New Employee Group Plan Vancouver, How Sponsored Pension Plan Works
What is a pension plan? In Canada, apension plan is a form of retirement plan wherein an employer is required to make contributions to a fund which is set aside for an employee’s future benefit. The funds are invested in the employee including earnings generated by the investment.
Talk to an expert from Save Corporation Tax to know how to can proceed with a pension plan.
Some plans feature a voluntary investment component apart from the employer’s contributions to the pension plan. In this case, the employee may contribute part of his income and divert into an investment plan to fund his retirement. The employer can also match part of the employee’s annual contributions.
Which Parties Should be Involved Setting Up a Group Pension Plan?
Usually, a pension plan relies on various service providers including an administration plan provider, life insurance companies, investment fund manager, and trust companies. A third-party administration plan provider keeps the records of the pension plan while an investment fund manager is in charge of the assets of the pension fund. An insurance company, on the other hand, can also provide the administration plan servicers and investment management. Meanwhile, trust companies offer custodial services.
Different Types of Group Pension Plan
There are two basic types of pension plans: defined benefit and defined contribution plan.
1. Defined benefit plan
This type of plan provides its members or employees with a retirement income based on a calculation depending on his and years of service rendered with the company. The employee can contribute to the plan while working for the company.
The contributions from both the employer and members are collected in a pension fund and used for investment. The employer is responsible for ensuring that the pension plan can pay the members the retirement income.
The employer guarantees that the member receives a certain amount of benefit after he retires regardless how the investment is performing. If the assets of the plan are not enough to pay the benefits, the employer becomes liable for the remaining amount of the payment.
2. Defined contribution
This plan is also sometimes referred to as capital accumulation. This type of pension plan allows companies to sponsor the plan without any investment risks involved. Each employee has his own account and the contributions from both employer and member are investments which are usually based on the investment selected by the member.
The member’s retirement income is determined by the performance of your investment. With a defined contribution policy, the employer creates a specific contribution plan for the employee. The employer’s liability to pay the benefits ends once the contributions are made.
This plan is also more affordable compared to a traditional pension. Therefore, a lot of companies are using this type of pension plan.
Some companies offer both types of pension plans to their employees. In some cases, there is another type of pension plan known as pay-as-you-go. This is set up by the employer but is often funded by the employee. The member can opt for a salary deduction or a lump sum contribution.
How an Employee Participates in the Plan
Members of a defined benefit plan do not pay direct fees and the pension plan may pay for the fees for investment management. On the other hand, members of the defined contribution plan may pay fees for the investment management as well as other services. These fees are often incorporated into the expense of the plan.
Are Pension Plans Taxable?
Most pension plans sponsored by an employer have a tax-advantage status wherein employers receive a tax break on the contributions they make. The same goes for employees whose contributions come from their salaries which are taken from their gross income and thus, reducing the taxable income.
The funds are put into a retirement account at a tax-deferred rate. This means that there is no tax due as long as the funds stay in the account. Both the defined benefit plan and the defined contribution plan enables the employee to defer the tax on the plan’s earnings wherein the dividend income can be reinvested.
Once the employee retires and starts receiving the benefits from the pension plan, he may have to pay state income or federal taxes. On the other hand, in case an employee does not have any investment or did not contribute anything in the pension plan, received all contributions tax-free or if the employer did not withhold any contributions from the member’s salary, the pension plan is fully taxable. Meanwhile, if the employee contributed after the tax was paid, the pension is partially taxable.
Distribution Plan
Employees with a defined benefit plan usually have two options in terms of the distribution. It can either be periodic which is usually monthly or a lump sum. In other cases, some plans allow you to do both options. Employees can take out a portion of the money in a lump sum and use the remaining amount to generate payments.
Annuity Payments
However, before you decide on a distribution plan, make sure you consider several factors first. Monthly annuity payments usually come as a single life annuity intended for you as an individual or as a joint and survivor annuity designed for you and your spouse. A joint and survivor annuity usually pays 10% less than a single life annuity. However, the payouts continue even after the employee’s death or when the surviving spouse dies.
Most people use a single life annuity and purchase a whole life insurance policy in order to provide benefits for the surviving spouse. The payout ends when the employee dies while the surviving spouse receives a huge death benefit which is tax-free. The payout can be invested and used to replace the taxable pension that ended.
This strategy is often referred to as pension maximization which is often implemented if the insurance cost is less than the difference between the two types of distribution payouts.
Annuities usually have a fixed rate and may or may not have inflation protection. Without inflation protection, employees will receive a set amount once they retire and can reduce the value of annual payments. Hence, most employees prefer to receive their benefits in a lump sum.
Lump Sum Payments
Employees who prefer lump sum means that they won’t have to worry about losing their pension in the event the company files for bankruptcy. They can, however, use and invest the money to earn a better interest rate. Meanwhile, if there is some money left after the retiree passes away, they can pass it along as part of their estate.
However, unlike annuity payments, lump sum payments do not have any guaranteed lifetime income. The employee is the one in charge of making sure the money will last him through his retirement. Also, the whole amount may be taxed unless you transfer the amount into a tax-sheltered account.
Employees under a defined benefit plan who are working for a public company will receive a lump sum equal to their contributions. Those who work for a private sector, on the other hand, will receive an amount equal to the value of the annuity or the total of the expected lifetime payments.
When an Employee Decides to Leave the Company
In case an employee decides to change careers and leave the company, he can choose from several options. However, it is always better to discuss your options with a financial advisor because the options can be quite complicated. Get in touch with a professional agent at Save Corporation Tax to help you make the right choice.
In most states, pension plan members may be vested. This means that members will receive the benefits from their own contributions as well as those from the employer without losing the employer’s contributions.
Some plans require the employee to work for a company for a specific period before he is vested. If the employee decides to leave before the benefits are vested, they will only receive the value of their own earnings and contributions. Meanwhile, if the pension plan benefits are vested by the time the employee leaves the company, he can choose from a number of options depending on the plan.
The employee can leave his assets in the plan or transfer the value of the plan to another pension plan as long as the new plan allows a transfer. Another option is to transfer the value to a registered retirement saving plan or other plans that do not allow employees to withdraw the money until they retire. Lastly, the employee can take the cash value assuming that it is not locked in the plan.
Conclusion
When it comes to retirement plans, there is no such thing as one fits all. All plans differ from each other depending on the company. Hence, employees need to understand how a pension plan works as well as what the company they are working for is offering. This will help you determine how you can participate in the retirement plan and how you will be able to pay for it.
