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Defined contribution pension plan

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Retirement planning
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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,[1] reflecting the individual's contribution.

How a DCPP operates is typically company specific. Generally they involve 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. There is a maximum yearly contribution expressed as a percentage of salary, with a hard cap, like in a Registered Retirement Savings Plan (RRSP).[2]

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 The funds in a DCPP cannot be withdrawn before the owner retires.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).[3]

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

DC plans help you save for retirement by providing tax-deductible employee contributions (through payroll deductions), additional contributions from the employer, and safety from creditors.[4] Those contributions are invested -- the employee must make investment choices -- and grow over time. Upon retirement, there are different options to turn the accumulated assets into retirement income (see below). The retirement income will depend on how much was contributed to the plan, investment choices, an investment returns. The employer makes no promises what that retirement income will be: the contributions are defined, not the benefits.

In a DC plan, 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.[5]

Some 75% of DC plans are mandatory[6] 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[7]

"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.[8]

Yearly maximum contribution

There is a maximum yearly combined (employee + employer) DC plan contribution expressed as 18% of this year's earnings, with a hard cap (indexed every year).[2][9] In 2025, that cap, known as the money purchase limit, is $33,810.[10]

This is similar to how RRSP contribution limits are calculated, but using 18% of this year's earnings rather than last year's earnings. An this year's money purchase limit is next year's RRSP dollar limit.[10]

Guidelines, regulations and solvancy

DC plans are expected to follow voluntary guidelines from the Canadian Association of Pension Supervisory Authorities (CAPSA), including:

DCPPs fall under the same regulations and legislation[11] 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. While DCPPs follow DB regulations, they are quite similar in how they work to Group RRSPs.

There should be no issues with solvency in a DC plan because:

  1. Pension assets are held in trust[4] -- they would not be in jeopardy if the employer became bankrupt
  2. The plan does not promise a pension related to a formula upon retirement and no actuarial calculations are required (by definition a DC plan is always fully funded[12])

Investing in your DC plan

You will be making investment choices in a DC plan, typically from a menu of funds. From this you will build a portfolio. The plan will provide information and decision-making tools, which will help you come up with an asset allocation. There might an automatically suggested fund choice or a default option.

Educate yourself

In a survey of over 2000 DC plan members in the US, 68% said that they did not really understand the investment options they had selected.[13] Plan members are urged to educate themselves about investing so that they become comfortable making their own decisions about asset allocation and fund choices, or at least confirm that the default options or automated fund choices are appropriate for them. Articles that may help include:

Target date funds

The default investment option in about half of DC plans consists of target date funds.[6][14] 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."[15] 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.[16]

Balanced funds

Another popular one-fund solution is a balanced fund[15], the default option in a quarter of DC plans in Canada.[14] Such funds 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.[17]

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 (e.g., [18] and see also Asset allocation over the lifecycle). This is especially true if the balanced fund is significantly cheaper to own than the target date fund. However, sequence of return risk might justify 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[19]. For example, none of the over 7000 pension plans administered by Sun Life offer ETFs on a stand alone basis.[20] However, pooled index funds may well be available, and should be among the least expensive options in the menu. They might even be cheaper than equivalent plain-vanilla index mutual 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:

FPX Balanced Four-index funds Portfolio
Asset Class ETF Amount
Domestic stocks BlackRock S&P/TSX Composite Index Segregated Fund 25%
International stocks BlackRock EAFE Equity Index Segregated Fund 15%
US stocks BlackRock U.S. Equity Index Segregated Fund 10%
Domestic bonds BlackRock Universe Bond Index Segregated Fund 50%

This example has a before-tax weighted average management fee of 0.24% (March 2015).[21]

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:[22]

  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:[23][24][25]

  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).[26]

Annuities may be joint (for retirees with spouses) and/or have guarantees.[2]

When choosing between a LIF (or pRRIF) and a life annuity, retirees can consider the following aspects:[26]

  • 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:[27]

"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?"

See also

References

  1. ^ Registered Pension Plans Glossary, viewed February 7, 2014.
  2. ^ a b c Marc Bachand, Nicolas Lemelin, Nicolas Boivin, Donnez un sens à vos finances 2024-25, viewed June 14, 2025.
  3. ^ Statistics Canada, Registered pension plan (RPP) active members by area of employment, table 11-10-0133-01, viewed June 15, 2025.
  4. ^ a b Canadian Association of Pension Supervisory Authorities, Defined Contribution Pension Plans: Did You Know?, October 2021, viewed June 15, 2025
  5. ^ Benefits Canada, CAP Suppliers Report: Provinces hold the keys to CPP expansion, December 17, 2015, viewed February 13, 2017
  6. ^ a b Benefits Canada, DC plans need better design and raised contribution rates: report, February 19, 2016, viewed February 13, 2017
  7. ^ Saskatchewan Pension Plan, viewed Feb. 6, 2012.
  8. ^ Canadians losing out on as much as $3-billion in ‘free money’ defined-contribution pensions | Financial Post, viewed December 18, 2014.
  9. ^ Defined Contribution Plans, groupbenefits.ca (Park & Associates Insurance Agency Inc), viewed June 15, 2025.
  10. ^ a b Canada Revenue Agency, MP, DB, RRSP, DPSP, ALDA, TFSA limits, YMPE and the YAMPE, viewed June 14, 2025.
  11. ^ Income Tax Act, subsection 147.1(1), viewed February 7, 2014.
  12. ^ Broadbent J, Palumbo M, Woodman E (2006) The Shift from Defined Benefit to Defined Contribution Pension Plans - Implications for Asset Allocation and Risk Management, 59 p., viewed June 15, 2025.
  13. ^ Benefits Canada, DC pension plan members want to take risks, but lack knowledge, March 6, 2020, viewed March 14, 2020.
  14. ^ a b Office of the Superintendent of Financial Institutions, 2019, Defined contribution pension plan study, viewed June 15, 2025.
  15. ^ a b Benefits Canada, Pension column: Greater simplicity for DC plans, November 20, 2014, viewed February 13, 2017
  16. ^ Canadian Couch Potato, Are Target Date Funds Right For You?, Aril 18, 2016, viewed February 13, 2017
  17. ^ getsmarteraboutmoney.ca, Workplace pensions and savings plans -- Investing your contributions, viewed February 14, 2017
  18. ^ Graham Westmacott, Should my portfolio be on a glide path?, November 2016, viewed February 16, 2017
  19. ^ Benefits Canada, Can ETFs work in defined contribution plans?, March 18, 2015, viewed February 16, 2017
  20. ^ Sun Life Group Retirement Services, 2024, Are ETFs an obvious choice for Capital Accumulation Plans?, viewed June 15, 2025.
  21. ^ UNBC Pension Plan, April 22, 2015, viewed February 17, 2017
  22. ^ getsmarteraboutmoney.ca, Leaving your DC pension plan before retirement, viewed February 15, 2017
  23. ^ Retraite Québec, Income from a defined contribution plan, viewed February 15, 2017
  24. ^ getsmarteraboutmoney.ca, Your DC pension options at retirement, viewed February 15, 2017
  25. ^ Robb Engen, Defined Contribution Plan, February 23, 2011, viewed February 15, 2017
  26. ^ a b Government of Saskatchewan, Financial and Consumer Affairs Authority, Retirement Options, June 2016, viewed February 16, 2017
  27. ^ Association of Canadian Pension Management, Delivering the Potential of DC Retirement Savings Plans, May 2008, p. 3.

Further reading

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