RRSP/Group RRSP vs. Pension Plan: Why is a pension plan better?

There is a lot to think about when choosing a workplace retirement plan. How many employees do you have? Is your workplace large enough for a group plan? What types of plans work best for your type of business? What resources do you have to implement a plan? How long will it take to set up? What fees will you need to pay? What are the internal costs?

Typically, small to medium-sized enterprises (SMEs) in Canada don’t sponsor traditional, single-employer defined benefit (DB) or defined contribution (DC) pension plans, due to the cost, risk, and workload associated with plan set-up, administration and regulatory compliance. As a result, SMEs seeking to establish group retirement plans have turned to Group RRSPs. Though less cost- and tax-efficient, group RRSPs were easier to set up.

However, this is no longer the case. New pension plans are emerging that allow businesses of any size (e.g. with 5 employees or 50,000) to offer a real pension plan to their employees. Outsourced pension solutions like Blue Pier’s Pension Plan as a Service allow employers to offer customized workplace pension programs that perform well for employees and enable employers to focus on their businesses. There is no denying these innovative new pension solutions are feature-rich and cost-effective, and many businesses are increasingly considering them as an option.

What kind of plan is best for your workplace? To help you decide, let’s take a closer look at the different kinds of plans

RRSPs Explained

An RRSP (Registered Retirement Savings Plan) is a personal “tax-deferred” retirement savings account that individuals can set up with a financial institution – the RRSP “Issuer”. With RRSPs and other tax-deferred vehicles like pension plans, contributions are tax-deductible, investment earnings are not taxed, and withdrawals are taxed as income. Key considerations with RRSPs are contribution limits, age limits, and what people can do with their RRSP savings. RRSPs must be registered with the Canada Revenue Agency (CRA) under the Income Tax Act (Canada).

1. RRSP Contributions and Investments

RRSP contributions cannot exceed the CRA contribution limits for the year, plus any unused contribution room carried forward from previous years. Carry-forward contribution room is reported on the notice of assessment (NOA) that the CRA provides taxpayers every year after they file their tax returns. Other than carry-forward contributions, RRSP contributions for a particular year are limited to the least 18% of the contributor’s previous-year earned income and a dollar limit that increases each year. In 2023, this dollar limit is $30,7801. You can also make contributions to a spousal RRSP, up to your deduction limit.

RRSP owners can invest RRSP savings in a wide variety of investments, including cash, mutual funds, exchange-traded funds, stocks, government and corporate bonds, and derivative financial instruments like stock options. RRSP funds can be transferred tax-free to any other RRSP or to any pension plan.

2. RRSP Age limit

RRSP owners can contribute up to December 31st of the year they turn 71. After that, they must transfer RRSP savings to a RRIF (Registered Retirement Income Fund) or buy an annuity. Otherwise, the RRSP funds can be fully taxed.

Retirement funds held in a RRIF must be withdrawn annually according to a minimum-withdrawal schedule established by the CRA.

3. Uses of an RRSP

a. Retirement Income

RRSPs are intended to provide individuals without pension plans a means to provide a retirement income for themselves. RRSP funds can be converted to retirement income by simply withdrawing funds (before age 71), transferring RRSP funds to a RRIF and withdrawing funds periodically according to the CRA minimum-withdrawal schedule (or more as needed), or purchasing an annuity from an insurance company that will pay a fixed for your lifetime in monthly or annual installments.

b. Home Buyers’ Plan

Under the Home Buyers’ Plan, RRSP owners can withdraw up to $35,000 to buy or build a “qualifying” first home without paying tax. The withdrawn amount must be repaid within 15 years.

c. Lifelong Learning Plan

The Lifelong Learning Plan permits non-taxable RRSP withdrawals to fund full-time education or training for RRSP owners or spouses, up to $10,000 per calendar year to a maximum of $20,000. Withdrawals must be repaid within 10 years.

Employer RRSP contributions and employer matching: What is the employer’s role?

