Defined Benefit Pension

V s

Defined Contr ibut ion Pension

By

Ryan Plante

July 2017

Planning for ones future retirement can be a daimting task when a person is entering the

workforce for the first time. What could a person of eighteen possible know about retirement or

really care for that matter. The more informed one can be retirement at the earliest possible time

can ensure a well-financed and happy retirement. Employers play a key role in planning for your

retirement by providing pension plans for their employees. Basically there are two types of

registered retirement plans: defined benefit pension plans and defined contribution benefit plans.

Companies use these plans to design their own pension plan programs in order to meet the needs

of their employees. A defined benefit pension plan guarantees a predetermined income at

retirement. This plan is based on a formula that takes into account years of service and amount of

earnings. The company manages the assets and the employee has no active involvement in the

management of the pension. In a defined contribution pension plan both the company and the

employee contribute a portion to the pension this could be based on a percentage of salary or a

specific dollar amount. The contributions are deposited into an account in the employee's name

which offers the employee the flexibility of managing the assets themselves. Whether you

pension plan is a defined benefit plan or defined contribution or a combination they are very

important to ensuring income for your retirement years. Knowing which plans are available to

you and what is best for you will determine how you can best contribute to your retirement

i n c o m e .

Now let's start to look at some of the advantages and the disadvantages to both types of pension

plans to further analyze what plan is the best option for which type of person. As well as how

you can make the most out of your money to ensure a stable and reliable income during your

retirement. First let's talk about Defined Benefit Plan, One of the greatest benefits of the defined

benefit plan is that you have the security of what to expect at retirement, your retirement income

is specified up front. The income that one will receive is predictable and easily calculated by the

salary and the number of years worked by the employee. This generated number is usually also

protected from inflation and many tax deductions such as GST. This allows a person to see how

much money they will be earning after they retire years before the day actually comes. This form

of income is highly resistant to change even due to changes in the market economy. All your

investment and savings are constantly monitored by an investment professional so that you can

be sure that the money that is being put away for your retirement is in good hands. The employer

assumes all of the investment risk, and ensures the investment generates enough money to pay its

retirees. Defined benefit plans are low risk investment options that ensure retirement funding and

require no management by the employee for it is all left up to a professional and the company's

assets at the time. Many of these plans may also come with added benefits like dental and vision

care or life insurance. These are more likely to be workplace specific they are preferred because

of the added value this can provide to one's overall well-being by knowing what to expect at

retirement. Now let us look to the disadvantages with a defined benefit plan. These plans have

no room for added risk taking and usually have a cap as to what you will be able to earn in your

retirement. Since you pension plan is being handled by another person you also have no say in

any potential investments made with that money. This means that you are at the mercy of the

company investors and have no chance to increase the amount you could earn for retirement.

Also with a defined benefit plan if one ends quitting that job before retirement it is very difficult

to get any red value out of your retirement savings for cashing it in results in income tax and a

early withdrawal fee putting a massive dent in your future retirement income. In conclusion once

you are in a defined benefit plan you are guaranteed a stable income after leaving the workforce

but it's like signing your retirement options away and being stuck with what you got. Looking at

a short example of what a defmed benefits plan might look like one could expect their employer

to pay them a certain percentage of their wage when they were in the workforce. Say a man

made $10 000 monthly and is employed has offer to pay 1.5% that amount for every year he

worked for the company. If he worked 20 years his employer would pay him 30% of his original

wage for the rest of his days.

Now let's examine the benefits and downfalls of a Defined Contribution plan. Defmed

contribution plans have the opportunity for more high risk investment options. Though with this

added risk factor comes the potential for greater reward in the end. With a defined contribution

plan the employee is responsible for putting away money from their own pay check into a

personal account that the employer will agree to match at an agreed upon percentage effectively

doubling your investment. This money is put away before income tax deductions essentially

lowering the amount of income you have to pay taxes on. This money is free to be invested into

anything the employee sees fit whether it is stocks, bonds, cash, property, commodities but is

usually recommended to just buy stocks and bonds that are well spread out to avoid major loss

during an economic downtum. This is where the risk comes in people with a defmed contribution

pension plans are more susceptible to market fluctuation and inflation and their retirement

income can become very hard to predict and might not be very reliable and may run out in the

long run. Based on the individual's own risk management retirement funds for people under a

defined contribution plan can be far above that of people under defined benefit plan but it is a

less dependable option for an assured stable and sustainable retirement income. Though the

greatest benefit is the investor is able to do what he or she pleases to do with their hard earned

money. Also unlike defmed benefit plans defined contribution plans are much easier to transfer

and continue to work on and grow when changing jobs or when you are laid off or fired. Here is

an example :̂

Let's take the case of an employee making $80,000 per year who Joins a defined contribution planat age 35 and retires at age 65. The terms of the plan are:

• the employee contributes 4% of salary matched by the company also contributing 4%• employee contributes an additional 3% of salary matched by the company contributing an

add i t i ona l 1 .5%

The contributions and benefits would be calculated as fol lows:

• total combined contribution is 12.5% of the employee's annual salary per year• $80,000 X 12.5% = $10,000 contributed per year ($5,600 employee, $4,400 employer)• The retirement income will depend on the actual rate of return achieved on the investment

over the 30 years in the plan and the life expectancy of the retiree.

