A defined contribution plan is sometimes call a money purchase plan. This plan is the opposite of a defined benefit plan because the contribution is defined and not the benefit. The contributions are a percentage of the employee’s salary, usually 2-2.5%. The employer will then match the employee’s contributions, which will total the amounts to 4-5% of the employee’s salary.
The pension that is received upon retirement depends on the performance of the funds and the length of time that has been invested in those funds. These funds are like RRSPs where contributions are tax deductible to both the employer and the employee. The growth of the investments is tax-sheltered until withdrawn at retirement. With a defined contribution plan the outcome is dependent on the plan’s investment strategy and the employee will not know the level of benefits until retirement.
Much like RRSPs the contributions made to defined benefit plan are subject to yearly maximums
Some highlights of a defined contribution plan include:
- The employer may impose a vesting period of up to 2 years.
- The contribution formula is clearly defined
- After the contributions vest, all monies are locked-in
- Employer contributions are NOT subject to payroll taxes
- Legislation states that voluntary contributions are allowed to be redeemed; however, employers have the option of locking-in all contributions
- Plans are creditor proof
- Low administrative costs
- The employer is responsible for the plan
- Creates a Pension Adjustment (PA)