- A tax deduction from RRSP contributions made today, and
- Tax-deferred growth as long as assets stay inside the RRSP account.
Why the RRSP in the first place
Although we believe the Tax Free Savings Account (TFSA) is a gift to all adult Canadians saving and investing for their retirement, we do need to point out the RRSP is no slouch either. We won’t repeat all the details and reasons why the RRSP remains a great way to invest, including beating the TFSA in some key cases for retirement planning, but we will link to that content below for your further reading: When does the RRSP beat the TFSA? Why for the most part, the TFSA beats the RRSP for retirement planning and investing. With the ability to get a tax deduction from RRSP contributions made today, to lower your taxable income each year, AND obtain long-term tax-deferred growth from assets held inside the RRSP account, this remains one great way you can build wealth to help fund retirement.How your Defined Benefit Pension Plan works
If you’re lucky, with your company benefits, you might have a defined benefit pension plan. You’re lucky because increasingly, many employees in Canada don’t have such juicy pension plan benefits – pension plans in general (whether they are defined benefit or defined contribution) have been trending downward as company benefits for some time. According to Stats Can, the pension coverage rate—that is, the proportion of all paid workers covered by a registered pension plan was 37.1% in 2019, essentially unchanged from 2018 (37.2%), but down quite a bit from the previous decade. A decade earlier, in 2009, the coverage rate was 39.4%. 20 years earlier, in 1999, it was 40.8%. So, whether it’s the shift from defined benefit to defined contribution plans by employers and/or defined benefits going away completely, Canadians really need to assess on their own what income sources, needs and wants they have for their retirement. A defined benefit pension plan is pretty much a traditional pension: one that provides a defined/predictable income benefit at retirement – hence the name. Consider it cash-for-life. For defined benefit pension plans, there is usually a formula involved to determine your income benefit – something like your average salary, years of service and potentially your age. Calculations between company plans vary but let’s say for the sake of this post it looks something like this:1.5% x Average Yearly Pensionable Earnings During Highest 5 Years x Years Pensionable Service In real math: 1.5% x ($100,000) x 35 Years = $52,500.Pretty good. But there’s more good news when it comes to most defined benefit (DB) pension plans:
- Given this is a company benefit, the employer is taking on the investment risk – not you! The employer is essentially on the hook to manage the right investments to fund your pension income (and everyone else’s in the plan).
- This defined/predictable future income stream can be a huge enabler to figuring out your retirement income needs and wants. Potentially you don’t need as much personal savings?
- There are often direct survivor benefits with DB plans. This is not true with defined contribution pension plans or your personal assets – you’ll need to determine your beneficiaries (which is critical for estate planning) on your own.
- DB plans might be inflation-protected – so do check with your plan administrator. We all know inflation can be a wealth-killer, so accounting for inflation in any retirement plan is smart and it’s even better when that inflation-protection benefit is designed in!
- You can often choose the timing of starting your DB income. Some plans allow you to take your pension income at age 55 (great for income splitting), or later, to mix it with Canada Pension Plan (CPP) and/or Old Age Security (OAS) government benefits. This way, by altering the timing of when you start your DB pension you can be more tax efficient.
Disadvantages of Defined Benefit Pensions
Here are some we can think of:- “Golden handcuffs”. Are you working longer than you really need to, only to fund your pension vs. saving and investing on your own? Will you really stay with your employer for 30+ years? Something to consider. In fact, you can retire just using the TFSA if used wisely! (see below).
- Not all DB plans are indexed to inflation. We believe you really need to think about how to fight inflation in your asset accumulation years but even moreso in your asset decumulation years.
- You may have involuntary company leave. I mean, everyone generally believes they might stay in an organization they love for a long time but really, who knows! Although the company bears the investment risk with any DB plan, there is also insolvency risk. The employer needs/must fund the pension for you and others – otherwise, there may not be enough money to pay out any pension income. Be careful about putting all your money or a big sum of your hard-earned money in anyone’s hands…in just one basket.
- When you pass away, you may be able to leave a portion (or all) of your pension to your spouse. However, once your spouse passes away, the pension stops there and cannot be passed onto the next generation (except under some specific circumstances).