Possible results (staled in today's dollars) are:

• $35,000/year to age 83, assuming an investment rate of return of 6%• $27,000/year to age 83, assuming an investment rate of return of 5%

Now you might ask which one of these two plans is better. Well it really comes down to the

circumstances that an individual exists within. For me I would prefer a defined contribution plan.

In today's global market in Alberta with the crash in crude oil prices a large part of our

provincial net income. This crash has caused hundreds of Albertans to lose their jobs for

companies had to cut expenses for the price on a barrel of oil dropped from an average of $95 in

2010 to $45.12 as of July 2017^ reducing Oil Corporation's profitability by almost half in the

province of Alberta alone. With the job insecurity right now for a lot of fellow Albertans 1

believe that a defined contribution plan is more beneficial for it provides more security in case of

layoffs and large market fluctuations. The idea of losing your job would be hard enough but also

losing up to 40% of your retirement fund to income tax and early withdrawal fees due to having

to cash in that money because you no longer are employed by that company could cause many

^ Engen, Robb."Defined Contribution Plan", Boom&Echo., http://boomerandecho.com/defined-contribution-plan/^ WTi Crude Oil Prices, /www.macrotrends.net/2516/wti-crude-oil-prices-10-vear-dailv-chart

additional years of work. Also with our market being in a rough patch and according to the ideas

of the boom bust economic cycle Alberta may be due for an economic rebound in the next

couple of years which could bring potential profit in stocks and smaller business and property

investments which the defined contribution plan would allow you to invest in. Even small

investments in the right fields could easily provide a stable base for future retirement income. On

a different note with being a younger individual with only a general idea with what I really what

to do for a career I feel like switching from job to job might be something that I do for a couple

of years until I find my calling with the business I really want to be a part of. Having a defined

contribution pension plan would give me more freedom to change careers and to explore my

options a little bit better. Defined benefit plans I see also to be limiting in the fact that what if

one puts in far more work than another individual they shouldn't be entitled to the same amount

of income at the end. An example of this being seen in Alberta's workplace is that company

GMC has switched from offering a hybrid of both the DB plan and the DC plan to a strictly DC

type of pension plans due to the hostility of the market in the recent years. This switch shows

that people in the work place who are living and breathing this issue today of which plan is better

are already showing that DC plans are better investments when it comes to thinking long term

about one's retirement plans. More and more we are seeing things like automation in factories

starting to dwindle away at more and more jobs that people would have previously been doing.

DC pension plans offer more security of an individual's retirement fund for it accounts for job

loss being a possibility and allows for the easy and cost effective transfer of funds so that one's

net loss is greatly reduced. If someone is willing to do the extra research to and work to make

more than they should be rewarded as so in their pension plan. This idea of encouraging people

to take risks is what should be reinforced more in society for it creates diversity and ingenuity

and that is exactly what we need going the next century as we need solutions to ever more

complicated problems like global warming and overpopulation and food shortages.

After examining both Defined Benefit plans and Defined Contributions plans I stand to believe

that DC plan provide better opportunities to make your life the way that you want and you're not

relying on someone else to create the retirement of your dreams. DC provide more flexibility and

adaptability in today's ever evolving world. Only 40 years ago cellphones, TV and Computers

seemed liked the things you would only see in a sci-fi film but today they are a part of our

everyday life and are so vital to communication and collaboration in the 21st century. We as

people need a retirement plan that will be able to evolve and change with the world around us

and currently that would be the Defined Contribution pension plan.

Bibliography

Simlife Financial website.(Archives).'Defined Benefit vs Defined Contribution' Retrieved fromthe website:.https://www.siinlile.ca/Canada/ataglance/Archives/Investments+-+ lnves t ing+ In fo rmat ion /Defined+Benefi t+vs+Defined+Cont r ibu t ion?vgnLoca le=en CA

Engen, Robb."Defined Contribution Plan", Boom&Echo., Retrieved from the website:ht tp: / /boomerandccho.com/defined-contr ibut ion-plan^

WTI Crude Oil Prices, Retrieved from the website: /www.macrotrends.net/2516/wti-crude-oil-pr ices-10-vear-dai lv-chart

Engen, Robb, "Gold Plated Pensions - A Blessing Or A Curse?",Eowng and Thrifty^ Retrievedfrom the website:httDs://voungandthriftv.ca^gold-plated-pcnsions-a-blessing-or-a-curse/

from the website: http://v\contr ibut ion-pension.htm