How does Canadian pension work?

Question

I’m confused by pensions. I’m 24 and embarrassed to admit I don’t know how pensions work and what I’m entitled to. I see that a portion of my paycheck (at least $50 CAD each check) goes to Canadian Pension Plan Contribution. When I retire, does this mean I will be taken care of to a certain degree? Thanks in advance.

In: Economics

Answer 1

Pensions come in two varieties. A defined benefit plan collects money from you and your employer while you work, and then pays you a benefit based on your earnings over the years – typically something like X percent of your last Y years earnings, less A% per year you retire early and B% per year less than C years worked. Plans like that were popular in the pre-1979s era. They work very well when people live a few years past retirement and then die. Now, with people routinely living into their 90s, they are ruinous for the organization that has to pay the pension. The one advantage of this plan for the employer is that the money in the plan does not belong to the pensioners. If the fund earns more than it pays out, the employer banks the excess. Nowadays however, this is almost impossible due to long lives and low inflation.

A defined contribution plan solves the ruinous nature of a defined benefit plan by collecting money from the employer and employee, investing it in a tax free way, and then paying the pensioner from whatever has been earned by those contributions. The money in the plan belongs to the pensioner, and when / if it runs out, the pensioner is out of luck. This allows the employer to transfer the economic risk posed by the long term pension commitment to the employee. A defined contribution plan is roughly equivalent to a registered retirement savings account.

CPP is a defined benefit plan managed by the federal government. It has a maximum payout of about $13,000. So, it will pay you. The federal government prints the money, there is no real risk they won’t pay, but it will really just pay to have the park bench you have to live under repainted periodically. You need to save for your own retirement if your employer does not have a plan which is much better than CPP.