Over the past couple of years I have had conversations with a number of folks younger than myself, about the basic financial tools Canadians can use to ensure their retirement does not include money worries.
I am invariably surprised at how little they know about the topic. The point being, the best time to have an understanding and awareness of funding your retirement is well before you get there. It’s kinda like the boy scout motto, “be prepared”.
Today’s blog is a simple (but comprehensive) primer about pensions.
In a future blogs (probably tomorrow and the next day to keep the momentum) I will review retirement saving options both taxable and tax free, government allowances, income funds, annuities and of course throughout all the blogs, tax implications associated with these things.
All of this is leading to death which ends the taxes, for you anyway but maybe not for your beneficiaries (that will be the topic of even another blog. )
Let’s Start with Pensions
Canada Pension Plan (CPP
Everyone with earned income in Canada contributes to the Canadian Pension Plan (CPP). Employer’s contribute on your behalf too. The money you contribute to CPP is not taxed and the earnings from investment on the CPP capital is not taxed. You can elect to receive an annual income from CPP starting at age 60 – 64 (reduced) or age 65 (full) or 70 (enhanced). The amount paid depends on your contributions from employment income over the years. The current maximum is about $12,700 year. (not including the post retirement benefit if you start after 65)
Employers Pension Plan
Many employers in Canada offer benefits above and beyond your basic compensation, like medical/ dental insurance, special time off options and pensions, among other things. When your employer offers a pension plan these come in two flavors (described below) and each is somewhat unique in the details but the basic concepts are the same. I also describe with each type what happens if you leave the company (and thus the plan) before retirement.
Defined Benefit
In this plan you contribute and your employer contributes monthly, both tax free (usually a % of your salary). The investment of the funds and the return on investment is managed by the plan’s administrator (a paid third party -e.g., like Sunlife). All earnings of the fund are tax free.
The pension society oversees the operation of the plan and determines the pension payout and this is usually based on your years of service and annual income when you retire (or average of several years near retirement). The risk that the pension fund won’t have received enough contributions or earned enough money from interest, dividends or capital gains is on the employer and they need to make up any shortfalls in the pension fund over-time. That is the benefit is fixed, good for the employee. (Of course if the company goes bankrupt and the pension fund is not fully funded, that is part of the bankruptcy, like Nortel, it is not good)
If you quit the company before retirement you have two options:
1) Have the money contributed by you and your employer and associated earnings on that money (interest and dividends) deposited to a Locked In Retirement Account (LIRA) You can manage your LIRA’s investments but cannot withdraw any money until age 65. You have to start taking annual withdrawals after age 72 at the latest. Money earned in the LIRA is tax free. Withdrawals, when they start are taxed as income and can be in the form of a life annuity or a retirement income fund (RIF) which will be explained in future blogs.
2)Elect to receive the pension due to you based on years of service and salary when you leave the company. This pension would not start though until the normal age of retirement (e.g 65) or if you choose early retirement age with a penalty (e.g. 60) or later than the normal retirement age (e.g, 70) but usually no benefit to doing this, except as it relates to your taxable income overall at the time the pension starts.
(Note: you need to have been in the plan at least two years to be vested. Otherwise you get what you contributed but not what the employer contributed. Also the take a pension option does not apply.
Defined Contribution
In this plan you contribute and your employer contributes monthly, both tax free (usually a % of your salary). The investment of the funds is directed by you. The plan is usually administered by a third party (e.g., Sunlife) All earnings of the fund are tax free.
Since you oversee the operation of the plan and determine how it is invested, the amount of money available to create an income when you retire is determined by you. (If you invest badly and lose money, oops) Basically the risk that the pension fund won’t have received enough contributions or earned enough money from interest, dividends or capital gains to pay what you need, is all on you.
When you retire how the money is paid to you as income is also decided by you – either an annual % usually paid monthly until the income is gone or through purchase of a life annuity (both of these options will be explained more fully in the next blog.
If you quit the company before retirement you have two options:
1) Have the money contributed by you and your employer and associated earnings on that money (interest and dividends) deposited to a Locked In Retirement Account (LIRA). Some of the money can go to an Registered Retirement Savings Plan (RRSP). This is based on provincial rules as to how much can be unlocked (so varies) and also your spouse (if you have one) must give a waiver.
You can manage your LIRA’s investments but cannot add or withdraw any money (beyond capital gains, dividends and interest being reinvested) until age 65 (i.e., it is locked). You have to start taking annual withdrawals after age 72 at the latest and these are through a Locked In Retirement Income fund (LRIF) explained in a future blog. Money earned in the LIRA is tax free. Withdrawals from the LRIF, when they start are taxed as income.
If you did choose to put some of the money in an RRSP you can withdraw it any time (but pay tax when you do) or transfer it to a Retirement Income Fund when ready to do so (not a locked income fund).
2)Elect to take the cash and pay the full tax. In this case though most Provinces (again this varies) require the spouse (if you have one) to give a waiver saying collapsing the retirement account is okay.
(Notes: You need to have been in the plan at least two years to be vested. Otherwise you get what you contributed but not what the employer contributed. Also the take a pension option does not apply.
That’s all for today, more than enough I am sure. Check in the future blogs to get the rest of the story.