You’re leaving your job. Now you need to decide: do you keep your employee pension intact or take a lump-sum pension payout and invest the money separately?
Let’s start by explaining the differences by looking at John, who left his job of 19 years with a national professional association and has to decide what to do with his defined benefit employee pension.
He could leave it alone and receive about $16,000 per year in retirement, or take a lump-sum pension payout of its commuted value and invest a portion in a locked-in retirement account (LIRA), with the balance received as cash.
The deferred annual pension would be guaranteed for life but, given that this pension would not be adjusted for inflation, if inflation were to rise considerably, in 20 years $16,000 may not seem so much. So it sounds like he’s better off taking the payout and putting the money in the markets to get (potentially) better growth. But that also carries some risk because if John took the lump-sum pension payout, invested it and then the markets were to collapse, he could end up with a lot less money.
John’s dilemma isn’t unique. Figuring out what to do with an employee pension after a job change can be challenging. There’s no single correct answer because everyone’s circumstances are different.
It could pay to consider the following steps before deciding whether to keep, exit or transfer a defined benefit or defined contribution pension plan.
How much RRSP room do you have?
When you take a lump-sum pension payout, only a portion of it can go directly into a LIRA in a tax-deferred transfer. The rest would be paid out in cash and taxable, so it’s typically advisable to defer tax as much as possible by contributing this remaining amount to an RRSP. If you don’t have enough contribution room left in your RRSP, tax on a lump-sum pension payout can be considerable.
Read the fine print
Defined benefit plans promise an income in retirement for life, for you and your surviving spouse. That payment is based on a formula, which is usually related to your years of service multiplied by an average of your best years of earnings. Some plans might allow you to continue to receive group health benefits, which can be a strong incentive to stay in the plan.
Dig into the details.
Find out if your plan offers a bridging option (which can provide increased payments prior to age 65 before CPP and OAS kick in) and how much your spouse would receive annually upon your death. Determine if your employee pension income will be indexed for inflation, which is especially important if you’re years away from retirement, as was the case for John.
Also, consider how stable your employer is. If there’s a chance the company could become insolvent, then a portion of your future payout could be at risk, so taking a lump-sum pension payout might be the better option.
Assess your defined contribution plan
Deciding what to do with a defined contribution (DC) employee pension plan is more straightforward, given that those savings don’t offer guaranteed payouts if they’re not used to purchase an annuity.
They’re based on how well your investments perform in the market, regardless of whether they remain in the plan or get invested in a LIRA.
The main differences between a DC plan and a LIRA are investment options, fees and flexibility. If your defined contribution plan is limited to a few cookie-cutter investment portfolios, you might want to consider taking a lump-sum pension payout and putting it into a LIRA, which offers a broader suite of options. It pays to do your homework.
Look at your whole situation
Before making a final decision about what to do with your employee pension, consider your other sources of retirement income, such as CPP, OAS, RRSPs/RRIFs and TFSAs. If you have other savings, then leaving your pension plan as is could be the best option. A proper financial plan can illustrate this for you.
Also, think about the estate planning implications that can come with both spouses having a defined benefit plan. While any unused retirement savings in a LIRA or RRSP/RRIF can be left to heirs, payments from a defined benefit plan, outside of any guarantee period, may cease upon the death of the plan member and their spouse. Amounts that you can leave to other family members may be limited.
Evaluate your options before taking a lump-sum pension payout
Your certified financial planning professional will be able to look at your options, taking into account your whole financial plan. They’ll be able to make suggestions that will make the most sense for your unique set of circumstances and run an in-depth analysis of the pros and cons of leaving versus moving your plan.
Most importantly, never take the advice to move your plan from an advisor who simply says they’ve run the numbers and it makes sense. Ask to see the analysis that shows how taxation and inflation as well as market returns all impact the calculations.
If you have a plan that you’re considering moving and want to see an analysis like that, feel free to reach out and I can put you in touch with a professional planner who will do the analysis properly and give you an honest recommendation.
This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.