Do you need an RRSP if you have a defined benefit pension summary
Whether it’s a DB plan or a DC plan, we believe you’re likely better off than most if you have either as a workplace benefit. Again, lucky you, take advantage, and enroll! However, to answer this question for today’s post, we also believe you should still consider contributing to your RRSP even if you have a DB pension at work for the following reasons:- Any company pension DB plan does not allow you to double-dip related to your RRSP contributions. Meaning, your available RRSP contribution room will decrease in relation to your pension contributions at work by you and/or your employer. A Pension Adjustment (PA) is an annual calculation submitted to Canada Revenue Agency (CRA) that estimates the pension value a member earned in a registered pension plan in a tax year. It is reported on a T4. (The PA was introduced in 1990 to essentially level the retirement savings playing field between individuals who earn a pension entitlement in Registered Pension Plans (RPP) and those who do not. The PA reduces a RPP member’s RRSP contribution room for the following year to ensure individuals who belong to a RPP aren’t able to save more tax-sheltered funds for retirement than those without a RPP. For example, an individual’s PA from 2021 will be used to lower their RRSP contribution room in 2022.) Pension adjustments are created to ensure there is not a major unfair advantage created for someone with a company DB plan vs. a worker without one. That said, even if your RRSP contribution room is reduced and lower thanks to your company pension plan contributions, you should try and take advantage of RRSP contribution room for tax-deferred wealth-building. It’s one of the very few accounts you can use to do so. The other major reason we feel this way is below.
- Any financial future is a very uncertain and clouded place. That means, we believe you should still consider contributing to your RRSP even if you have a DB pension at work. Some deeper considerations on that note:
- Will you stay with your company that offers a healthy DB pension plan for 30-40 years consecutively? How do you know?
- Will the company change its employee benefits approach or strategy in the future? How do you know?
- Is your company pension plan solvent? How is that predictable?
- Will your pension plan income be enough to fund retirement alone? How do you know, especially when you factor in inflation, taxation, longevity risks, market and economic trends and more?
- What is the plan for your company pension plan and how might that change over the coming decades for estate and/or beneficiary planning?
Need help with the retirement planning puzzle?
Everyone has a different path on their asset accumulation journey. We know. At Cashflows & Portfolios, even though we both own 7-figure investment portfolios now, we’ve built our respective portfolios similarly but differently. The common denominator on our respective retirement readiness paths is we have leveraged various income sources in our asset accumulation years to help meet any future retirement needs and wants. That includes contributing to a workplace pension and the RRSP, managing a corporation, understanding how to optimize the use of the TFSA, managing a taxable investment portfolio, and more. Knowing how to manage such accounts, in asset accumulation and asset decumulation is something we can and want to help others with via this site.If you need some help solving your retirement decumulation puzzle, contact us.
If you are interested in obtaining private retirement projections for your financial scenario, please contact us here to get started.
- We encourage you to avoid these five big RRSP mistakes.
- This is how a part-time job can help you save your retirement plan.
Great article. One note would be – yes DB are “cash for life” however not everyone paying into a DB is making $100,000. Many are in the 50-75k range so the monthly payout is considerably less then the 57k in the example. Even factoring in CPP and OAS having an RSP (and TFSA) makes total sense.
Would agree Connie. We just did that to keep the math very simple and prove our point: hardly anyone stays in the same job for 35+ years AND makes consistently over $100k.
Are you investing these days? Wild times!
CAP
I’ll echo Connie’s comments. My
Wife has an OTPP DB plan but has been an occasional teacher for most of her career so her pension benefit will sit around 20-25% of her pre-retirement annualized salary so we do contribute to her RSP as well as a spousal RSP.
The nice thing about her plan is if the opportunity arises for her to get full time work for the next five years she could see some tremendous growth in her pension benefit due to the pension formula.
Great stuff James and makes sense to us. Even with a small DB OTPP benefit, that’s a nice base to build RRSP and TFSA assets around.
CAP
James,
What are the buyback opportunities with OTPP? I’m in AB and you can buy back sub time and have it partially subsidized by the Province. It’s often a simple transfer of funds from RRSP to pension manager.
Great question. The buyback period is long gone, and when we could we were a single income family with two toddlers 13 months apart and no maternity benefits. We decided decided for my wife to stay home until the kids reached kindergarten.
We don’t regret our choices but we didn’t realize the challenges she would face when trying to restart her career. The kids are 22 & 21 now but the challenges persist. She has been fortunate to get several full year maternity and stress leave positions the last few years, but that’s never a guarantee. If she can get them for another five years she’ll make a significant improvement to her db pension.
Yes, I feel fortunate to have a DB plan. Although I will only have 20 years of service when I retire, I am still getting “some” money from the plan. My question/confusion relates to RSPs vs TFSA. If my current income level (and tax bracket) is much higher (double) than it will be when I retire, shouldn’t I prioritize RSPs over TFSAs? Or is that a mute point since my RSP contribution room is so small every year (due to having a pension) that I can do both?
