Tuesday, October 23, 2007

Making sense of pensions

Reading Tim's post last week at Canadian Dream: Free at 45 about his company's new pension plan got me thinking about the components of my own retirement plan.

I contribute to an RRSP. That's it.

My employer offers a defined-benefit pension plan, but I have not enrolled. The big reason is that I don't know how long I will stay with the company (who does know this?). Of course, there's also the fact that I really don't understand pensions all that well. I know the contribution rates, and can calculate what my future benefit would be under certain assumptions, but I'm having a hard time working out just how the pension plan stacks up against the option of investing my would-be contributions myself.

With a pension, in addition to your monetary contributions to the plan, you're making a time and service investment to your employer, so it makes sense that you would get more out of it than just the dollars you've put in. If I make the $3,250 annual contribution to the pension plan, then 20 years of service gives me a benefit of roughly $20K per year, whereas an annual return of 7% on the same amount invested in the market for 20 years comes to $146K, which, assuming 5% investment income, could sustain $20K per year for only 8 years. That's a big difference.

What I've realized during my hashing out of these scenarios, is that I'm not sure how to handle a number of the assumptions required to make these projections. How do you forecast something like an RRSP contribution limit? Marginal tax rates? Pension contribution limits and YMPE? Do you assume these factors will remain constant, or do you apply some sort of inflation factor over time? I'd appreciate your thoughts on this.


George W. said...

Pensions are complicated beasts, but they're definitely worth contributing to, especially since the employer will contribute to the plan as well. As long as you stay in the plan for a few years (the "vesting" period), the benefits will be yours for life, whether you stay employed with that employer or not - the benefits can either be transferred to your new employer's pension plan (in some cases) or transferred to a LIRA (in other cases).

I highly recommend a book called "The Pension Puzzle: Your Complete Guide to Government Benefits, RRSPs and Employer Plans"; the authors are Bruce Cohen and Brian Fitzerald. It's the only book I've found that explains pensions in Canada with any sort of depth. Most libraries should have a copy, or you could order it from Amazon.

SavingDiva said...

I'm lost about pensions as well. However, I do appreciate your post. If you do have any new knowledge, it would be a great educational post (for someone like me).