Defined contribution (DC) pension plans have grown in popularity among Canadian employers and employees in recent years. This type of group retirement savings plan helps workers save for retirement through regular contributions made by both the employee and employer.
But how exactly does a DC pension plan work? What are the key features, pros & cons, and rules around withdrawing funds? Our guide here will explain everything you need to know.
What is a Defined Contribution Pension Plan?
A defined contribution pension plan (DCPP) is a registered pension plan offered by an employer. The contributions made by the employee and employer are pre-defined, usually as a percentage of income.
With this plan, the retirement income provided is not predetermined. It depends directly on the total contributions made and the performance of the investments. Employees bear the risk and responsibility for investing the money and funding their retirement income.
How Does a Defined Contribution Pension Plan Work?
A defined contribution pension plan (DCPP) operates by having predetermined contributions made to an employee’s individual account by both the employee and the employer.
The employee directs how these contributions are invested by selecting from a range of available investment options offered through the plan. The growth of the account over time depends on the performance of the invested contributions.
At retirement, the total amount accumulated in the account is used to provide retirement income for the employee. Unlike defined benefit pension plans, the retirement income is not pre-determined or guaranteed. The income level will depend entirely on the account balance at the time of retirement.
What Are The Key Features of DC Pension Plans?
Defined contribution pension plans have four key features that make them an attractive retirement savings option for many Canadian workers:
- Tax-deferred growth: No tax is paid on investment earnings in the account until funds are withdrawn. This enables faster growth compared to a regular, taxable investment account.
- Employer contributions: Many DC plans involve matching or non-matching contributions from the employer. This amplifies the retirement savings.
- Wide investment options: Employees get to pick from a selection of investment funds and asset mixes based on their risk tolerance.
- Portability: If an employee leaves their job, the DC account can be transferred to the new employer or converted to a personal Locked-in Retirement Account (LIRA). This provides control over your pension savings.
Other features may include retirement planning tools, professional investment management, low fees through group buying power, and automatic payroll deductions that help you save consistently.
Who Is Eligible To Participate in a DC Pension Plan?
Eligibility criteria for joining a DC pension plan can vary between different plans and provinces. But generally, full-time employees are required to join their employer’s plan after a specified period, such as one or two years of service.
Part-time employees may also be eligible if they meet certain criteria, such as:
- Earning a specified level of income
- Working a minimum number of hours
- Being employed for a certain period of time
Companies also have the option to offer DC pension plans on a voluntary enrollment basis. Then, it is up to each employee to decide whether they want to opt in and start contributing to the plan. Voluntary plans may appeal to employers who want to provide access to those interested, but not force mandatory enrollment.
How Are DC Pension Plan Contributions and Limits Determined?
In a DC pension plan, employees are typically required to contribute a percentage of their salary, often between 0.5% to 3%.
There are annual limits that apply to the combined employer and employee contributions:
- For 2025, the total contributions are capped at 18% of the employee’s earned income up to $33,810.
- Unused RRSP contribution room can allow higher DC pension contributions beyond these limits.
- Voluntary additional contributions can also be made by employees to supplement their retirement savings.
These extra contributions can help boost your retirement income, especially if you start early. However, it’s important to track your total contributions to avoid going over the annual limit.
Pros and Cons of Defined Contribution Pension Plans
DC pension plans have some great benefits that give employees more control and flexibility:
- Employees have control over how contributions are invested based on their risk appetite and objectives.
- Strong potential for higher investment returns compared to conservative options.
- Accounts are portable when changing jobs compared to defined benefit pensions.
At the same time, these plans also have some downsides that need to be kept in mind:
- No guaranteed retirement income – account balance and returns are uncertain.
- Employees bear the responsibility for investment decisions and performance.
- Subject to market risks based on the chosen investment mix. Poor returns can impact retirement income.
Generally, DCPPs can be a great way to build retirement savings for the future. Still, it’s important to understand the risks and take an active role in managing your investments.
When Can You Withdraw Funds from a DC Pension Plan?
Funds from a DC pension plan cannot be withdrawn before retirement, unlike those from an RRSP. The earliest age an employee can retire and start receiving DC pension income is 10 years before the normal retirement age, typically 55.
