get any money from it while working for that employer. After the employment is terminated for whatever reason, the pension plan becomes more like a "locked-in RRSP" - cannot add to it, and may not be able to withdraw all money at once - though for age 55+ it's easier and can withdraw at least 50% of the amount the same year.
Deal Addict
Dec 4, 2016
1348 posts
551 upvotes
My take on this:
1. Contribute 4%, and nothing more. Contribute to personal RRSP at a bank/credit union with left over RRSP room (10% of income in this case).

2. Each defined contribution is different, but if it's anything like the one I have with Manulife, the employee contribution can be withdrawn at any time, but the employer portion can't be withdrawn until your dad leaves that job. Take a look at the funds offered. If there's Index funds with MER below 0.5%, I say just leave it there. For what it's worth, I've never bothered to withdraw my RRSP contribution from Manulife. Their MER is 0.35% for S&P 500 index fund, while TD e-series has similar MER. I might eventually move my contribution to TD, so I can buy ETF with MER below 0.1%.
Deal Addict
Jan 21, 2018
1113 posts
976 upvotes
Vancouver
There are a couple of simple principles you can use to help cut through the complexity:

- Defined benefit plans essentially became non-viable when changing age demographics shifted the balance between young workers and old retirees. The few companies that still have them are getting out of them as fast as possible, before the plans and the companies end up bankrupted by the costs. The only ones likely to remain are government employee plans, where the taxpayers are paying the rising cost instead of the employees - and even those may not survive if the taxpayers get upset enough. Taking your father's case, you wouldn't seriously expect him to receive a full pension for 25 years after retirement based on 19 years of work with small yearly contributions to the pension. It's just not financially viable.

- The benefits to putting your money into an employer defined-contribution plan are simple:
1. If they employer makes a matching contribution up to a certain percentage, you are doubling your money. That's a no-brainer (although if it's a new arrangement, you have to ask how that compares to the old arrangement!)
2. There may be a tax benefit, for example it may be tax-protected beyond your own personal RRSP limits, and it may be more easily transferable to dependents in the event of your death.
3. Large pension funds have professional investment management, and they can usually negotiate a better deal on management fees than individuals. If you aren't an expert investor with lots of time to spend on it, you may be better off to let the pros do it for you.
4. And of course, some people are just not disciplined savers, and need a defined pension plan to force them to save for retirement.

So the question is, which of these benefits apply to your father?
Jr. Member
Oct 24, 2011
143 posts
102 upvotes
Markham
First, if the company decides the CLOSE the pension plan (which they have the right to*), your dad does not have a choice but to switch over the the DC plan (which is still good).
*a pension plan is just a benefit plan provided by the company to their employees, what they cannot do however is to REDUCE any benefit that is earned (for your dad's case, before this DC plan switch)

For DC plan, your dad should at least contribute the 4% to get the 100% match, since it's a DC plan, whatever your dad puts in + the company $ will count towards his RRSP contribution (adjusted by the Pension adjustment AKA PA). As to WHY you should do it, there are a few reasons:
1) some people thinks they will not need this money, and too lazy to open their own TFSA, therefore they just pool all the money together
2) the fees that are charged under company pension plans are generally CHEAPER than what you would pay if you go to a bank

Thirdly, i mentioned this multiple times, contrary to what other have said, AS LONG AS the company that holds the DB plan is still around, they will always have the obligation to fund the plan by law. When pension plans do conversions, sometimes they would offer you to CONVERT the DB pension into the DC plan as well. Whether or not you want to do it it's up to you. Whether the money is safe or not, the only question you have to ask yourself is "Is the company gonna be around in the next 40-50 years, if the answer is yes, there's no reason to worry about losing any portion of the money. Having said that, no one could've foresee sears going under 30 years ago...

Going back, the DC contribution this year will affect your room for next year, i don't think there's a concern there.

When the employee retires, DC plan will usually offer an "Annuity option", basically means they will go out and purchase an annuity for you. The market value at that time will dictates how much pension you can buy for your retirement, in other words, the employee is not subject to the market risks.
Sr. Member
User avatar
Dec 24, 2007
919 posts
852 upvotes
BC
Dostk wrote:
Jul 7th, 2019 12:37 pm
  • Is a Defined Contribution plan basically like an RRSP?
  • If you already contribute to an RRSP, how does impact contributions to a defined contribution pension plans?
  • Tax free savings account is an investment option under the defined contribution pension plan, but if my dad has already maxed contributions to a personal Tax free savings account, how does that impact the contributions to the defined contribution pension plan?
1. Basically, yes. The risk in both cases fall on you as the investor of the contributions. If the investments you choose do poorly, the amounts you can withdraw on retirement will be lower - the company does not guarantee any level of payout. Only difference is that with an RRSP you have total control over the investment, whereas with a DCP, it up to the terms of the DCP what you can invest in, what and when you can withdraw. Given a choice I'd rather have my money in an RRSP than a DCP, I don't trust companies to have my best interest in mind. The only benefit to contributing to a DCP is if they offer a match in which case that is "free money". Don't contribute more than they match.

