Defined contribution pension plan

A defined contribution pension plan (DCPP or DC plan ) is one type of a Registered Pension Plan. A DCPP has no pre-determined payout at retirement, it is based on the assets in the plan at the time your retire. The investment risk is borne by the beneficiary not the plan. They are also known as money purchase plans, reflecting the individual's contribution.

How a DCPP operates is typically company specific. Generally they involved a fixed contribution amount or percentage of salary that are deposited into an account in your name. The amount can either be contributed by the employer, the employee, or some combination of both based on the setup of the specific plan. These contributions are tax deductible, and the assets grow on a tax-deferred basis.

In a DCPP, you are responsible for the investment choices for the contributions, from a selection of options available for your plan. The funds in a DCPP cannot be withdrawn before the owner retires. The "cost" of a DCPP can be readily calculated but the benefit is ultimately unknown as it depends on the investment returns of the plan.

Over one million Canadians are covered by a defined contribution pension plan (DCPP).

Origins
Defined contribution pension plans are nearly contemporary with defined benefit pension plans (DB plans), dating back to more than a century ago. They were first given legislative expression with the Government Annuity Act of 1908, which allowed for individual savings accumulated over a lifetime of labour to be converted into life annuities.

How DC plans work
DCPPs fall under the same regulations and legislation as DB plans, even though their structure is quite different. Under a DB plan, the sponsor assumes liability for the payout, the investments, the service providers and along the way, the plan's solvency.

In a DCPP, the sponsor employer contracts with a plan administrator to provide the investment options; normally a limited menu negotiated at low cost; as well as the record-keeping for individual plan members. Because of their experience in offering group benefits, life insurers like Manulife, Sun Life and Great-West Life (including its London Life and Canada Life subsidiaries) dominate the DC pension space.

While DCPPs follow DB regulations, they are quite similar in how they work to Group RRSPs.

Some 75% of DC plans are mandatory and the rest are voluntary. One example of a voluntary contributory DC Plan is the Saskatchewan Pension Plan, which states on its website that it is "'a fully funded, participatory money purchase or defined contribution pension plan. It is designed to provide supplementary income to individuals with little or no access to private pensions or other retirement savings arrangements or as part of a larger investment portfolio.'"

Matching contributions
Many company defined contribution plans top up employee contributions with matching funds, often up to between 3% and 6% of earnings. This gives the employee the incentive to join and contribute to their plan. Yet employers are paying out just 40% to 50% of available matching funds, according to industry estimates.

CAPSA guidelines
DC plans are expected to follow voluntary guidelines from the Canadian Association of Pension Supervisory Authorities (CAPSA), including:
 * Guideline No. 3 - Guideline for Capital Accumulation Plans (2004)
 * Guideline No. 8 - Defined Contribution Pension Plans Guideline (2014)

Investing in your DC plan
You will be making investment choices in a DC plan, so be sure to read about portfolio design and construction, asset allocation, and rebalancing.

Target date funds
The default investment option in almost half of DC plans consists of target date funds. You pick your approximate retirement date and the fund automatically adjusts it's asset allocation as retirement approaches, lowering the proportion of equities and increasing the proportion of fixed income investments. Sunlife, a big provider, notes that target date funds "can be particularly appealing to less sophisticated or engaged investors looking for a streamlined portfolio choice." If the target date fund corresponding to your approximate retirement date is too aggressive, or too conservative, to your taste, you can choose one with a different date.

Balanced funds
Another popular one-fund solution is a balanced fund, which typically contains a fixed percentage of equities and fixed income investments. In DC parlance, balanced funds are sometimes known as "target risk" or "asset allocation" funds and range from very conservative to very aggressive.

Although target date funds, with their asset allocations that change with time (a.k.a. "glide path"), appear more sophisticated, some studies suggest that you might do as well with the constant allocation of a balanced fund. This is especially true if the balanced fund is significantly cheaper to own than the target date fund. However, sequence of return risk justifies the declining equity allocation of target date funds.

Simple index portfolio
If you want more control, and perhaps lower fees, consider building a simple index portfolio in your DC plan. Exchange-traded funds (ETFs) will probably not be available, but index funds may well be, and should be among the least expensive options in the menu. They might even be cheaper than equivalent plan-vanilla index funds available to the general public.

The following table is an example of a simple index portfolio built with "FPX Balanced" allocations, using four index funds offered in the DC plan of the University of Northern British Columbia:

This example has a before-tax weighted average management fee of 0.24% (March 2015).

Leaving your plan before retirement
Most DC plans require you to transfer your money out of the plan when you leave your employer. In Ontario for example, you will typically have three options:
 * 1) Transfer to an individual locked-in retirement account (LIRA)
 * 2) Transfer to an insurance company to buy a deferred annuity
 * 3) Transfer to another pension plan, if they will accept the transfer

Options at retirement
Typically, a DC plan does not directly pay a pension after retirement. Instead, members typically have two options to obtain an income:
 * 1) Transfer their funds to a Life Income Fund (LIF), which is similar to a Registered Retirement Income Fund (RRIF), but with both minimum and maximum annual withdrawals
 * 2) Purchase a annuity from an insurance company, which guarantees an income for life

In Saskatchewan, no new LIFs are allowed, but retirees can open a prescribed RRIF (pRRIF).

When choosing between a LIF (or pRRIF) and a life annuity, retirees can consider the following aspects:
 * What are your goals?
 * Are you permanently retired?
 * How much risk are you willing to bear?
 * How long will you live?
 * What do you expect annuity rates to be?
 * What's your complication threshold?

Since the purchase of an annuity is an irreversible decision, retirees are urged to consult a qualified and conflict-free professional before making the decision.

Problems
The Association of Canadian Pension Management outlines the challenges DC plans face: "Can a retirement savings plan make a significant contribution to a reasonable retirement income? Will retirement savings plan sponsors and members contribute enough? Will members invest these contributions appropriately? Should investment advice be provided to members? Who will provide investment advice to members? How will retired members manage mortality or longevity risk – the risk that they could outlive their money? Do members understand the risks and costs that they bear? What can be done to help them manage these risks and reduce these costs?"