Defined Contribution

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Introduction

A Defined Contribution Pension Plan (DCPP or DC plan ) is a kind of 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 sometimes 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 The funds in a DCPP cannot be withdrawn before the owner retires.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.

Origins

Defined contribution pension plans are nearly contemporary with Defined Benefit 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.

Types

DC plans

DCPPs fall under the same regulations and legislation as Defined Benefit 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 to Group RRSPs.

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."

Group RRSPs

Just as the inflexibilities of Defined Benefit plans prompted a migration to less-risky (for the employer) DCPPs, rigidities in pension regulation and legislation have sparked a move toward more flexible Group RRSP arrangements. Since the beginning of the decade, Group RRSP assets have doubled.

A Group RRSP is similar to individual RRSP, with a few exceptions. The primary one is that plan members enjoy lower-cost investing thanks to the buying power of the plan sponsor, despite the fact that monthly contributions by individual plan members may be quite small. Still, these are considered "sticky assets" by the plan's manager, most often a life insurance company, that will stay put until the employee retires. The tradeoff, to keep costs down, is a limited menu of investment options.

Deferred Profit Sharing Plans (DPSP)

A Deferred Profit Sharing Plans (DPSP) is a plan designed to enable an employer to share a portion of profits with arm's length employees.

Problems

In a recent report, the Association of Canadian Pension Management outlined 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?"