Which kind of plan do you have?

Knowing the difference between a DB and DC pension can make a big difference when it’s time to retire.

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From the February 2011 issue of the magazine.

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The two main ways that employers help you save for retirement couldn’t be more different. The defined benefit (DB) pension is the traditional pension plan that government workers and workers in heavily unionized workplaces tend to have. With this type of plan, you get a guaranteed payout for life. On the other hand, with a defined contribution plan or group RRSP, your employer basically gives you the money to invest, and you take the risk. If the markets do well, you’ll have more, if they tank, you’ll have less.

The great virtue of a defined benefit pension is that it assures you a set pension income in retirement that doesn’t depend on market performance. But if you’ve ever tried to decipher your pension plan statement, you’ll know how maddeningly complex it can be to figure out where you stand when you’re still many years from retirement. The typical way to calculate what you’ll get (assuming you retire at 65), is to take your number of years of service, multiply that by a payout factor (often 1.5% or 2%), and then multiply that by the average salary you earned during your last few years of service.

Usually if there is a funding shortfall in a defined benefit plan, the employer is solely responsible for making up the shortfall, although in some plans it is shared with employees. The result of all this is that the generosity of defined benefit pensions varies widely. You probably won’t be surprised to learn that the most generous plans are typically found in a few industries with powerful unions and in the public sector.

The other approach is called either a defined contribution (DC) pension plan or a group RRSP—depending on whether it is set up under pension legislation or not. Under that approach, your employer oversees and contributes to the plan, but the balance in the account is yours and you decide how to invest the money from a menu of options.

To be honest, a defined pension plan isn’t what most people think of as a pension. “It should be called a retirement savings plan,” says Malcolm Hamilton, partner with Mercer Human Resource Consulting. The main difference between defined contribution pension plans and group RRSPs is that DC plans have legislated “lock-in” restrictions against taking the money out prior to normal retirement age and group RRSPs don’t.

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