Understanding Defined Contribution Pension Plans: What You Need to Know

My first full-time job did not have any benefits. I am aware that in certain careers, a lack of an employer-sponsored retirement saving benefit is the norm, whether a Defined Benefit pension, plan, Defined Contribution pension plan, Group RRSP, or Deferred Profit-Sharing Plan. Nevertheless, for many Canadians, a workplace retirement savings plan of some sort is a key component of financial security in retirement.

 

For this blog post, I want to focus on Defined Contribution (DC) pension plans. I don’t know whether I can refer to them as the dominant model in the private sector, but it is certainly true that many companies that once offered Defined Benefit (DB) pensions have switched to the DC model.

 

Unlike DB plans, DC plans shift investment and longevity risk to the employee. That doesn’t mean DC plans are bad; having almost any kind of employer-sponsored retirement savings plan is better than not having one at all, especially since it usually means you effectively receive additional income from your employer.

 

The purpose of this post is to demystify how DC plans work and help Canadians make better retirement decisions.

 

What Is a Defined Contribution Pension Plan?

A DC Pension is a retirement plan where the employer defines how much they will contribute, not what the benefit will be.

 

Typically, the employee must also contribute a fixed percentage of salary, often matching the employer’s contribution.

 

Plan assets are held in individual accounts for each participant and managed by a plan administrator, not the employer.

 

Unlike a DB plan, in the case of DC pensions, retirement income depends on total contributions and investment returns, not a predetermined formula.

 

Pension plans are regulated under either federal or provincial pension legislation depending on the employer’s jurisdiction. You will often find that employers are provincially regulated. Three notable industries that fall under federal jurisdiction are Banking (e.g., Royal Bank of Canada), Telecommunications (e.g., Telus), and Transportation (e.g., Greater London International Airport Authority, that is, the airport here in London, ON, where I live).

 

How Contributions Work

Employer contributions are usually a percentage of salary, and, if not mandatory, are often contingent on employee contributions. Sometimes there will be a smaller percentage that the employer will contribute that does not need to be matched by an employee amount.

 

Employee contributions are typically matched by the employer. Sometimes, employee contributions are required to receive any employer funds; in other situations, employee contributions will trigger additional employer contributions up to a specified limit.

 

Contribution types vary by employer but can include the following:

 

• Fixed: e.g., 5% of earnings by the employer + 5% of earnings by the employee
• Graded: e.g., higher contributions at higher salary tiers
• Additional Voluntary contributions: or AVCs, if permitted by the employer/sponsor

 

Vesting rules dictate when employer contributions become fully owned by the employee. Some employers offer immediate vesting, while others may impose a longer period, such as two years of employment, for example.

 

Annual contribution limits are governed by the Canada Revenue Agency (CRA). As with Registered Retirement Savings Plans (RRSPs), the maximum is 18% of earned income up to the dollar limit for the year. In 2025, the DC plan contribution limit is $33,810, which will be the RRSP limit for 2026.

 

Investment Choices Within a DC Plan

The Plan Administrator is often an insurance company. Sun Life, Manulife, and Canada Life are among the biggest players in this space. While I worked for my church in Japan and Canada, I accumulated a DC plan under the administration of iA Financial Group, another significant player in pension plan administration.

 

Range of investment options: This can vary depending on what the sponsoring company and plan administrator have agreed to, but among the typical options are:

 

• Target-date funds (the default for many plans)
  • These funds automatically adjust the risk level as retirement approaches, reducing the proportion in equities in favour of adding more to bonds. This is a simple “hands-off” option for employees who are not comfortable with selecting their own investments.

 

• Balanced funds
  • This is typically a combination of equities and bonds but may also include investment opportunities usually only available at the institutional level, such as “alternatives.”

 

• Canadian, U.S., international equity funds
  • Individual participants may want to select their own investments instead of relying on a packaged solution like target-date funds or balanced funds.

 

• Bond funds, money market options
  • Those who want to select their own investments may use some combination of equity funds plus bond funds and/or money markets to effectively create a balanced portfolio.

 

Employee-directed investing:

As noted above, there is generally an opportunity, if not an obligation, to personalize your DC pension portfolio. For those who are not satisfied with the default, a menu of funds is available to choose from. Depending on the plan, the menu may not be particularly attractive, however. Sometimes, the range of funds available is limited, or those that are available have excessive investment management fees, index-tracking options do not exist, etc. Nevertheless, strides are being made in establishing guidelines that are in the plan participants’ favour.