An employer’s role in RRSP contributions is best examined in RRSP employer matching:

Employers usually contribute to Group RRSP accounts based on a formula that considers factors such as salary levels, employee age, and service, how much the employee contributes, etc. Contributions may be made in lump sum amounts or by payroll deduction.
Group RRSPs require their members to select investments from a list provided by the employer. While this group approach can reduce fees, it also reduces investment choices.
Because employer contributions to a group RRSP count as taxable income, they can increase employer and employee payroll taxes that are based on employee income or total payroll, e.g. Canada/Quebec Pension Plan premiums, Employment Insurance premiums, Workplace Safety and Insurance Board premiums, and Employer Health Tax. Because the extra payroll taxes triggered by employer contributions to a Group RRSP can be significant, some employers will set up a “deferred profit sharing plan” for employer contributions. While this can help, it means the employer has the extra workload, cost, and risk of administering two group retirement plans instead of one.

RRSP vs. Group RRSP – What’s the difference?

All RRSPs are individual, personal accounts. A “Group RRSP” is a group of individual RRSPs established for employees of a particular employer and administered according to an agency agreement under which the RRSP Issuer delegates some administrative and fiduciary responsibilities to the employer.

Group RRSPs are subject to additional regulatory guidelines issued by the Canadian Association of Pension Supervisory Authorities (CAPSA) for Capital Accumulation Plans (CAPs). CAPSA guidelines require employers to provide investment information and decision-making tools to members as well as to review investments and investment performance regularly.

What is a pension plan?

A pension plan is a tax-deferred retirement savings plan established to provide retirement income to retired workers in respect of their employment service. The amount of retirement income a pension plan provides depends mostly on plan design and years of service. Like RRSPs, every pension plan must be registered with the CRA. Pension plans must also be registered with a provincial or federal pension standards regulator, such as the Financial Services Regulatory Authority of Ontario.

Types of pension plans

1. Defined-Benefit pension plan

DB pension plans provide retirement benefits based on a formula that typically takes into account salary and years of service. Benefits are provided in the form of a pension paid for the member’s life. If the member has a spouse who has not waived rights to a survivor pension, the pension spouse continues to receive a pension for life if the member dies first.

Because DB pension plans promise a pension benefit, they are often perceived as more secure than other plan types. However, there are some risks and drawbacks with all retirement saving plans. DB plans are no exception:

Complex and costly to administer, DB pension plans are suitable only for large workforces. With 100 or fewer employees, most of Canada’s employers or too small to operate a DB plan.
Benefits are not fully portable. When the lump sum value of a DB pension is transferred to another plan, a significant portion may be immediately taxed.
All DB plans involve some “cross-subsidization” within and between generations of plan members, with the result that some members (and their beneficiaries) will get more, or less, value from the plan than others, even though their salaries and contributions may be similar.

2. Defined-Contribution pension plan

A DC plan does not promise a specific pension benefit. Instead, retirement benefits are based on the accumulated value of employer and employee contributions, plus investment returns. DC plans have a number of advantages for both employers and members:

The administration is considerably simpler because no actuarial valuations are required, as they are with DB plans.
Members have less exposure to insolvency risk because their accounts are safe if the employer goes bankrupt.
DC plans allow for tax-free portability to RRSPs and to other pension plans.

There can also be drawbacks to DC plans.

Like Group RRSPs, most DC plans expect members to build an investment portfolio from funds made available by the employer. This doesn’t work very well because members typically don’t engage in the process and lack the knowledge required to make good choices when they do.

With some DC plans, the plan administrator manages the plan assets with support from institutional managers and advisors. This approach typically delivers better results with less work and cost.

Most DC plans – especially single-employer plans – don’t pay pensions. Retiring members must buy an annuity from an insurance company or transfer their funds to a personal RRSP or RRIF and manage their own money through retirement. Many retirees struggle with this.

Some DC plans allow members to stay in the plan through retirement and continue to benefit from lower fees and better investment performance.

Single-Employer and Multi-Employer Pension Plans

Whether DB or DC, pension plans come in two types – single-employer and multi-employer:

Single-employer pension plans are established and operated by an employer for its own employees. The employer is responsible for plan administration – investment selection, asset custody, recordkeeping, member communications, and regulatory compliance – as well as withholding and remitting contributions and paying out benefits. Employers typically delegate administrative and compliance tasks to consultants and other service providers, but they remain responsible to regulators and members to ensure that the tasks are done correctly.
Multi-employer plans are established for employees of several employers. Plan administration is managed and supervised by a board of trustees, and the employers’ only tasks are to make contributions, support member enrolment, and report contributions to the CRA. With large pools of assets, multi-employer plans are more efficient and can access institutional-class services. This delivers better results and reduces cost and work for both members and employers.