I once asked a HR person why companies bother having a DCP if all the risk falls onto the employee, why not just give a raise of up to 4% so that they can invest in a whatever they like in an RRSP. Their response was that people like to hear that a company offers a "Pension Plan". Also a lot of people don't contribute to the pension plan so the company does not need to match and the company saves money. Not a great endorsement of DCP, it's really just "marketing".

Whatever you invest in take a look at the MER as they can easily eat up your returns and in the long run will cost you money. A MER of 2% doesn't sound like much but if the return on the investment is only 7%, that is 2/7 or 29% of your hard earned money just handed over to the fund company and over a long period of time that means you gave up at least 1/3 of your money in fees. Go for low cost options like index funds.

2. You have only one contribution limit based on the Earned income in the prior year and whether you choose to use it up as a contribution to a DCP or RRSP, it is up to you. Eg. If the contribution limit is $5,000, you can contribute $2,000 to a DCP and $3,000 to a RRSP or you can contribute $1,000 to a DCP and $4,000 to a RRSP.

3. Don't understand the TSFA option in a DCP as a TSFA and a DCP are 2 entirely different things. You don't get a tax deduction with a TSFA and it's already non-taxable similar to a DCP whereas a contribution to a DCP gets a tax deduction.
Deal Addict
Jan 21, 2018
1113 posts
976 upvotes
Vancouver
WetCoastGuy wrote:
Jul 8th, 2019 1:52 pm
I once asked a HR person why companies bother having a DCP if all the risk falls onto the employee, why not just give a raise of up to 4% so that they can invest in a whatever they like in an RRSP. Their response was that people like to hear that a company offers a "Pension Plan". Also a lot of people don't contribute to the pension plan so the company does not need to match and the company saves money. Not a great endorsement of DCP, it's really just "marketing".
That is one of the aspects of human psychology that employers need to take into account. You can tell employees that nothing is free - if they receive benefits, and if they receive a pension, they are paying for it out of their share of the company's revenues. Nobody is running a charity, and there is no other place for the money to come from. If they truly understood that, many of them would rather have the money directly so they could decide what to do with it. But most of them think that those benefits are a necessary perk to match what other companies do, and they would be losing out somehow not to have them. Most vaguely think that there is some kind of additional contribution coming from somewhere else, without knowing precisely where from.

There are some factors to take into account though, mostly to do with the government. There can be tax benefits to defined company-sponsored plans that are not available to individual taxpayers, thanks to disorganized government meddling in the tax structure and favoritism to insurance and financial sector companies over the years. Also as mentioned above, if you are a government employee then the taxpayers are bearing part of the cost of your government pension rather than you having to fund it.
Deal Addict
User avatar
Feb 1, 2012
1022 posts
1125 upvotes
Thunder Bay, ON
Sorkid49 wrote:
Jul 8th, 2019 1:13 pm
Thirdly, i mentioned this multiple times, contrary to what other have said, AS LONG AS the company that holds the DB plan is still around, they will always have the obligation to fund the plan by law. When pension plans do conversions, sometimes they would offer you to CONVERT the DB pension into the DC plan as well. Whether or not you want to do it it's up to you. Whether the money is safe or not, the only question you have to ask yourself is "Is the company gonna be around in the next 40-50 years, if the answer is yes, there's no reason to worry about losing any portion of the money. Having said that, no one could've foresee sears going under 30 years ago...
One small clarification. DB pension plan funds are held in trust by a third party trustee, separate from the company's assets, and protected from bankruptcy or any other liability of the company. Even if the company goes bankrupt or ceases to exist the pension funds will remain for the pensioners and managed by the trustee.

What may happen is the pension could become underfunded because of low investment returns, low interest rates, or increasing member lifespan. If that happens, the pensioners will receive reduced payments. But it is highly unlikely that the pension will be reduced to zero and completely unable to pay anything.
Invest your time actively and your money passively.
Deal Addict
Oct 4, 2009
2417 posts
1162 upvotes
Montreal
Ask whether employees are allowed to transfer out funds in the DCPP to a LIRA, whether there are costs to do so, at what frequency they can request transfers, whether there are penalties for transferring out(such as losing the employers contributions), etc.

That way if the products offered are too costly or poorly managed he can potentially transfer out and invest in low cost products that meet his investment objectives.
Jr. Member
Oct 24, 2011
143 posts
102 upvotes
Markham
Deepwater wrote:
Jul 8th, 2019 5:12 pm
One small clarification. DB pension plan funds are held in trust by a third party trustee, separate from the company's assets, and protected from bankruptcy or any other liability of the company. Even if the company goes bankrupt or ceases to exist the pension funds will remain for the pensioners and managed by the trustee.

What may happen is the pension could become underfunded because of low investment returns, low interest rates, or increasing member lifespan. If that happens, the pensioners will receive reduced payments. But it is highly unlikely that the pension will be reduced to zero and completely unable to pay anything.
I agree, and also in Ontario, there's the PBGF (Pension benefit guarantee fund), which covers a minimum amount of pension per member.

Top