Make the most of your pension

Question

My employer offers the option for both a contributory pension plan and a non-contributory pension plan. What are the advantages of each? I understand that with a non-contributory plan I have more room for my own RRSP decisions, but I am not sure if there are inherent benefits to either plan. What factors should I consider when deciding which plan to join?

Answer

I am grateful to live in a country that values free speech. And I’m equally grateful to live in a country that mandates the use of seat belts. Some freedoms are fundamental to our democracy, and some enforced behaviours are fundamental to save us from ourselves.

Recent data on retirement saving suggests we could use more help saving us from ourselves. Traditional pensions are on the decline in the corporate world and contributions to RRSPs are dismal: in 2010, only 26% of tax filers contributed to an RRSP.

For those not familiar with these types of pensions they work like this: contributory pensions require its members to put money into the plan, which is then matched by the employer; in non-contributory plans the employer contributes to the pension based on a formula, regardless of whether the employee puts money into the plan.

When it comes deciding between a contributory pension and a non-contributory plan every situation is different. But there are a couple of reasons why a contributory plan may be a more compelling option.

Making the most of the employer match

One of the advantages of a contributory pension plan is that in order to benefit from the matching program from your employer, you to have to make a contribution to the plan. In other words, it forces you to save for your own retirement. This match is usually up to a maximum percentage of annual income, say 6%, which is a very compelling benefit.

The non-contributory plan, on the other hand, calculates the employer contribution based on a formula—the employee doesn’t have to make a contribution to qualify for it and the match typically isn’t as rich.

A typical non-contributory plan might offer a guaranteed 3% of employer contribution while a contributory plan might match 100% of employee contributions, up to a maximum of 6% of annual income, says Melanie Jeannotte, the managing partner at Vital Benefits, a Calgary-based benefits consulting firm.

The question is, which is better? “The contributory plan is going to result in a larger benefit from the employer,” she says. “And the employee will have 12% applied to their RRSP’s contribution room as a result of both their and the employer’s contributions.”

Over the years I have talked with many people who didn’t make the most of employer-matched contributions and lived to regret it.

Say you make $50,000 per year and your employer will match any contribution you make up to 6% of your salary. But instead of maxing out the benefit, you sign up for a 3% withdrawal from your paycheque. Your contribution to the plan would be $125 per month, while your employer would chip in another $125. If you took full advantage of the employer’s matching program, then both you and your employer would contribute $250 per month towards your pension.

The difference between these two examples is $125 a month or $1,500 per year. If you compound that extra amount over 30 years, growing at 5%, it would be worth $105,000. No surprise then that I would strongly encourage you to make sacrifices in other areas to qualify for the juiciest employer match possible.

Saving you from yourself

Non-contributory plans, on the other hand, put the onus on the employee to maximize their RRSP contributions because there is no the incentive to encourage you to save on your own “The reality though is that most Canadians do not maximize their annual allowable RRSP contributions so have room to save in addition to the annual maximums,” says Jeannotte. “If that is the case for this individual, the 12% that will go into RRSP’s in the contributory plan are going to get them closer to their retirement savings goals.”

She adds that most companies do not require an employee to choose between contributory and non-contributory plan, but rather allow participation in both which is ideal to maximize employer contributions. “If the employee has to choose then the plan formula becomes important as an evaluation tool,” she says.

Other factors to consider

Other circumstances: Do you have a spouse who will be earning significant pension income in retirement? If the answer is yes, that may mitigate the risk somewhat of your choices.

Investment savvy: Are you interested in self-directed investing? Because you have more control of your retirement savings with a non-contributory plan, there are more choices to make and therefore more work involved. If investing isn’t of interest to you, a contributory plan might make more sense.

Willpower: Can you rely on yourself to keep the money invested in a non-contributory plan? The ability to direct funds to other needs can be both a blessing in an emergency and a curse if you don’t have the willpower to stay focused.

Choosing between a contributory or non-contributory pension plan is a big choice. Sit down with your human resources contact and go over the details to ensure that you make the right choice for you.