Do you need an RRSP if you have a Defined Benefit Pension?

Whether or not you have a defined benefit pension plan, the Registered Retirement Savings Plan (RRSP) offers two huge benefits in our book:

1. A tax deduction from RRSP contributions made today, and
2. Tax-deferred growth as long as assets stay inside the RRSP account.

These are very helpful benefits and tools in your retirement planning toolbox.

However, for some Canadians, they might want to consider avoiding RRSP contributions because the tax savings today may not be worth the potential higher tax rate in retirement.

So, this begs an important retirement planning question for an answer:

Do you need an RRSP if you have a defined benefit pension?

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:

1. 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).
2. 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?
3. 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.
4. 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!
5. 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.

Of course, there are some downsides when it comes to defined benefit pension plans and this relates to our question:

Do you need an RRSP if you have a defined benefit pension?

Disadvantages of Defined Benefit Pensions

Here are some we can think of:

1. “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).
2. 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.
3. 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.
4. 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).

Further Reading:

• You can retire using just your TFSA!
• How you can take advantage of inflation can be found here.

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?

As you can appreciate, these are big questions without easy answers that also change over time.

At Cashflows & Portfolios, we believe a solid asset accumulation investment strategy should take advantage of any defined benefit pension plan as an enabler to retirement savings, while encouraging all Canadians to prioritize maxing out their TFSA over their RRSP. You know from us that using your TFSA for long-term wealth-building, your eventual withdrawals from this account will not be taxed. Unless you’re anticipating a sizeable pension in retirement (which is almost certain to drive higher taxes in retirement than when working), after you max out your TFSA you should also consider contributing to your RRSP for retirement income planning.

By having multiple income sources in retirement, your potential pension, TFSA, RRSP, taxable income, let alone government benefits, you have removed the risk of putting all income eggs into any retirement basket.

For these key reasons and a few more, we believe that it’s always better to save a bit more money for retirement than not to save enough – should any employee have a DB pension plan at work they should also consider saving and investing for their retirement using some RRSP contributions as well.

We welcome your thoughts on this subject!

Mark and Joe.

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.

Stay tuned for more, great, FREE content on our site. We’re happy to publish it.

Further Reading:

• We encourage you to avoid these five big RRSP mistakes.
• This is how a part-time job can help you save your retirement plan.

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