Investment Management and Fees

Regardless of the retirement-plan type, the most important task of plan administration is investment management. Even small differences in investment return make a big difference: as a rule of thumb, a one-percent difference in investment return – or fees – over a career translates to a 20-percent difference in retirement income. So it’s important to keep fees low and to get the best investment-management services possible.

That can be hard to do with small plans like RRSPs, Group RRSPs, and DC pension plans. In these plans, results are often poor because the plans are not large enough to access the lower-cost, institutional investment-management services that are available to large, multi-employer plans.

Employer pension plan contributions: What is the employer’s role?

DB plans have financial risks for both employers and employees. Employers are required to make extra contributions when investment performance is poor. Employees are at risk of losing promised benefits when an employer sponsoring an underfunded plan goes bankrupt
DC plans have much less financial risk for employers who have no financial obligation other than to make contributions. There is little or no cross-subsidization among members. Most pension regulators require that contributions immediately vest in a member so that employer and employee contributions, once made, belong to the member and no one else.

Which is the right plan for you?

Irrespective of the plan type, a tax-deferred group retirement plan that has mandatory employer and employee contributions is a good choice for employers who need stable workforces. Employee churn is costly and with unemployment at historic lows, more workers are changing jobs more often to get better pay and benefits. A pension plan in particular can help a lot with attracting and retaining workers, because almost 80% of workers will change jobs to get pension coverage.

For most employers, joining a multi-employer pension plan (MEPP) is usually the best option for providing a group retirement plan because MEPPs allow employers to outsource pension management and pension risks (depending on the plan type) to a third party, and to benefit from the economies of scale that come with a MEPP. With that said, it’s important to note that participation rules and plan terms for some MEPPs may be too restrictive or problematic for some employers. For example, a DB MEPP may restrict an employer’s right to withdraw from the plan, have limited design flexibility to allow the employer to determine costs and benefits, and/or expose employers and members to cross-subsidization risks.

A DC MEPP can be more flexible and less risky for employers, because it does not pool funding risks and there are no pension deficits or surpluses to manage. A DB MEPP requires members to receive their benefits in the form of life pension and has limited portability to other plans. A DC MEPP provides for more flexible retirement income options, as well as tax-free portability to other plans. If desired, participating employers can even allow members to use some of their DC MEPP assets for the Home Buyers Plan or the Lifelong Learning Plan.

While an RRSP is not usually the best choice for a workplace plan, it can make sense for an employer to make contributions to the RRSPs of employees who have the ability to manage investments and a strong preference for doing so. In this scenario, employees would be automatically enrolled in a group plan selected by the employer – e.g. a DC MEPP – unless they opt out. For employees who don’t opt out, the employer would make contributions to the DC MEPP. For employees who do, the employer would make contributions to their personal RRSPs.

The Blue Pier Advantage

Canada’s first Pension Plan as a Service, Blue Pier’s DC-only MEPP is available to any employer, anywhere in Canada and delivers a first-class, institutional workplace pension solution for less cost, risk and work than other options.

Key advantages of Blue Pier over competing workplace plan options are summarized below:

Outsourced administration: Employers enroll employees and make/report contributions. Blue Pier does the rest.
Your Customized Plan, Right Now: With Blue Pier, your employees can be onboarding your customized workplace pension program in 6-8 weeks.
Institutional Investments: Blue Pier members’ money is managed by Canada’s largest, most successful asset manager.
Low, Transparent Fees: Blue Pier fees are lower than most competing options. And tax-deductible.
Tax-Free Portability: Members can stay with Blue Pier for life. But they don’t have to.
Flexible Retirement Options: Because some members may want something other than a just a pension.
Your Money is Yours: No cross-subsidization risks with other employers or members.

To learn more about the Blue Pier™ Pension Plan as a Service and get a free consultation, contact us today.

References

Canada: MP, DB, RRSP, DPSP, ALDA, TFSA limits and the YMPE