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.
