How Do Pensions Work: A Senior’s Guide to Money Management

Carrying a pension, it’s not always clear how they work or what to expect from them. Pension plans are a major financial advantage for those who have them, coming in different configurations. The key commonality between all types of pension plans is they play a huge role in retirement savings.

For those of you who want to learn about how do pensions work, here’s a little bit more information into how pension plans work exactly:

1. Defined benefit plans

How pensions work may depend on which program you are enrolled in. There are two basic kinds of employee pension plans, the most popular being ‘defined benefit plans’. Someone with a defined benefit pension factors in years of service and salary earned. Members can contribute to the plan when they are employee. All contributions are pooled and invested, and then the sponsor – in this case, the employer – is responsible for ensuring this plan can pay its members’ retirement income.

2. Defined contribution plans

Defined contribution plans do not carry the investment risk that defined benefit plans do. Each member has their own separate pension account under a ‘defined contribution’. This allows you to make your own moves in terms of how you invest any and all contributions. Then, retirement income is determined based off how your investments have performed. Registered retirement savings plan, employee share purchase plans, deferred profit-sharing plans, and group tax-free savings accounts are all examples of this type of pension plan.

3. The role of the employer

Pension plans have a sponsor which oversees the distribution of income as its’ withdrawn. Employers typically rely on service providers, investment fund managers, life insurance companies, trust companies, and consultants to help them manage the investment. The role the employer plays is significant. Although there are a range of managers helping to oversee the fund, the employer will be your point-of-contact.

4. If you’ve left an employer in the past…

Let’s say, you’ve left an employer you’ve worked for after a significant portion of time. Does this affect pension plan income? Most pension plans are automatically vested, which means you’re entitled to the benefits of your own contributions as well as those of the employer under the plan. You haven’t lost the employer’s contributions by leaving the company. In some provinces, you may have had to work for the employer for a specified length of time prior to having your investment automatically vested.

5. Canada Pension Plan (CPP)

When you worked, you also contributed to CPP. This is a pension designed to pay 25% of your earnings, in retirement. The normal start date for CPP is 65 years of age although you can start it as early as age 60 at a reduced income rate of 7.2 percent for each year you are from 65. Alternatively, if you delay your CPP income to age 70, this increases your pension plan by 8.4 percent per year over age 65. You are allowed to request a statement from CPP once a year, which can assist in your retirement planning and in budgeting expenses.

6. Old Age Security (OAS)

Old Age Security is a pension plan designed to provide minimum income to Canadians 65 and older. OAS does not depend on employment history and you don’t need to be retired to collect it. The amount you receive is tied to the length of time you’ve lived in Canada. If your current income exceeds a certain amount, OAS can be clawed back. To receive an OAS pension, you must apply at least six months prior to when you want to receive it. OAS benefits are indexed to inflation and paid monthly.

7. Taxes on Canadian pensions

Most pension plans are taxable which is key to remembering, taxed at your marginal rate. Some Canadians may be able to claim a $2,000 pension deduction which can assist with your tax bill. Pension income can also be split with a spouse or common-law partner if you so elect on your income tax return. Normally, when you fill out a TD1 form which is necessary to begin receiving pension income from an employer, this form will indicate how much tax to deduct.

8. What happens to my pension when I die?

A surviving spouse age 65 or older and who is not otherwise receiving CPP benefits is entitled to 60 percent of the CPP retirement pension of their deceased partner if said partner has already been receiving benefits at age 65. Unfortunately, this also subjects the surviving partner to a maximum which is $1,114/monthly. If both partners were receiving maximum CPP retirement pension, no survivor benefits are paid out.

10. The average Canadian on CPP

It can be a struggle for some trying to make things work with only pension income to pull from. Currently, the maximum annual payout on CPP alone is $13,370 per year although the average Canadian only receives $8,221/year. That’s a significant difference and highlights some of the struggle that befalls our senior population. Combined with OAS benefits and for those fortunate enough to have an employer pension plan of some kind to rely on, paying for housing, medications, food, utilities, and other expenses can be tight.