Employers have several options available to them when it comes to setting up a retirement savings plan for their employees. Defined Contribution Pension Plans and Group RRSPs are the most accessible plans for most businesses. Here is what you need to know about each plan and the benefits for your employees.
What Is A Defined Contribution Pension Plan?
A Defined Contribution Pension plan is an employer sponsored retirement savings scheme available to Canadian business owners and their employees. Defined Contribution Pensions Plans are made up of a combination of employee contributions, employers’ contributions, and an optional voluntary contribution component. Defined Contribution Pension Plans are regulated by provincial pension laws, which vary from province to province.
What Is a Group RRSP?
A Group Registered Retirement Savings Plan (Group RRSP) is an employer sponsored retirement savings plan. Group RRSPs are identical to individual RRSPs with the only difference being that they are administered on a group basis. The plans are made up of employee and employer contributions, but unlike traditional pensions, the employer is not required to contribute any amount to the plan.
Similarities and Differences
Tax Deferred Savings
Both Defined Contribution Pension Plans and Group RRSPs offer tax deferred savings for employees that contribute to them. Contributions are taken at the source before tax and contributed to the plans on the employee’s behalf. Both investment options allow employees’ investments to grow tax free until retirement, and the funds are only taxed upon withdrawal.
Contribution Limits
Both plans are subject to annual contribution limits. This amount is equal to a percentage of each employee’s income from the previous year. Both employee and employer contributions count towards this annual limit. Both plans will also cause a pension adjustment to employees. This means their individual RRSP deduction limit will be reduced based on the amount contributed to their employer sponsored plan. This keeps an equal playing field for those who do not have work pensions.
Age Limits
Both Defined Contribution Pension Plans and Group RRSPs require that employees stop contributions and start making withdrawals from the plans at the age of 71. At this point, employees must convert the plans to an income fund that will produce retirement income. For Defined Contribution Pension Plans, this fund is called a Life Income Fund (LIF). LIFs have minimum and maximum withdrawal requirements that plan holders must adhere to. Group RRSPs holders have two options at age 71. They can either cash out the plan and pay all tax owing or convert the plan to a Registered Retirement Income Fund (RRIF) and start drawing income from it. RRIFs have minimum withdrawal requirements that plan holders must adhere to.
Pros and Cons
Defined Contribution Pension Plans
Pros
- Attractive to Employees due to the employer matching component. This can greatly accelerate employees’ retirement savings.
- Funds are locked-in and therefore not accessible until the employee retires. They do not have the option to spend their retirement savings frivolously.
- Funds grow tax free if they stay in the account
- Employer Contributions are tax deductible
- Typically, investments offered in a Defined Contribution Pension Plan carry lower investment management fees.
- Large selection of investment options available within the plan.
Cons
- Defined Benefit Pension Plans can come with higher administration costs and require continuous maintenance.
- Funds are locked-in until retirement.
- Employer contributions are expected. This can be a significant expense, depending on how many employees a business has.
- Benefits at plan end are at the mercy of market fluctuations.
Group RRSPs
Pros
- Employer contributions are not mandatory. This allows for businesses to offer their employees a retirement savings option regardless of the financial abilities of the company, with the flexibility for the company to contribute at any point when this becomes feasible.
- Funds grow tax free if they stay in the plan.
- Group RRSPS have low start up and maintenance costs.
- No legislative regulation means flexibility for employees to dip into their savings to take advantage of the Home Buyers’ Plan or the Lifelong Learning Plan.
Cons
- Employees have the option to withdraw from the plan at any time which can severely impact their retirement savings.
- Investment opportunities are limited to the roster of products offered by the plan carrier. These will often come with high investment management fees.
- Employer Contributions are a taxable benefit to employees.
- Benefits to employee are not guaranteed and are subject to market fluctuations.
Bottom Line
Both plans have advantages and disadvantages, with each having something unique to offer. Whichever you choose for your business, you can rest assured you are helping your employees work towards a financially secure retirement!