Transferring your pension
When you leave a company that has a pension plan, you will need to make some decisions about what to do with your pension.
Are you vested?
Vesting refers to whether you have the rights of ownership to the contributions made by your employer and the investment earnings. Vesting can occur at any point in time but must occur no later than after two years of continuous plan membership. In some provinces, pension laws have been changed to reflect the requirement for immediate vesting.
If you are vested, the employer will send you a pension package outlining a number of options.
Different types of pension plans
The first thing we need to do is distinguish between the two basic types of pension plans:
Defined Benefit Plan
Under the defined benefit plan, the known element is your pension benefit at retirement. This benefit is usually expressed by three variables:
- Number of years you worked for the company
- Your salary (it is usually an average of a number of years)
- A predetermined factor like 1% to 2%
Let’s say Monica worked for her employer for 18 years and her pension plan offered a 2% benefit and her last 5 years of salary averaged $53,000/yr. In this example, Monica’s pension would be $19,080 per year (18 X 2% X $53,000). The unknown element is the amount of money that is going into the pension plan to create this income. Typically, the employer bears all the risk.
Defined Contribution Plan
Under the defined contribution plan (sometimes called the Money Purchase Plan), the future benefit is the unknown. The future benefit depends on how much money is put into the plan by the employer, the employee and the rate of return earned by the investments. What is ‘defined’ in this plan is the amount of contributions that will be put into the plan. This is usually expressed as a percentage of income.
For example, Chandler is earning $45,000 per year and under his pension plan, he will contribute 2% of his income to the plan and his employer will put in 4%. In this example, Chandler will have a deduction of $75 per month going to the pension plan and his employer will be putting in $150 per month for a total of $225 per month. In some cases, Chandler may have the ability to make some investment decisions on his portion of the contribution. His benefit at retirement will depend on how much he puts in, for how long and the rate of return his investments earn in the pension.
Related article:Pensions plans are the foundation of retirement planning
Should I stay or should I go?
If you are not looking for immediate income, you generally have a couple of choices:
First, you can leave the money with the company pension plan. Under this option with a defined benefit plan, your company typically provides you with a guaranteed pension amount at normal retirement (age 65). You may have provisions to take the pension earlier but with a reduced amount based on a prescribed formula.
Alternatively, you will be able to move the money out of the company pension plan to be self-managed. Under this option, you can move it to a Locked-in Retirement Account (LIRA) for accumulation purposes.
Related article: Understanding Locked in Retirement Accounts
Doing the calculation
Theoretically, the calculation to determine which option is best for you is really quite simple.
Figure out how much money your company is willing to give you as a lump sum transfer to a LIRA. Accumulate this money to age 65 based on a number of different interest rate assumptions (I like to use 5%, 7.5% and 10%). Then figure out what kind of monthly income (annuity) this accumulated value might get you at age 65.
Let’s say Shirley is being offered a lump sum pension transfer of $72,000 at age 57. Alternatively, she can take a guaranteed joint life pension at age 65 of $650 per month.
According to my calculations, if we take the $72,000 and accumulate it to age 65 based on 5%, 7.5% and 10% returns; Shirley’s monthly pension will range from $600 per month to $877 per month. The breakeven return was about 5.6%. In other words, if Shirley felt she could invest the $72,000 and earn more than 5.6% then she would be better off choosing to transfer the money into a LIRA and self manage her pension.
More than just numbers
Certainly numbers create the bottom line. The problem with this example is it is oversimplified. There are a number of assumptions that are needed in order to make this calculation. Indexing, survivorship, guaranteed periods and integration can affect the outcome.
In my opinion, there are some very important considerations to review in addition to the numbers: do you want to provide survivorship income to your spouse? Do you want to provide an estate for your children? Is it important to make your own investment decisions? Do you prefer to minimize the decisions and management of your pension? Would you prefer to have income flexibility other than an annuity? Do you prefer to have a guaranteed income amount?
Making this decision is not an easy one. If you are confused, you might want to seek help from a professional. Most financial advisors should be able to help you make the necessary calculations to determine what is best for you.
|Company pension||Self managed|
|Income continued to the spouse||Yes||Yes|
|Estate Value passed on to the children||No||Yes|
|Investment choice and flexibility||No||Yes|
|Flexibility to draw income at any time||partially||partially|
|Lump sum withdrawals||No||No|
|Income options flexibility (LIF/LRIF)||No||Yes|