Should I Stay or Should I Go?
As well as being a hit song for the Clash, this is a dilemma that many employees may find themselves in when leaving an employer or retiring. If they are part of a company pension plan, they may have to make some very important decisions.
Two potential options, are leaving the pension with the employer or transferring the commuted value to a Locked-In Retirement Account (LIRA). Each pension plan is unique in their benefits and each employee has their own unique circumstances and situations to take into account. These are some of the factors that need to be considered before you make that decision that will have long term consequences.
In a pension plan, the plan administrator will make the investment decisions for the Defined Benefit Pension Plan. Their goals and risk tolerance may not align with yours. In a LIRA, the annuitant will have more involvement and choose from a much wider range of investments.
If you take the pension, initially you will have the full dollar value, though some company contributions may take 1 to 2 years to fully vest to you. In a LIRA, there may be a maximum Transfer Value that can be rolled to a LIRA. If you have available RRSP room, some can be transferred to a RRSP. The difference may have to be taken as cash and added to your taxable income. A cash payment from a commuted value may assist a person if they have any debt, such as a mortgage. Your personal circumstances are always a factor in your decision making.
The pension has limited flexibility once your payments have begun. Benefits are payable for life and no lump sum withdrawals are allowed. When converting a LIRA to a LIF, you have much more flexibility. You can start at any age between 55 and 71, though the annual income will be subject to minimum and maximum amounts. Pensions registered in Ontario, can be unlocked up to 50%. This can be transferred to a RRSP or even taken as cash, with its tax consequences.
If pension payments have started, if the owner passes away, the spouse usually receives a reduced amount payable monthly. The reduced amount payable to the surviving spouse can vary by plan, and in some plans, the payments are only for a limited period of time. There is no estate value once the surviving spouse passes away. In a LIF, the surviving spouse may receive 100% of the remaining value tax deferred. Once the surviving spouse passes away the remaining value is payable to any named beneficiary or the estate. The estate is responsible for paying taxes on this amount. A LIRA or LIF can also be unlocked and made accessible for financial hardship, shortened life expectancy, lesser amount or medical expenses.
A company pension is invested as the plan administrator chooses. Some administrators choose to invest in GICs. Lack of flexibility in their investment mandates may make it difficult to maintain funding objectives. The commuted value of a pension plan has an inverse relationship with interest rates. The commuted value, when paid out, represents the present value of what would be needed to pay a given stream of future payments. The lower the interest rates are, the larger the lump sum payment you will receive. We are presently at historically low interest rates, which will most likely not change soon.
In Ontario, the Pension Benefits Guarantee Fund protects up to $1,500 per month of your monthly pension payout. The difference could be lost if the employer has financial difficulty or employer bankruptcy. With a LIRA/LIF you can control the guarantees of your investment and diversify as you wish to ensure its continuity.
Other important factors to take into consideration when making your decision include the following. Surviving spouse benefits from a pension plan are usually only paid to the spouse at the date of retirement. A new spouse after retirement will not receive survivor benefits. Some pensions are not fully indexed to inflation. You will find your purchasing power quickly eroding as the years add up. If you have worked for a number of different companies, you can consolidate your LIRAs into one LIRA. Taking the commuted value may provide an opportunity for an inheritance to a non- spouse. Usually, only retirees who receive a pension qualify for medical and dental benefits after age 65.
Working with a trusted advisor, you can review the pros and cons of your specific options. Each pension plan is structured differently and should be analyzed for your unique situation to achieve your goals and objectives. Ensure you have a financial plan in place. This may reduce the temptation to deplete funds that have been set aside for retirement. Looking at your overall goals use the plan as an opportunity to create a financial future that achieves your objectives.
Written by George Comminos CFP CIM