Understanding your defined benefit pension options at retirement
There are 2 kinds of pension plans: Defined Contribution Pensions and Defined Benefit Pensions. The retirement options will differ depending on the type of pension plan.
Related article: Pension Plans are the foundation of retirement planning
For this post we will run through some of your pension options at retirement for Defined Benefit Pension so you can make the best choices:
Defined benefit options at retirement
When you retire with a Defined Benefit Pension, your employer will send you an options package which will outline all your pension options. Here are some of the key issues you will need to think about.
Single vs joint pension
If you have a spouse, your spouse has rights to the pension under pension legislation. As a result, your pension options will default to joint pension with a survivorship. You will likely be given options to have 100%, 75%, 66.67% or 50% of the income continue to the surviving spouse. Every pension is unique so the options may vary slightly from pension to pension. The Joint pension will pay a lower income than single pensions. Some pensions allow the spouse to sign a waiver of rights to allow for single life options.
The other issue most people face in a pension plan is to choose the appropriate guarantee period. In most cases, you can choose a 15 year, 10 year, 5 year of no guarantee period. If someone chooses a 10 year guarantee, the pension is on the hook for the income payments for at least 10 years. For example, if the annuitant dies after 1 year, the insurance company must pay the beneficiary the remaining 9 years of payments or the commuted value of those 9 years. The longer the guarantee period, the lower the annual income will be. Mathematically, the theoretical value of the different guarantee periods will be the same.
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Choosing the right guarantee period is really a matter of knowing your life expectancy. If you are going to live a long life then choose a short guarantee period (or no guarantee period). If you are going to have a short life expectancy then it make sense to choose as long of a guarantee period as possible.
Coordination or integration
Some defined benefit pensions give the option to coordinate pensions with CPP (Canada Pension Plan) and/or OAS (Old Age Security). The basic mechanics of coordination is you are borrowing money from your own pension prior to age 65 and have to pay back the money once you turn 65.
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In other words, instead of a fixed pension for the rest of your life, you will get a higher pension to age 65 and then your pension will drop after age 65. Theoretically, the drop in pension at 65 will be offset by new income from CPP and OAS at 65.
Choosing to coordinate your pension may be appealing because of the higher initial income but before you consider coordination or integration, here’s a few more issues to think about
- The calculation is a theoretical calculation. The pension does not talk to CPP or OAS so they do not know how much CPP or OAS you are eligible for.. The amounts are theoretical and may not be exact.
- Choosing the coordinated option does not mean you have to wait until age 65 (or later) to collect CPP. Keep in mind, if you take CPP early, the pension coordination still happens at age 65.
Related article: Should you take CPP early?
- Coordination really benefits those with shorter life expectancies. If you live a long life, you will wind up paying back more income after age 65 than what you got extra prior to 65.
Choosing the right pension options at retirement is a big deal. You essentially have one chance to make the right decisions because once you elect your pension options, there is no going back.
Next week, we will look at pension options for Defined Contribution Pension Plans