 

Fees for the investment options are typically lower than retail mutual funds but vary by provider and type of fund. A fund that is lower priced than its retail equivalent is of little value if it would not be an investment fund that the plan participant would like to invest in.

 

The Accumulation Phase: Building Your Retirement Savings

The comments in this section can also, to a large extent, apply to investing in general.

 

• Start early: Compounding benefits increase dramatically over time.

 

• Contribute consistently: Regular contributions are the key to growth. Usually, this is not a problem as contributions are deducted from the employee’s income every paycheque on a pre-tax basis. Being able to automate investment contributions is a great boon to people seeking to build up their savings for retirement.

 

• Review investments periodically: While it is important to do this, the kinds of things that a review is supposed to accomplish, like confirming that your investments fit your risk tolerance and retirement timeline, and periodically rebalancing toward your target asset allocation can also be done automatically and is frequently a built-in feature.

 

• Avoid common pitfalls:
  • Ignoring a pension account for years is generally less problematic due to the prevalence of automated contributions. However, plan participants should still review their accounts periodically. A previously selected fund might be replaced with one that the member finds unsuitable, or newer, lower-cost options may become available. While target-date funds are a convenient default for many, they may not be the best fit for all plan members.
  • Overconcentration in employer stock, if allowed, is a bad idea because of the risk involved. Plan members already have a significant amount invested in the company under their employment status. Further investment by putting company stock into their pension plan puts employees at serious risk of not only job loss, but pension loss, if the company becomes insolvent. One of the most important rules in investing is to diversify and one’s pension plan is not excluded from that rule.
  • Chasing recent performance does not mean day trading, but the tendency to regularly update the portfolio by picking the most recent hot-performing fund is not eliminated in a pension plan. This can be the case especially when the options include actively managed funds that are seeking to beat the market but more often than not are simply volatile. Again, settling on a diversified asset mix and sticking with it over the long term, is often a better choice, even though it should be reviewed periodically.

 

The Retirement Transition: What Happens at Retirement?

• A specific income is not guaranteed: The account value at retirement determines the plan members’ available options.

 

• Option 1: Transfer to a Life Income Fund (LIF):
  • This continues tax-deferred investment growth. It can continue to hold the same investments under the administration of the same insurance company, or it can often be transferred to an investment firm where the account holder can either manage it in a self-directed manner or turn it over to an advisor or portfolio manager.
  • Once transferred to a LIF, just like when an RRSP is transferred to a RRIF, annual withdrawals must begin. Unlike RRIFs, which have only minimums, LIFs have both minimum and maximum withdrawal limits.
  • Locked-in rules apply: Depending on the jurisdiction, at the time of switching from accumulation to disbursement, the option may be available to “unlock” a portion of the pension plan and move it into an RRSP or RRIF.

 

• Option 2: Purchase an annuity:
  • A Defined Benefit (DB) plan is an annuity. Purchasing an annuity with the lump-sum value of a DC plan is to effectively convert the DC plan into a DB plan, providing the plan participant guaranteed income for life.
  • Doing so eliminates both investment risk and longevity risk.
  • Annuities come with options. If the plan member is married or in a common-law relationship, typically there will be a mandatory survivor option for the partner that continues at a reduced level, e.g., 60% or 70%. One can also buy payout guarantees of, for example, 10 years so that a named beneficiary can continue to receive payments after the early death of an annuitant. Indexing at, for example, 2% per year, provides a perceived hedge against inflation, although it means that a lesser amount is received early on versus an unindexed annuity.

 

• Option 3: Combine LIF and annuity:
  • This provides a balance of guaranteed income and flexibility/liquidity.
  • This option could be appreciated by retirees who want both elements, a degree of income certainty plus the ability to control investments and invest in a manner that has the potential for returns that are greater than inflation.

 

Unlocking and Portability

• Unlocking may be possible under specific circumstances, depending on the jurisdiction. The following are examples that may not apply in all locations:
  • Small balance rule: the total value of all locked-in assets is not more than 50% of the YMPE in the year (50% of $71,300 in 2025, or $35,650).
  • Non-residency: after ceasing employment with the plan sponsor and leaving Canada for 2+ calendar years (a calendar year = 183 days or more in the year)
  • Financial hardship: this can be due to low income or high medical or disability-related costs. Zero income can mean up to 50% unlocking. At 75% of YMPE or $53,475 income in 2025, unlocking under financial hardship is eliminated.
  • Shortened life expectancy: no specific time limit is specified. Instead, a physician must certify that a medical assessment has determined that unlocking is warranted.

