Contributions to DC plans

Similar to an RRSP contribution, the amount you contribute to your DC plan is deductible from your taxable income. It will be reported in box 20 of your T4 slip from your employer and can be deducted on line 20700 Registered pension plan deduction on your Income Tax and Benefit return. The amount the employer contributes is tax deductible to the employer and is not considered taxable income for the employee. 

The total amount contributed to your DC plan generates a Pension Adjustment (PA), which decreases your RRSP contribution room in the following year. This is intended to equalize the tax-deferred retirement benefits individuals can accumulate whether they are a member of a pension plan or not. The employer reports the PA in box 52 of your T4 and the value is to be reported on line 20600 Pension adjustment on your tax return. 

Advantages of DC pension plans

• Employer contributions
  Employers contribute a percentage of the employee’s earnings and often match a portion of the employee’s contributions. This employer match is a critical component to the overall value of the retirement benefit. It is recommended that you contribute at least as much as the amount your employer is willing to match. In other words, don’t leave money on the table. 
  
  
• Tax advantages 
  Employee contributions to DC plans are made on a pre-tax basis, reducing the employee’s taxable income. Investment growth is also tax-deferred, meaning taxes are only paid when withdrawals are made in retirement, when the individual is likely in a lower tax bracket. 
  
  
• Individual control
  Employees have control over how their contributions are invested based on their individual circumstances. This can lead to higher engagement with the process, increased financial literacy and the potential for higher investment returns. 

Challenges of DC pension plans

• Investment risk
  Employees bear the investment risk with DC plans. Unlike DB plans, where the employer assumes the risk for ensuring there are sufficient funds to support the required retirement income, with DC plans, it is the employee’s responsibility to manage the investments and accumulate sufficient assets to provide for their desired retirement income level.
  
  
• Longevity risk 
  Unlike DB pensions, which pay a lifetime guaranteed income as long as you live, with a DC plan there is the risk of outliving your pension savings if not managed correctly. As life expectancies continue to increase, this becomes a bigger risk.

Options for your DC pension plan when you leave the employer

When you retire or terminate employment from your employer you will have the option to transfer the value of your DC plan on a tax-deferred basis to a personal “locked-in” registered savings account, a life annuity or leave the funds in the DC plan.

• Locked-in registered savings account
  Your DC pension proceeds, if governed under Alberta legislation, can be transferred to a Locked-in Retirement Account (LIRA) or a Locked-in Income Fund (LIF). A LIRA is essentially an RRSP that is governed by pension legislation, or “locked-in,” and a LIF is essentially a locked-in RRIF. Similar locked-in account types are available in other jurisdictions. 
  
  LIRAs and LIFs are tax-deferred investment accounts that allow you to choose how the funds are invested and subject to certain restrictions, when to initiate regular income payments. The payments are included in your taxable income in the year of withdrawal. Withdrawals are not permitted directly from a LIRA, however, you can initiate on-going retirement income with a transfer of the locked-in proceeds to a LIF.
  
  Locked-in accounts, as well as being governed by the Canadian Income Tax Act, are also regulated by the applicable provincial or federal pension jurisdiction. This additional regulation is to ensure lifetime retirement income is available for both the original pension plan member and the member’s spouse or common-law partner, since this was the intent of the original pension. These rules limit how and when the funds can be accessed and provide for spousal protections. Our article, What is a locked-in account, and why would I have one? discusses locked-in accounts in more detail. 
  
  
• Life annuity
  A life annuity will pay you a set amount of annual or monthly income over your lifetime. Payments from the annuity are taxable in the year they are received. The annuity is purchased through an insurance company and the amount of income you will be entitled to is based on a variety of factors including: the current interest rate, your age, health and life expectancy. 
  
  When you purchase an annuity you are giving up control over your capital in exchange for a guaranteed income. The loss of control makes some people uncomfortable as you can no longer access the capital if an unexpected expense arises. Guaranteed income, however, may appeal to others. If an annuity is purchased without indexing, inflation will also be a factor as the purchasing power of the annuity payments will decrease over time. 
  
  
• Leave the funds in the DC plan
  In some cases, you may be able to leave your money invested in your former employer’s DC pension plan and receive retirement income directly from the plan. This is often referred to as a variable benefit. In Alberta this option is considered a Life Income Type Benefit (LITB). An LITB mirrors the requirements of a LIF, with the same minimum and maximum payment requirements, but is provided through the pension plan rather than requiring the member to transfer funds to a financial institution. In many cases the member will have access to low fees and often the same investment options they had while being a contributing member of the plan. 

DC pension plan at death  

If you pass away while you are a member of a DC plan, the value of your DC pension plan is payable to your chosen beneficiary. How the taxation is applied and whether it can transfer tax-deferred depends on who the beneficiary is:  

• Spouse or common-law partner as beneficiary - the value of your DC plan can be transferred on a tax-deferred basis to your spouse or common-law partner, generally to a LIRA or LIF, or a life annuity. In some jurisdictions it may be possible to unlock and transfer tax-deferred to your spouse or common-law partner’s RRSP or RRIF. 
  
  
• Financially dependent minor child or grandchild as beneficiary - the proceeds can be transferred tax-deferred to a term certain annuity that pays the proceeds out to the child or grandchild until age 18. 
  
  
• Financially dependent child (any age) that is financially dependent as a result of mental or physical impairment - the proceeds can be transferred tax-deferred to any of the following accounts of the beneficiary:
  
  • RRSP
  • PRPP
  • SPP
  • RRIF
  • Annuity
  • RDSP
    
    
• Other beneficiary, or tax deferral options above not utilized - The value of the DC plan is paid to the beneficiary, and the beneficiary must include that amount in their taxable income in the year it is received. 

LITB and variable benefits at death

When the owner of an LITB dies, death benefits are paid as follows:

• If there is a pension partner on the date of death, as a tax-deferred transfer to a RRIF, RRSP or as a taxable cash payable to the pension partner.
  
  
• If there is no pension partner, or the pension partner has signed a form to waive their rights to the death benefit, the named beneficiary or the estate receives a cash lump sum payment less withholding tax and any fees charged.   

DC plans are a powerful tool for building retirement wealth. An employee with a DC pension plan has greater control over their pension savings, with a potential for higher returns and the flexibility to adapt their investment strategy over time. DC pension plans, however, do come with certain risks and challenges. As employees take on more responsibility for their retirement savings, financial literacy, investment knowledge and professional advice is more important than ever. With the right strategies and advisor support, your DC plan and other retirement income sources can work together to provide you with a secure and comfortable retirement.