Let's Talk: Defined Benefit Pension

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This week, let's learn about the Defined Benefit Pension (DB). It's a great program that very few employers offer to ensure a guaranteed income for their employees. This is simply because it's too expensive for them.

How Does It Work?

Staying with a single employer for your entire career is something that few people are doing these days. If you happen to pull it off, you'll be rewarded with a DB pension plan if your employer offers it. Both the employee and employer usually make a contribution to the pension plan. Contributions made into the pension is called pension adjustment and will reduce your RRSP contribution room. The employer assumes the risk of investing the funds for the employee. What you receive in retirement usually depends on your years of service with the company, your annual salary and the plan's percentage amount. It involves a formula to calculate how much you would receive during retirement. Typically, there are 3 methods to calculate the formula:
  1. Best/Final Salary: Pension Benefit = (Years worked) x (Average salary of best/final years) x (%)
  2. Average Salary: Pension Benefit = (Years worked) x (Average of total annual salaries) x (%)
  3. Flat Benefit: Pension Benefit = (Years worked) x (Flat benefit amount)  

If you quit your job while contributing to a pension, you may keep the portion that's unvested. Remember, this means that you need to work for a period of time to keep the funds. Upon leaving, here's what you can do with your DB pension:
  • Stay in your current DB pension plan but can no longer make any contributions
  • Buy an annuity with an insurance company
  • Transfer a lump-sum value to your RRSP, RRIF, RPP, LIRA
  • Transfer to your new employer's pension plan

Qualifying Factor

The qualifying factor is also important to consider when planning to retire with your pension. This is a number based on another formula that allows you to receive your pension without it being reduced. The general rule for the qualifying factor is 85 but may be different for each individual pension. Make sure you read and understand the conditions to receive an unreduced pension with your employer. Below is the qualifying factor formula for a pension plan with a QF of 85: 
Qualifying Factor = (Age of retirement + Years worked)
  • If QF is less than 85, you receive a reduced pension
  • If QF is 85 or over, you receive an unreduced pension

Buy Back

Your pension may also offer you the option to buy back years of service. This is an option to purchase and increase the number of years worked for your pension, allowing you to retire sooner or to help you bridge the gap to receive an unreduced pension. 

Upon Death

Upon receiving your pension, you also have the option to guarantee it for a period of time, usually up to a maximum of 15 years. This means that even if you die early in retirement, the pension still has to pay you for the remaining guaranteed years it was agreed upon. If you're expecting a shorter life due to an illness, you should get a longer guaranteed period. If you're expecting a longer life, you should consider a lower guarantee period or none at all. If you die before or after you retire, your beneficiary will be paid a monthly pension or a lump-sum value of your pension.  

Rules to Remember

  • The benefit is based on a formula
  • Qualifying factor provides an unreduced pension if you meet the requirements
  • You can split your pension with a spouse
  • You can buy years of service
  • Consider a guarantee period if you're expecting a short life expectancy



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