Should You Keep Your Company Pension Or Take The Commuted Value?
Upon retirement, members of defined benefit pension plans are entitled to receive a pension for life based on their years of service and employment earnings. In certain circumstances, employees may be given the choice to either stay in the company pension plan and receive a lifetime monthly pension at retirement, or take the commuted value out of the plan.
If you choose the commuted value, you have the option of buying a life annuity or rolling the funds tax-free in to a locked-in registered account. You will be responsible for investing this money wisely and ensuring that it will last you the rest of your life.
This is a difficult decision as there are many variables to consider. Although a large lump sum can be tempting, there are important factors to consider, as the decision will be final. Consider the following scenarios taken from 52 Ways to wreck Your Retirement by Tina Divito
How long will you live?
This is almost impossible to determine. There is peace of mind in knowing that your money will never run out if you choose the guaranteed pension. However, a large lump sum of money today might seem more valuable to you if you are not confident you’ll have a long life.
Does the pension include survivor benefits?
Are payments guaranteed for the life of the survivor, or just for a certain number of years? Survivor pension payments generally continue only to a spouse. If you have no spouse and your only beneficiary is your child they likely will not be entitled to any payments from a pension plan.
If you want to leave an estate, the lump sum commuted value option will enable you to leave any unspent funds to your chosen beneficiary.
How secure is your employer?
This is a moot point for any public employee. For anyone in the private sector you need to think about how secure your employer’s business might be in the future. Is the pension fully funded? It’s not unusual for a DB pension to not have enough money in the plan to pay pension for the members, especially if investment returns are less than anticipated.
If you think this can’t happen to you consider former Nortel employees. When the company filed for bankruptcy retirees were faced with having their pension income cut, as there was not enough money to pay the promised amounts.
Post-retirement benefits
In some cases, retirees are entitled to additional benefits such as extended health and dental care, life insurance and possibly employee discounts. These benefits are not usually available to employees who take the lump sum option. However, they are not guaranteed and the coverage can be changed at any time.
Is there inflation protection?
A pension that offers full inflation protection is hard to beat. Some plans offer only limited increases.
Will a lump sum exceed the tax-deferred rollover amount?
In some situations the commuted value might be substantial and exceed the amount you can roll tax-free into a locked-in registered account. In this case you have only two options for the excess. Take the cash and pay tax on it, or you can contribute the excess into your RRSP if you have unused contribution room.
How will you invest the money?
Do you have the time and expertise to manage the money you receive in a lump sum? Can you beat your company pension? A very conservative portfolio or a few years of negative returns can cause your money to run out before you do.
The decision to take a lump sum commuted value of a pension is an important one. Get a financial advisor to do some projections and calculations to help you understand the implications of your choice.
Be cautious with this, many investment advisors and mutual fund sales reps will suggest you take the CV in order to generate a huge commission, up to 5%. Which is never in your best interests. Find an advisor that doesn’t use load funds, and is fee based.
@Cameron: That’s a good point. I would say that taking The CV in most cases is almost never a good idea unless the sum is quite low – for example, I worked part time for 5 years and I doubt the monthly pension I could receive would pay for a movie ticket so I’ll likely take the cash.
Under the Section titled, “How Secure is Your Employer” you write “this is a moot point for any public employee.” Ha! Two quick points: 1) IL, LA, NJ won’t have enough money to make pension payments starting about 2017. 2) You seem to believe that even Illinois will just take whatever money is necessary from taxpayers to cover all these multi-million dollars govt pensions. Well they can try, but what happens is that everyone just leaves because they don’t want all their earnings going to pay ridiculously high public pensions. This isn’t a prediction; it’s already happening. NJ and IL are leading the nation in net outward migration. Or, see Prichard, AL.
@Douglas: I should have clarified and said Canadian public employees. While it certainly is possible that they could be in the same unfortunate boats that you mention, I don’t think it’s probable. It’s too bad that the top level positions will always get their money while the hard working “lower” positions will be left with nothing. BTW do you really think that everyone will leave those states to avoid paying higher taxes caused by high pensions. It seems a bit extreme – but I’m not there.
[…] presents Should You Keep Your Company Pension Or Take The Commuted Value? posted at Boomer & Echo, saying, “Employees may be given the choice to either stay in the […]
How secure is your employer?
“This is a moot point for any public employee.”
This may be true over the next 5-10 year span. But, I don’t know that I would bet on it over the longer term. If government pay and pensions exceed those in the private sector too much there will be a rebalancing.
Never say never. Sometimes, a bird in hand is better than two in the bush.
@Prince Chong: You could be right. Obviously we can’t predict what will happen in 10 or 20 years. I just wonder how it will be for us taxpayers in the future when I have already seen our provincial government bail out an underfunded teachers’ pension, as one example.
The government ‘bail-out’ is more properly seen as the government finally paying up its portion. It was accompanied by a major increase in the plan members’ contributions as well. To repeat, the government did not meet its obligations for years, and then negotiated a funding formula to make up for this neglect.
oops, should clarify that my post is particular to one province, and I’m not sure it’s the same one you have written about…
Why don’t you have anything on the Pension Adjustment Reversal (PAR) that the person will receive?
@Paul:
A PAR is usually obtained if the pension plan has not been vested. As a result the employee may only have their own pension contributions and not any from their employer.
If you get a PAR the previous pension adjustments (all or a portion) are cancelled and your RRSP deduction limit will be increased.
PAR is calculated by your pension plan administrator.
Thanks for your question.
You are not correct that a PAR is usually obtained if the pension plan has not been vested. PARs will be generated any time the commuted value of the pension is less than the cumulative pension adjustments. The PAR is the difference between these two numbers.
This will happen for probably many people who terminate who are less than age 40 or 45. After that, the commuted value increases as the person gets closer to retirement age.
I am retiring next year and will have 41 years in the IWA pension plan. I live in BC. How can I determine the value of the CV?
I do not have a spouse so there will not be survivor benefits should I stay with the IWA plan. I want to make sure the unused portion is left to my children. I am thinking that with a well managed LIRA or annuity would be my best choice.
The big unknown is how much the CV is valued at so that I can plan on what type of income I will have based on that amount to be invested.
@Monte: Check with your HR dept or pension administrator. The CV should have been reported on each annual statement your received.
Also, with regard to annuities, most are for your lifetime only. Not many leave a residual amount to beneficiaries.