What is a pension? They come in all shapes and sizes, and you’re lucky if you have a good one.
A pension is, most basically, a source of income during retirement. It is common to have retirement income from more than one source. In Canada, we typically identify three sources of retirement income: the Canada Pension Plan (a plan all workers pay into during their career, managed by a public administrator), Old Age Security/Guaranteed Income Supplement (a government funded and operated anti-poverty program for low-income retirees), and workplace pension plans (which are managed by employers, either alone, or jointly with unions). There is also a fourth important source of retirement income: personal savings, often from an individual RRSP or retail mutual fund.
The system for providing retirement income we have in Canada is intended to have the publicly-run programs – CPP and OAS/GIS – provide a “floor” of retirement income. CPP was intended to provide about 25% of the income an average Canadian worker will need in retirement; it was recently expanded to target 33%. In theory, the remaining retirement income should be provided by the workplace pension plan and individual savings combined. In practice, about two thirds of Canadian workers no longer have access to a workplace pension plan at all, particularly in the private sector where nearly 80% of workers do not have a pension. Experts and governments have recognized that this is a problem, particularly among non-unionized workers. Workers in trade unions, however, usually have access to a workplace pension plan. Trade unions have long fought for decent pensions and continue to protect good pensions for their members.
The mechanics of benefit payments from a workplace pension are as follows (we will describe the CPP, OAS/GIS and RRSPs in similar detail in future blog posts): Benefits from an employment-based pension plan are paid periodically (usually monthly) after “retirement,” which is discussed in more depth below. The specific amount of payment usually depends on the length of employment (or “service”) with the employer providing the pension – the longer you work for the employer, the greater the pension amount in retirement. In some cases, the amount will depend on the level of contributions made to the pension plan, which can change over the course of employment.
Typically, contributions to an employment-based pension plan are made as a percentage of an employee’s annual salary, but in some cases, particularly in the construction industry, they can be a portion of an employee’s hourly wage. Contributions are either made by the employer alone or in combination with contributions deducted from the employee’s pay. Pensions are a highly efficient way of accumulating income for retirement and the value of a pension can account for a significant portion of an employee’s total compensation – in many cases a pension is an individual’s second most valuable asset after their home equity.
To complicate things further, workplace pensions generally fall into three basic plan types based on how benefits accumulate (or “accrue”) through contributions and returns on investment. There are “defined benefit” plans, “target benefit” plans, and “defined contribution” plans:
- As the name suggests, a defined benefit plan is one that guarantees a specific level of pension income in retirement determined by a formula that takes into account an employee’s salary and years of service.
- A target benefit plan aims for a specific level of benefit in retirement but does not guarantee it.
- A defined contribution plan only guarantees that a pre-determined amount of money will be put into a savings and investment account – it doesn’t guarantee any particular level of savings or income in retirement.
Traditionally, most pension plans were of the defined benefit type and in Canada the majority of employees participating in pension plans are covered by plans of this type. However, the past 30 years has seen a decline in defined benefit plan coverage and a shift towards defined contribution plans, particularly in the private sector. This trend means that an increasing proportion of pension plan members do not have access to guaranteed benefits on retirement.
That term – retirement – also needs a little more explanation. Fifty years ago, we had a better idea of what retirement was and when it took place: once you ended a career at your employer at age 55 or 65, you would retire from working altogether, and begin receiving your pension. However, over the past 20 years or more we’ve seen two key developments in labour force participation that change this understanding: first, whereas we used to think of workers staying in the same job for most of their lives, many people now change jobs far more frequently than in the past. Second, people are continuing to work well beyond age 55 and even 65. As a result, although older workers “retire” from their employer, and begin receiving a pension, it is increasingly common to continue to work for another (unrelated) employer. “Retirement” is taking on a different meaning and may involve continuing to work in other areas.
As this short introduction to pension benefits makes clear, there are several sources of retirement income including workplace pensions, which involve a range of benefit payment and plan types, and the concept of retirement at the heart of pension benefits is changing. Our future blog posts will unpack some of those key features and issues.