 

• Portability at job change:
  • A DC account can be transferred to:
    • Another employer’s plan (if allowed),
    • Locked-In Retirement Account (LIRA),
    • In rare cases, a personal RRSP if plan rules and provincial laws allow.
  • The pension plan will have a default, so it is critical to make a timely transfer decision if the default is not desired.

 

Tax Implications

• During accumulation, i.e., your working years
  • Contributions are tax-deductible.
  • Investment income and gains grow tax deferred.

 

• During decumulation:
  • Withdrawals from a LIF or payments from an annuity are fully taxable as income.
  • Annuitants cannot “income split” with their spouse/partner until age 65 unless the payments come from a RRIF or LIF with eligible terms.

 

• Coordination with other registered accounts is a significant challenge:
  • Unlike the income-earning years when money was usually accumulated from only one source, in retirement, the annuitant needs to consider how RRSPs, TFSAs, CPP, and OAS interact with LIF withdrawals or annuity payments.
  • Tax-efficient drawdown strategies can help to minimize the lifetime tax burden.

 

Planning Considerations

If you participate in a DC plan, your big question may be:

 

Will the DC pension provide enough income?

Pension plan websites often provide tools that allow you to project the income you can expect to receive in retirement.

 

You may wish to consult a financial planner to model different outcomes.

 

Supplementing with personal savings:

Depending on your personal history, including retirement savings plans offered by your employer(s), it may be important to have additional sources of retirement income. This can include personal RRSPs, TFSAs, and non-registered accounts.

 

Risks to plan for:

Longevity Risk is hugely important. If you plan to live to age 75 and you live to 95, there is a 20-year financial gap that needs to be covered.

 

Inflation, which erodes purchasing power, is often best addressed by retaining a significant portion of your investment assets in equities (stocks), which have a history of outperforming inflation over the long term.

 

Market risk, nevertheless, is a factor that cannot simply be ignored. Investment losses are a real possibility, although evidence suggests that a globally diversified equity portfolio of stocks will serve retirees well… if the volatility can be tolerated.

 

Creating a retirement income plan includes, among other things:

• Deciding when to begin drawing CPP and OAS,
• Determining the order of withdrawals from registered and non-registered accounts, and TFSAs,
• How or whether to blend annuities and LIFs.

 

 

DC Plans vs. Other Workplace Retirement Programs

The following is a very brief comparison of other plans that your employer may offer to help you save for retirement.

 

• Defined Benefit (DB) Plans:
  • Offer a guaranteed benefit; the employer bears the responsibility to fund the plan according to the stated terms but consequently also bears the risk.
  • DB plans have become less common due to the cost and potential volatility of funding requirements depending on the investment performance of the assets that the pension invests in.

 

• Group RRSPs:
  • These are not pension plans so pension legislation to protect them does not exist.
  • There are no locking-in rules so undisciplined retirees can quickly deplete their retirement assets.
  • On the other hand, group RRSPs are more flexible and therefore easier to adapt to a particular retirement income strategy.

 

• Deferred Profit Sharing Plans (DPSPs):
  • These are employer-funded only; the employee does not contribute to these plans.
  • DPSPs may be used alongside DC plans or group RRSPs. I have seen situations where the employer funds a DPSP and an employee contributes to the group RRSP. Effectively, the DPSP is the employer’s matching contribution.
  • Vesting rules may differ. The Income Tax Act requires that vesting must occur not later than two years after the employee begins to participate in the plan, but the employer may choose to allow vesting earlier.

 

To recap, DC plans are an important but complex component of retirement. Employees must take active roles in contribution decisions, investment selection, and planning the transition to retirement. While many do just fine on their own, if you are uncertain about what to do, feel free to reach out. There is no cost for an initial consultation.

 

This is the 289th blog post for Russ Writes, first published on 2025-05-12.

 

 If you would like to discuss this or other posts, connect on Facebook,  Twitter aka X, LinkedIn, Instagram, Mastodon, or Bluesky.

 

Click here to contact me for an appointment.

 

Click here and select FinPlan30: Financial Planning in 30 min under Specific Questions for a 30-minute free no-obligation financial planning conversation.

 

Click here for a 2-week free trial of the Money Architect Financial Planning platform.

 

Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.

 

Photo by Willfried Wende on Unsplash