Understanding your options: Retiring with a Work Pension
You’ve worked your whole life and finally are ready to retire, congratulations! If you are one of the roughly 7 million Canadians who are active members of a registered pension plan, you have a decision to make with regards to how to receive the pension that you diligently contributed to over your working life. But not all pensions are created equal, and it’s important to understand and consider your options carefully before making a decision.
Let’s start off by quickly explaining the two common types of registered pensions: Defined Benefit and Defined Contribution. A Defined Benefit Pension Plan (DBPP) is one in which an employee can expect to get a fixed amount of income for their entire retirement based on a formula that incorporates their years of service and earnings. Both employees and employers make regular contributions based on an annual percentage of earned income and all the pension funds are managed together in a pool. The investment risk is borne by the employer and if the pension pool is not meeting the required rate of return to meet the pension obligations of members, then the employer is required to make up the shortfall. DBPP’s are commonly found in government and public sector jobs and are a great benefit for employees as the pension income that employees receive is guaranteed for life. In a Defined Contribution Pension Plan (DCPP), both the employee and the employer make annual contributions into the plan based on a percentage of earned income in the same way as a DBPP. The main difference between the two plans is that the retirement benefit is not known in advance or guaranteed with DCPP’s. The risk of a DCPP is borne by the employee, in the same way that investment risk is borne by individuals in their other investment accounts such as RRSP’s. If the investments perform poorly, the individual may have to manage their expectations on what they can expect to receive for income from the pension in retirement.
The two most common options for taking a pension are 1) receiving a fixed monthly payment for life based on the formula for a DBPP or investment value for a DCPP or 2) working with a financial professional to convert your pension into a retirement account, where you select the investments and withdrawal amounts within the prescribed limits. Like any decision, there are pros and cons of each option. The fixed monthly payment is guaranteed for life, no matter how long you live and gives many retirees peace of mind knowing that the amount will always be there. However, retirees give up control over the funds and this results in less flexibility over the course of retirement and can also impact what happens to the funds upon death. With option 2, retirees are able to decide on how they want to spend the pension money during retirement based on their individual circumstances. For many, this means withdrawing more earlier in an “active retirement” stage while they are still healthy and able to do things such as travel.
Choosing what to do with your pension is one of the biggest financial decisions a person will make in their lifetime. If you want to better understand your options, bring a pension statement or option sheet to a financial advisor for review. With their help, you can ensure that you are making an informed decision and doing what is best for your unique situation.
Riley Love, MBA, CCS, BSc. Pharm
Partner/Financial Advisor – Love & Persson Group