A defined benefit pension plan (DBPP) is often a confusing topic for many Canadians.

This post will help you understand how the DBPP works, and how it differs from other types of pensions.

DBPP Has No Investment Risk to You

As of December 31, 2024, Canadian defined benefit pension plans achieved a median solvency ratio of 125%, marking a significant improvement from 116% at the end of 2023. This indicates that most plans are well-funded and financially healthy.

What is a Defined Benefit Pension Plan in Canada?

The DBPP in Canada is one of the two main types of registered pension plans you can use in Canada. According to this plan, the company you work for will pay you a predefined monthly income for life after you retire as an employee of the company.

The DBPP amount you receive by the time you retire can be calculated in various ways. Typically, the formula used to calculate the payments you receive is based on the average highest salary you made while you were at the company and the number of years of service you provided the company.

While it is not necessary, you may have to make contributions to the plan. The employee will also make contributions to this plan and accumulate the amount in a fund that it manages. The employer manages the funds and invests it to grow the overall amount. 

In this plan, the employer is responsible for guaranteeing a certain amount in payments to their employees. The benefit is already defined, regardless of the performance of the investment.

DBPP Has No Investment Risk to You

In a Defined Benefit Pension Plan, the employer essentially carries all the investment risk for the funds. Employees have very little control over the funds until they start receiving the money when they retire. 

The employer is entirely responsible for investing and distributing the funds. DBPPs usually require complex actuarial projections and insurance that can offer a guarantee due to the risks involved for the employer. The administration costs for these plans are higher for the company.

Despite a historical shift towards Defined Contribution Pension Plans (DCPPs), Canadian Defined Benefit Pension Plans (DBPPs) demonstrated strong performance in 2024. The average Canadian DB pension plan returned 11.3% for the year, marking the strongest annual return in five years. Additionally, the median solvency ratio improved to 125% by the end of 2024, indicating robust financial health across plans. You can read more about the differences below.

How Much Money Can You Receive From a Defined Benefit Pension Plan?

Perhaps the best thing about a DBPP in Canada is that it entitles employees to a fixed benefit that they will receive based on their income. The amount is predefined, and employees have no responsibility for managing the funds to ensure their income in their retirement. 

The amount you can receive from a Defined Benefit Pension Plan in Canada can drastically differ. However, there is a way to find out the probable amount you can get from your employer.

While the way your employer calculates the exact amount can differ, there is a formula that uses your average highest salary at the company and the number of years you have worked there. 

A common formula for calculating DBPP benefits is: 2% × average pensionable earnings during the highest income years × years of pensionable service. For instance, if your average earnings are $60,000 over your top five years and you have 30 years of service, your annual pension would be 2% × $60,000 × 30 = $36,000

In 2024, the average investment return for Canadian DB pension funds was 12.6%, reflecting strong performance across major asset classes

Both you and the employer will be contributing to this plan, but it is primarily the employer’s responsibility to make sure you receive your pension. If you retire before a certain age and you have not worked at the organization for long enough, your pension from the company may be subject to an early retirement discount.

If you leave a Defined Benefit Pension Plan before retirement, you may have the option to transfer the commuted value—essentially the lump-sum present value of your future pension—to a Locked-In Retirement Account (LIRA) or similar vehicle. Note that the commuted value is subject to regulatory limits and may not fully replicate the guaranteed income stream of the DBPP. This amount is essentially what the projected benefit might be worth as a single payout today.

Example of a Defined Benefit Pension Plan 

Let’s consider David. David works for a particular well-paying company for several years before his retirement. The organization employs a Defined Benefit Pension Plan in Canada that uses the formula of multiplying a certain percentage (let’s assume 2%) of the best average income (let’s assume $50,000) for the last period before retirement. The calculation multiplies by the years of service (let’s assume 25 years).

The amount that David can receive for his Defined Benefit Pension Plan would total 2% x $50,000 x 25 = $25,000 per year. The DBPP is essentially a flat-rate benefit. The pension can vary from employer to employer. The benefits can be higher or lower than the amount David might receive per year after his retirement.

How Defined Benefit Differs From Defined Contribution Pension Plan

Commuted Value: The lump-sum amount you can transfer out of a DBPP if you leave the plan before retirement. It represents the present value of your future pension benefits.​

Solvency Ratio: A measure of a pension plan’s ability to meet its long-term obligations, calculated by comparing plan assets to liabilities. A ratio above 100% indicates a surplus.​benefitsandpensionsmonitor.com

Pension Adjustment (PA): An amount that reflects the value of the pension benefits accrued in a year, which reduces your RRSP contribution room accordingly.

