Mention the words “pension planning” to most people and the typical response is one of underwhelmed excitement. Before your own eyes glaze over at the thought of reading the rest of this blog post, imagine yourself in the future, having completed a successful career and entering into retirement. Do you see yourself as financially secure or are you in financial peril?
One hopes that the vision you have for yourself is that of financial security. The means to achieve that security are dependent on the fiscal planning decisions you make now, or that are made for you by your employer through the enrolment of employees in a pension plan.
As we know from our compensation studies, defined pension plans come in two categories.
The first is the defined benefit plan. This program provides for “retirement income based on a proportion of the employee’s pay” upon retirement. This means that an employee would receive a set amount of income, once they retire, based on a calculation of earnings that the employer has invested on their behalf. The employer is responsible for managing the investment.
The second is the defined contribution plan. This approach provides for “retirement income based on the accrued value of employer and employee contributions to the plan.” This means that both the employee and the employer pay into the plan on a set percentage. The employee can decide how the funds are invested. The income upon retirement is subject to strict regulations, and the amount the employee receives is dependent on the overall value of the fund.
Which one is better? There are conflicting evaluations for both types of plans.
A critique of the defined benefit pension plan is provided here. As noted by the author, defined benefit plans seem to be increasing in risk, based on numerous and evolving factors. This type of plan appears to be on the decline as an effective tool for ensuring financial security in retirement.
The risks that come from defined contribution plans are explored here. This author identifies the risks that may be in place should the employee not know how to invest or access the funds accrued on their behalf once they do retire. Defined contribution plans continue to be implemented as a preferred option for both employers and employees though, compared to the defined benefit plan option.
In either case, it is important that employees know what their options are well before the thought of retirement becomes a reality and, with it, the need for realizing a financially sound future.
Discussion Questions:
- In your opinion, should Canadian companies continue to offer defined pension plans for retirement security to employees? Explain your rationale.
- If you had to choose between a defined contribution plan and a defined benefit plan for yourself, which one would you choose? Explain your rationale.
- What other types of retirement planning alternatives could an employer provide instead of defined benefit plans?