If an employee leaves their job before retirement, they have the option to transfer their DC account balance to:
- A Locked-In Retirement Account (LIRA)
- Another pension plan (if permitted)
- Purchase an annuity
Hardship provisions may allow for the early withdrawal of funds in exceptional cases, such as financial hardship or disability. However, restrictions apply, and taxes are owed on withdrawn funds.
Overall, the locked-in setup is designed to help your savings grow over time. Taking money out early can lower both your contributions and the long-term growth of your retirement fund.
How to Convert DC Pension Assets into Retirement Income
At retirement, there are two main options for converting defined-contribution pension assets into retirement income:
- Annuitizing the account balance – This involves using the accumulated capital to purchase an annuity from an insurance company, which then provides a guaranteed income stream for life.
- Transferring funds to a Life Income Fund (LIF) – This type of locked-in account requires you to withdraw annual income between a minimum and maximum amount each year. LIFs provide income flexibility while ensuring the funds last.
DC pension holders can also combine these options, annuitizing a portion of their assets and transferring the remainder into one or more LIF accounts. This hybrid model balances guaranteed income with maintaining control over the investments.
No matter the approach, the goal is to convert lump-sum savings into steady taxable income to support retirement needs. Withdrawals are taxed as regular income.
How Do DC Plans Compare to Other Retirement Savings Accounts?
Of course, there are different types of retirement savings accounts that you can take advantage of, and it’s helpful to know how a DC plan compares.
DCPP vs. RRSP
While DC pension plans and RRSPs are two of the main retirement savings tools for Canadians, they have some notable differences:
| Feature | DC Pension | RRSP |
| Withdrawals | Usually locked-in | Anytime |
| Contribution Limits | $33,810 for 2025 | $32,490 for 2025 |
| Employer Contributions | Yes | No |
| Responsibility | Shared | Individual |
| Growth & Risk | Institutional options | Self-managed |
| Fees | Potentially lower | Varies |
DC vs. Defined Benefit (DB) Pension
DC and defined benefit pensions (DB) differ mainly in their income structure:
| Feature | DC Pension | DB Pension |
| Guaranteed Income | No | Yes |
| Funding | Shared | Employer |
| Investments | Employee managed | Employer managed |
| Risk | Higher | Lower |
| Portability | Higher | Lower |
As you can see, each plan type comes with its own pros and cons. So, choosing the right one depends on your financial goals, and whether you prefer more control or more certainty.
Integrating DC Pension Income with Other Sources
DC pension plan savings can be combined with income from other sources, such as Government benefits (OAS, CPP), RRSP/RRIF savings, non-registered savings, home equity, etc.
Layering multiple income streams helps provide sufficient income and optimize cash flow and tax efficiency throughout a longer retirement.
The bottom line
Defined contribution pension plans are a growing workplace retirement savings vehicle for Canadians. They provide many benefits, including tax-deferred investing, employer contributions, and flexibility. Understanding how DC plans work, including their key features, eligibility rules, and retirement options, is important for maximizing their advantages as part of an overall retirement plan.
FAQs related to Defined Contribution Pension Plans in Canada
How are defined contribution pension plans taxed?
Contributions made to a DC pension plan are tax deductible and investment earnings grow tax-deferred. Taxes are only paid when money is withdrawn in retirement at regular income tax rates.
What happens to my defined contribution pension if I die?
DC pension funds can be transferred tax-free to a surviving spouse. For non-spouse beneficiaries, the funds are paid out as a taxable cash lump-sum.
Where are the funds in my defined contribution pension plan held?
DC pension assets are held in a trust fund by the plan administrator and kept separate from the employer's finances
When can I start collecting my defined contribution pension?
Most DC plans allow starting pension income at least 10 years before the normal retirement age, typically age 55
Do I have to contribute to my employer’s defined contribution pension plan?
Typically, full-time employees are required to join their employer’s DC plan. Part-time staff may need to meet eligibility criteria
Is a defined contribution pension plan better than an RRSP?
DC plans allow higher tax-deductible contributions than RRSPs and benefit from employer contributions. But RRSPs offer more flexibility.
