Should you take a deferred pension or the commuted value?
If you have a defined benefit pension plan at work consider yourself lucky. Less than one-third of employees in the private sector have a workplace pension plan. In you decide to stay with your employer until retirement, you can start drawing on the monthly pension you’ve accrued over the years.
Related article: Defined Benefit Pension options
But what if you don’t? What if you leave your employer before you’re retirement eligible? You’ll be faced with a tough decision: should you defer your monthly pension or take it as a lump sum? Unfortunately, there’s no easy answer, but here are four factors to consider.
Take your investment advisor’s advice with a grain of salt.
Similar to life insurance, pensions are an often misunderstood topic. Many people go to their investment advisors to seek assistance on deciding what to do with their pension. While most investment advisors are honest, the problem is that there’s a clear conflict of interest. If you elect a deferred monthly pension, your advisor won’t collect any commission, but take the commuted value and your advisor will be compensated handsomely. Your advisor can be a good source of information for deciding which funds to invest the commuted value in should you decide to take it, but at the end of the day the decision should be yours and yours alone.
Related article: Financial Advisor or salesperson
How stable is your employer?
If you’re 30 years old and you leave your employer, do you really feel comfortable deferring your pension with said employer 35 years until age 65? 35 years is a long time. Who’s to say your employer will still be around? If you’re close to retirement (within 10 years), it may be worth deferring your pension, but if you know for a fact your employer’s finances are on shaky ground, chances are you’re better off transferring your pension. Unless you’re in Ontario where the Pension Benefits Guarantee Fund protects up to $1,000 per month of your monthly pension, you could lose a big portion of your pension if your employer goes belly up.
Where are interest rates?
Interest rates can play a big part into your decision of deferring your monthly pension or commuting it. Interest rates and the commuted value have an inverse relationship. The lower interest rates are, the larger the lump sum payment you’ll receive (the commuted value is a lump sum payment representing what you’d need to invest at today’s interest rates to be able to buy an annuity the equivalent of what your deferred pension would be at age 65). Today’s rock bottom interest rates means there’s never been a better time to take the commuted value. If interest rates go up in the future and you invest wisely, you could come out ahead since your commuted value will grow a lot faster (conversely, if you invest poorly, you can end up with a lower payout).
Do you plan to take an early retirement?
If you have a deferred monthly pension and you decide to retire early, you’re often “punished” with a stricter reduction than if you were an active member in the pension plan. Unless you plan to wait until age 65 to start drawing your pension, you’re probably better off taking the commuted value.
These are just some of the factors to consider. Everyone’s financial situation is different, so weigh each factor carefully to decide what makes the most sense for you.
The vast majority of people who are considering the CV/pension question have absolutely NO idea how pensions work; nor do they have ANY experience with investing. They like the word “guaranteed” and despise the word “risk” without an in-depth understanding or regards for taxation or risk management.They have NEVER invested much or at all, so managing their CV would not be a prudent decision anyway.
As a result, they are incapable of making an informed decision and simply take the path of least resistance and do nothing. Do the math as I have and you will be pleasantly surprised … but how many people will actually do that with one of the biggest financial decisions of their lifetime.
So how does your math work out when the person soon after retirement, is told they have cancer and a short time to live ??
The math says you should have taken the CV. The pension will have been reduced significantly, up to 40%, for the benefactor and will only pay a modest income. The CV lives on in perpetuity if done properly so there will be something left over when the benefactors are gone. Not so with the pension option. If you don’t know how to invest, seek professional help. I will end up with twice what my pension would have paid because of interest rate differential, assume only minimal risk and still be able to pass on whatever is left when my time has come and gone.
I’m 54 years old thinking of commuting my BC teacher pension but would like to know the commuted value prior to doing so. Is there a quick formula for figuring it out?
call your pension office. they will tell you exactly what your commuted value is and how much tax you will have to pay.