My 2 cents worth – if your current income is double your retirement income, you should contribute to the RSP rather than the TFSA. If your pension is relatively small, you can supplement your pension by withdrawing RSP funds in a lower tax bracket before starting CPP and OAS. I think most people with DB pensions should withdraw RSP funds and delay CPP to receive the automatic increases. Let’s see what C&P suggests…
Thanks David.
We think it depends.
If the goal is to reduce taxable income, now, then of course the RRSP works. That means by all means max out the RRSP – even if the contribution room is very small. Our point is: maxing out the TFSA is a gift for future tax mitigation – the more you can max that account out now, the better.
To your point, we have seen clients max out RRSPs over the years, only to now realize they need to slowly withdraw the RRSP funds in their 50s and 60s to avoid a heavy tax hit during those early retirement years. They simply haven’t realized the tax burden that RRSPs actually are – including with a DB pension. So, if you have a DB pension, and have been contributing to RRSPs over the years, it absolutely makes sense to start withdrawing from RRSPs potentially before CPP and OAS income streams kick-in. Some folks are taxed quite heavily in retirement with combinations of pension + RRSP + CPP + OAS income. A good problem to have though!
CAP
Here is a typo free version of my initial reply. Please substitute this version for the original…Thanks.
Another benefit of delaying CPP and even OAS payments until late 60’s or 70 and withdrawing much of ones RRSP funds in the years before starting CPP and OAS payments is that it reduces the risk of running out of money during your life time. CPP and OAS payments are for life and indexed to inflation. Another benefit is it is likely to even out ones income at a higher level.
Frederick Vettese’s book “Retirement Income for Life” is an excellent, fairly short, well written book that explains the strategy and the pro’s and cons.
Yes, we’ve written about that concept in various posts Paul, very important.
I/we see CPP and OAS as “big bonds” = inflation-protected, fixed income. This means if you can delay one or both, do so, since you can withdraw from RRSP/RRIF before CPP and even OAS payments begin. This way, you can smooth out taxation of personal assets over time and reduces personal investment risk too.
We like Fred’s work, very smart and are aligned with his thoughts on many fronts. I had (Mark here) a post on that one from My Own Advisor here:
https://www.myownadvisor.ca/retirement-income-for-life-review-and-giveaway/
We should do a book givevaway here 🙂
CAP/Mark
Unless one of your goals is to reduce income tax owing, now, then maxing out the TFSA and then striving to contribute to the RRSP is usually the best plan in our book. If your RRSP contribution room is very small, thanks to any pension adjustment, then it’s even more of a case to max out the TFSA first since you likely have more $$ to contribute to that account vs. RRSP contribution room. i.e., you can invest more money 🙂
You can always invest in both accounts of course! We have and do!
CAP
Marie, from personal experience, and in a similar sounding position to yours, I can tell you that to know for sure what is right for you, requires a lot of analysis – easyish when you know what you are doing and have the right tools, lots of time and effort when you don’t. There are so many moving parts it’s easy to get it wrong, and you can’t go back later for another run at it.
In my case, it worked out that only paying a certain amount into the RRSP each year and then switching to the TFSA produced the best result. In retirement, drawing from the RRSP enabling me to delay CPP a few years is working out well, but that might not be right for you.
Thanks Bob. I can only contribute $5k every year to my RSP anyhow, so I guess it’s not a big deal. I just wish that the TFSA contribution room was higher!
I worked 31 years with a DB plan . During that time I was able to max my rsp and also my tfsa in later years . My wife has no plan so income splitting is happening . But from my experience if people max tfsa they will retire happily and also follow the dividend strategy. Good luck all. Cheers
We would agree, Jeff. That TFSA is a gift of an account to every adult Canadian.
For my wife and I, even though I was contributing to a DB plan, it was a good move to pay into an RRSP to benefit from the difference in the tax refund while working and the tax we would pay in retirement i.e. 43.4% vs 27.75%. The money was actually going into a spousal RRSP as my wife didn’t have an income. This too was a good move as our retirement incomes today are, after some DB pension splitting, perfectly balanced. CRA gets it’s 27.75% and we get to spend the 15.65% on us.
The answer to the question is in the numbers. To get it just right requires a lot of effort; knowledge, calculations, and forecasting.
Mark here, Bob, I feel the same. Even though I have a small DB plan, I paid into my own RRSP so I could have options later on in life. Those days are near!
Absolutely, the math always helps!
CAP