What is a Defined Contribution Plan & How Does It Work? | You Money, Your Choices with Susan Daley

Updated : Sep 13, 2019 in Articles

What is a Defined Contribution Plan & How Does It Work? | You Money, Your Choices with Susan Daley


If you’re fortunate to be one of the 1.1
million Canadian participants of a defined contribution pension plan, you might be curious how these
plans work and what their benefits might be. In today’s video, I’ll outline what a
defined contribution pension plan is how it works, and some of the drawbacks associated
with this plan. I’m Susan Daley and this is Your Money,
Your Choices. A defined contribution pension plan is aptly
named, since the employer benefits portion of this plan are related to the contributions. Each year, the employer will contribute a
specific dollar amount to the plan. This is usually stated as a percentage of
your salary. The employer contribution is often contingent
on you making a contribution to the plan yourself, but doesn’t have to be. For example, your employer may match contributions
up to 4% of your salary. If you contribute 3%, your employer will contribute
3%, if you contribute 5%, your employer will only give you 4%. This is often referred to as “free money”
since for those who would already be saving for their future, their employer is topping
that up for them. Sun Life Financial estimates that Canadians
are leaving over $3 billion on the table from not contributing to these matching programs. Of course there are many reasons why Canadians
are using their money for other things aside from matching, but if it’s a result of lack
of knowledge, that’s something that needs to be addressed! Unfortunately, with this type of plan, the
employer is only responsible for providing a contribution to the plan. Once they’ve made that contribution, the
rest is up to you. You are given a list of options to invest
in based on what the pension plan provider (like Sun Life, Manulife, or Great West Life)
is offering. It is your responsibility to select the investment
option that you’re comfortable with from a risk perspective. For more information about risks when investing,
check out my “Risks for Millennials Investors” video. The amount of money you receive at retirement
will depend on how much you contributed to the plan, and how well your investments have
done. These plans should really be called savings
plans, rather than pension plans. A Defined Contribution plan is similar to
an RRSP (with employer contributions). However your investment options are limited,
and there are additional government restrictions around withdrawing your money. Now if you watched my previous video around
Defined Benefit pension plans, you might be thinking, this plan isn’t nearly as good
as a defined benefit plan. All the risk is on you. And in general, you’re right. A Defined Contribution plan may provide some
advantages over a defined benefit plan though: First, the money saved in your plan won’t
change (aside from savings, withdrawals, and your investment returns) if your employer goes
bankrupt. Second, you should have greater flexibility
around withdrawing your income in retirement. Third, you can receive a higher retirement
income if you invest in a riskier manner and it works out for you. However, the opposite could be true, if you
outlive what your assets can provide due to a long life or your investments fall at the
wrong time. Fourth, a lump sum is available to your heirs
if you (and your spouse) pass away before spending the income. Most individuals don’t have a choice whether
they have a defined contribution or defined benefit plan, though it’s important to know
which plan you have so that you can plan for your retirement accordingly. In addition, depending on the plan you currently
have and the plan at a potential employer, this may be a consideration if you’re looking
to switch jobs. In the future, I’ll outline in detail what
options you have with pension plans if you do change employers. Are you one of the lucky 6.3 million Canadians
that has an employer pension plan? I’d love to hear about it in the comments
below. I’m Susan Daley and this has been Your Money,
Your Choices. If you’re watching this on YouTube, be sure
to hit the subscribe button below, and click the bell to be notified when new videos are released.

6 Comments

  • Love the GoT books in the background! In all seriousness, keep up the good work, a lot of my students do not understand these differences and they are about to step into the workforce.

  • Thank you for clearing that up! I had two job offers, one provided a pension – it's a government (unionized) job, the other was private and provided matching (I put in 5%, they match 8%). The matching rrsp job was around $2000 less salary than the job with the pension plan. I took the government job because the private one required me to move to another city (though would have provided me with more direct career related advancement – ie. a road towards licensure). I guess I made the right decision? I was wondering what the difference was, but I'm curious to know what your thoughts are regarding those two offers from a financial perspective.

  • Hi thanks for the great informative videos. I just have a question about using DCPP contribution to pay off Home buyer plan loan taken from RRSP contribution. Can I use this contribution as repayment of RRSP home buyer loan.. I think as it is affecting RRSP contribution limit then it should also cover repayment. Please let me know what are your thoughts on this. Thanks

  • Hi Susan, I want to know that how a participants in DC plan receive his money?
    At retirement do he receive a full amount of his investment? or in installments. for example INR 200,000/- amount per year for 20 years till the account get exhausted?

  • I have a defined pension plan called municipal pension plan or mpp. I am not going to rely on it. Instead, I have my own portfolio of individual stocks. I don't invest in index or etf or mutual funds or bonds or GICs. I go straight the point. I have high tolerance for risks because I used to work at the Casino as a card dealer.

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