In Canada there are several varieties of pension plans and all have the same goal to help you fund a long and secure retirement. Pension plans fall into two main categories: government and private plans.
Canadian Pension Plan
If you have worked in Canada you most likely have contributed to the Canada Pension Plan (CPP). This government pension is considered a user pay style plan. The more years you contribute to the plan and at the maximum amount the more you can expect to receive when you retire. See CPP Benefit or Curse?
You normally begin to collect this pension at age 65, but you have options available. Starting as early as age 60 is possible, but you will be penalized 0.6% for each month you collect before age 65 (7.2% per year). Delay receiving CPP until age 70 and you will collect an additional 0.7% for each month after you turn 65 (8.4% per year). The CPP is adjusted for inflation once per year by the government based on the consumer price index.
Old Age Security
Old age security (OAS) is a government funded pension plan available to any Canadian citizen and can be collected once you turn 65 – there is no early option for the OAS.
To qualify for OAS you must be age 65, a Canadian citizen or legal resident and have lived in Canada for at least 10 years since the age of 18. There is no work qualification attached to the OAS. If you don’t fully meet these standards, you might qualify for a partial pension. The payments are adjusted quarterly to account for inflation.
Guaranteed Income Supplement
Since no responsible government wants seniors to be thrust into a state of extreme poverty, the government also administers a program called the Guaranteed Income Supplement (GIS). This funding is intended for low income seniors who are receiving only the OAS pension. The amount of GIS will depend on marital status and yearly income. The yearly income levels are set quite low and only the poorest seniors will qualify for this supplemental income.
Defined Benefit vs. Defined Contribution
Aside from the CPP and OAS pension plans there are registered private pension plans. These are commonly provided through private and public corporations, although government plans also exist.
Private pension plans fall into two categories; defined benefit and defined contribution plans. The defined benefit plans are much preferred, although they are becoming rare due to their higher costs to companies.
Defined Benefit Plan
In a defined benefit plan the pooled contributions are invested by a professional money manager. You are relieved of all responsibility in the investing process. Imagine not having to learn a thing about portfolio management as you wait patiently for the magic date you can retire. In a perfect world these plans guarantee you a set retirement income, and might even be indexed to inflation. Some have medical benefits as a bonus.
Defined Contribution Plan
A defined contribution plan has a similar set up to the defined benefit plans. You can deduct a set yearly amount from your earnings and invest that amount in the plan. The major downside of these pension plans is they are self-directed.
That means they are not actively managed, so you must become your own personal portfolio manager. You have to learn how to access your account and place orders to buy funds. You will decide which funds to buy, what percentage of each asset class you will own, track your gains, and decide where to diversify.
Defined contribution pension plans are less expensive for companies to administer which is driving the change away from professionally managed pension plans.
Regardless of the company pension plan available to you always check to see if your employer offers matching contributions. Company matched contributions are free money and there is no excuse not to take maximum advantage of this offer. Maximized company matched contributions in a pension plan is one of the most effective ways to achieve a secure and possibly even early retirement.
Note: Whether a defined benefit or defined contribution plan, the money will be invested using your Registered Retirement Savings Plan (RRSP). If your registered pension plan (RPP) does not use up your savings room for the year, the unused space is carried forward into the subsequent tax years. You could use up all of the savings room by using the extra room to set up and RRSP.
The impact of pension income on a secure retirement plan cannot be overstated. The more pension income you can expect, the lower the amount of savings you’ll need.
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