I’ll admit I didn’t know much about my defined benefit pension plan until recently (yes, after over 10 years of contributing to my pension) because I decided to look closely at my annual Member’s Benefit Statement. I just knew that they were deducting money off each of my paycheque each time I got paid.
What’s So Great About a Defined Benefit Pension Plan Anyway?
The great thing about a defined benefit pension plan is that the amount you will receive when you retire is based on a formula (a secret formula) that uses the number of years of service, your highest average salary (often over five years), and your age at retirement.
And that amount that is paid monthly is guaranteed regardless of market conditions and investment returns of the Pension Plan.
The other great thing about it is that you don’t have to worry about investing by yourself because the Pension Plan does it for you. Most people end up trading too much or selling when the going gets tough, so very rarely beat the market.
In Boomer and Echo’s guest post on the Y&T blog Are Defined Benefit Plans a Blessing or a Curse he argues that the deduction from his salary towards his defined benefit pension leaves less room for an independent investment. The other factor is that it acts as an incentive for employees attached to defined benefit plans to never leave their job or switch jobs and that might induce brain-death for the average millennial or generation Y (you know, since we are notorious for switching jobs every 16 months or so).
The other downside (or upside?) is that the earliest you can reach retirement age to receive a pension is age 55, but is age 50 for those who are police officers or firefighters.
Other Factors to Think About
Many financial experts warn people who contribute to a defined benefit pension plan not to contribute to an RRSP, because if you contribute to an RRSP although you will be getting a tax deduction now, you will be paying the taxes later when you retire. However, if you plan to retire before your pension kicks in, your RRSP will still be a good option because you will have low income at that time, before the pension or other Canadian retirement benefits kick in.
Now of course if you can’t reach the magic number because you do not anticipate working for so long, then of course you wouldn’t have as much paid out on a monthly basis to you compared to if you worked for 35 years. In addition, the pension amount you receive in retirement changes if you work part-time for a number of years. However, it is still better than nothing! In your pension statement you will see how much you will be paid after a certain age if you were to stop working that year.
Finally not to be a Debbie Downer, but what if your life expectancy does not allow you to enjoy the fruits of your 35 year labour? However, I suppose that’s the case for anyone thinking about retirement, but I think it is the concept of not wanting to rock the boat and leave your cushy Defined Benefit Pension job because you want that gold plated pension.
If you take days off without getting paid for them (e.g maternity or paternity leaves), make sure you pay back your pension (you can also pay back your pension for the first six months that most people are in a probationary period, but you must do so within I believe five years of the time you had off. I wish I did this for when I started, but didn’t end up doing this (and it has been more than five years) so that ship has sailed.
What I Look Forward To
I don’t think I can last another 25 years in the work force (not because I don’t like my job, but because it would be nice to retire and have financial independence aka “Findependence” and the freedom to do what I please because I will have the time to) but do look forward to the day when I receive a guaranteed amount every month.
This quest for financial independence is the chief reason that I opened my discount brokerage account (see my Questrade review for more details) and that I’m constantly talking to people about TFSA and RRSP options within Canada. Even if you don’t want to be bothered buying and selling individual stocks, bonds, and/or ETFs, there are still some excellent investment routes available that are super low maintenance! Robo advisors such as Betterment and Wealthfront have transformed the USA wealth management space over the last few years and have proven that there is a huge appetite for online solutions that minimize the amount of work investors need to do, yet still cut fees substantially from traditional mutual fund options. Our Wealthsimple review has quickly become one of our most looked-at articles after launching in Canada only two years ago. While I personally still prefer to go with my discount broker at Questrade, I’ve been recommending this robo advisor route to more and more of my friends who don’t necessarily share my nerdy love of all things personal finance. It’s simply a great way to build your eventual retirement nest egg without having to check in on things throughout the year. The easier and simpler we can make investing, the more likely we are to stick with it.
I don’t think I will ever take money out of my pension if I do finish my job or go part-time or switch to another job.
Readers, what do you think of the defined benefit pension plan?