I'm leaving my job and I'm wondering if I should leave my money in the defined benefit pension plan, or take it out as a lump sum.
It's a question more Canadians are facing when they switch jobs, get laid off or contemplate leaving the work force before they can start drawing a pension.
Because it's a complex issue, we've reached out to some experts. With their help, we've put together a list of five questions you should ask when trying to choose the alternative that is best for you. A good financial planner can also walk you through the pros and cons of leaving your money in a defined benefit plan or taking the commuted value.
1. How healthy are you?
The longer you live, the more valuable a pension is. That's because benefits continue until you die, or in some cases at a reduced rate until your surviving spouse dies. So if you are in excellent health and your parents lived well into their 90s, it would tilt the decision in favour of staying in the pension plan, says Ross McShane, director of financial planning with McLarty & Co. in Ottawa.
On the other hand, if you are in poor health and have a shortened life expectancy, taking a lump sum may be more attractive. You'll get the same commuted value as someone who has a longer life expectancy, which is a good deal for you. Plus, when you die, your remaining assets can be passed on to your heirs, whereas pension benefits cease when you die, or your spouse dies.
2. How healthy is your pension plan?
Mr. McShane recently met with a client who was leaning toward taking the lump sum value of his pension.
"I said, 'Don't treat it as a slam dunk. You may want to reconsider and take the deferred pension,'" Mr. McShane recalls. "Then the client pulled out a letter from his employer stating that the pension plan is about two-thirds solvent, and I said, 'That changes the picture.'"
With high-profile busts such as Nortel Networks highlighting the shaky state of some company pensions, people are right to question whether their full pension benefits will be there in the future, he says. If your plan has a shortfall and your company is struggling financially, taking your money out may be a prudent move, he says.
3. How do you feel about managing money?
The nice thing about drawing a pension is that you get a cheque every month while someone else looks after your capital. But if you withdraw the commuted value of your pension and put it into a locked-in retirement account, you'll have to manage the investments yourself or find someone to do it for you. For some people, the pressure is too much.
"The more uncomfortable you are with having the money and having to take responsibility for it, the more the pension is going to look like a good idea to you," says Malcolm Hamilton, pension consultant with Mercer in Toronto.
On the other hand, because interest rates are at historic lows, commuted values are much higher today than they were in the past. That's because, when rates are low, a larger principal is needed to generate the same level of benefits.
4. What's your risk tolerance?
On a related note, you might have the knowledge to manage money – but not the stomach. Some people have commuted values of $1.5-million or more, Mr. McShane points out, so if their investments fall by just 10 per cent, they'll be down by $150,000.
"If the market starts to decline, will they hang in there or bail out?" he asks. Those who are inclined to hit the panic button might be better suited to a pension.
5. Do you work in the public sector?
Public sector workers are more inclined to leave their money in the pension plan, Mr. Hamilton says. That's because government pensions are more secure and are indexed to inflation, so benefits aren't eroded over time.
But most private pensions provide little, if any, protection from inflation, he says. That explains why private sector employees often take the lump sum.
"If you're 40 years old, your deferred pension isn't going to start for 25 years. And then, if you live a normal life expectancy, it will continue another 20 years after that," he says. So if you leave your money in a non-indexed plan for a long period, "you're taking a big risk."