The DBPP is one of the two main pension plans used in Canada. The Defined Contribution Pension Plan (DCPP) is another pension plan that has become popular over the years. It can differ in several ways from the DBPP including:

• Contributions: A DCPP requires employees to make contributions to their plan, and the employer may match their payments. A DBPP is primarily the employer’s responsibility to handle.
• Investment Options: The employee manages their DCPP. The employer handles all the responsibility of how the funds are invested and grown in a DBPP.
• Amount received: There is no predefined amount you can receive when you retire with a DCPP. It all depends on how well you invested your funds. A DBPP is a predefined amount based on the salary and years of service multiplied by a certain percentage. It entitles employees to a guaranteed and fixed retirement income from the company, regardless of the performance of the investments.
• Portability: The DBPP is not a portable plan because the funds are in an account managed by the employer. You can transfer your DCPP when you move to another company because the amount is yours, and you have an individual account for it.

Pros and Cons of Defined Benefit Pension Plan in Canada

The Defined Benefit Pension Plan in Canada has its advantages and disadvantages for you. I will discuss the pros and cons of the DBPP to help you determine whether it works better for you compared to a DCPP.

Pros

• You know that there is a guaranteed income that is fixed.
• It is possible to get payroll deductions for employee contributions.
• The employer takes on the responsibility for investing the funds and any deficits.
• Employee contributions to a DBPP are tax-deductible, reducing taxable income in the year of contribution. The annual pension adjustment (PA) reflects the value of the pension benefits accrued and affects RRSP contribution room. For 2024, the maximum annual pension accrual per year of service is $3,610
• The funds are professionally managed to maximize returns.

As of 2024, the Canada Revenue Agency has set the maximum annual pension accrual for DB plans at $3,610.00. Additionally, the Year’s Maximum Pensionable Earnings (YMPE) under the Canada Pension Plan has increased to $68,500, with a new upper limit, the Year’s Additional Maximum Pensionable Earnings (YAMPE), set at $73,200. Earnings between these thresholds are now subject to additional CPP contributions.

Cons

• Employees do not have individual accounts and only have rights to a stream of payments, not to an account.
• The pension plan is not transferable. If you choose to exit a DBPP, you can take the amount as a lump sum payment.
• You have no control over how the funds are invested. Even if you are financially savvy and feel you could make better investments, the company bears all the responsibility.
• It is a lot more challenging to understand and navigate.
• There aren’t many DBPPs available anymore, as employers are not willing to take on this risk.

Frequently Asked Questions (FAQ)

1. What is a Defined Benefit Pension Plan (DBPP) in Canada?
A DBPP guarantees a fixed retirement income based on your salary and years of service. Unlike defined contribution plans (DCPPs), the employer manages the investments and bears the risk.

2. How is a DBPP different from a DCPP in Canada?
In a DBPP, the benefit is defined, and the employer manages the fund. In a DCPP, the contribution is defined, and the employee is responsible for investing it. Returns and retirement income in a DCPP depend on investment performance.

3. What does ‘commuted value’ mean in a DB pension plan?
The commuted value is the lump sum you may be eligible to transfer out if you leave your DBPP before retirement. It represents the present value of future pension payments.

4. Are DB pension plans still common in Canada?
While still available, DBPPs are less common than before. Many employers now prefer DCPPs due to lower long-term costs and fewer funding risks.

5. What happens to my defined benefit pension if I leave my employer?
If vested, you may have options such as leaving the pension in the plan until retirement or transferring the commuted value to a locked-in retirement account (LIRA), depending on plan rules and provincial legislation.

6. Is income from a DBPP taxable in Canada?
Yes, your DBPP income is considered taxable retirement income and must be reported on your annual tax return once you begin receiving payments.

7. What is the DBPP maximum pension accrual limit for 2024?
For 2024, the maximum annual pension accrual for DB plans is $3,610. This limit affects how much you can accrue tax-deferred each year in a registered pension plan.

8. What is the difference between DBPP and DCPP portability?
A DBPP is not fully portable because you don’t own a personal investment account. A DCPP is portable, and the funds belong to you, allowing transfer when changing jobs.

9. Can I receive both CPP and income from a defined pension plan?
Yes, you can receive Canada Pension Plan (CPP) payments alongside income from your defined benefit pension. They are separate retirement income sources.

10. What does DBPP mean for RRSP contribution room?
Your DBPP creates a pension adjustment (PA) that reduces your RRSP contribution room. The PA reflects the value of benefits accrued in your DB plan for the year.