Pension or lump sum?


Green wheel barrel full of dollars bills

 You are leaving your current employer before the earliest date you can retire. You are not sure what to do with the money in your defined benefit (DB) pension plan. You can either leave the money in the plan and collect a pension later on, or transfer a lump sum representing the present value of your pension to a locked-in retirement account.

Here are some factors that will influence your decision:

Age and service: If you are many years from retirement and have only worked for the company for a few years, both the lump sum and the pension you can expect to receive in future will be small. In these circumstances it may make more sense to take the lump sum.

  1. Life expectancy: No one knows how long they will live, but if you are healthy and both your grandparents lived to age 90, chances are the pension payments you receive for life will exceed the value of the invested lump sum over time.
  2. Other assets: You may want to leave an estate for your children. If you have other assets like a paid up house when you retire in addition to this pension, you may be less concerned that if you die prematurely your pension dies with you or your surviving spouse.
  3. Risk tolerance: Are you comfortable investing hundreds of thousands of dollars and then drawing down amounts from your RRIF to cover expenses? How will you react to market fluctuations? If you want the security of a guaranteed monthly income, you may prefer to receive a pension.
  4. Company’s financial health: Take a look at whether the pension plan is fully funded. Are you confident that the company can survive the test of time and pay you benefits for 35 years or more?
  5. Public vs private sector: Public sector plan members don’t have to worry about company solvency or the funded level of their benefits. As a result, the decision whether or not to take a pension may be less difficult.
  6. Health benefits: Some employers offer valuable health benefits to retirees defined as former employees receiving a pension. So if you opt to take the lump sum commuted value of your pension instead of future periodic payments, you could inadvertently wipe out your right to medical benefits when you retire.

When I left my corporate employer over nine years ago after almost 18 years of service, I opted for a pension of about $45,000 until age 65 and $35,000 thereafter, when my government benefits kick in. This pension was reduced because I left before age 65.

However, because I was beyond the early retirement age in the plan, I did not have the option to transfer a lump sum representing the full commuted value of the benefit into a locked-in RRSP. But I have always been curious what the benefit was worth at my retirement date.

I was delighted when pension consultant Shawn Patton, Managing Partner of the Vancouver firm Ampersand Advisory Group agreed to do a a rough calculation for me. If I live to age 85, I can expect to receive about $1,250,000 in total payments. Using a discount rate of 4%, he told me the benefit at my date of retirement was worth in the neighbourhood of $719,000.

Even if I could have taken a lump sum in 2005, I don’t think I would have. The pension has given me a basic level of financial security so I could afford to develop a second career as a workplace journalist.

Like most pension plans, mine has been underfunded from time to time, but the company stock has been strong since a merger several years ago. I am keeping my fingers crossed that my former employer will “live long and prosper.”

However, whether or not you decide to take a lump sum or a deferred pension when you move on is a complicated decision based on your own personal circumstances.

“Each individual should get an independent professional to run the numbers,” Patton says. “However, taking the lump sum is typically a good deal only if you are very certain that over tine you can beat the discount rate your pension plan is using to calculate the lump sum value of your pension.”






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