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Commuted Value vs. Pension Promise

Defined benefit pension plans have been the backbone of many people’s retirement planning in the past but those days are quickly coming to an end.  While government and quasi government plans such as HOOP, Teachers Pension and OMER’s continue, private companies are switching to defined contribution plans or group RRSP’s to shift the responsibility of managing retirement savings back to their employees. While the employer may still make plan contributions, the employees are left to make the investment decisions.

Companies such as GM continue to offer commuted value buyouts for some employees in order to take the retirement funding burden off the company.  As a result, individuals must take more time to evaluate their investment strategy and ensure that they have a proper plan in place to provide for a secure retirement.

If you or someone you know is faced with making a decision on whether or not to accept a commuted value of a pension payout, it is critical to meet with a financial planner to review the offer and consider the implications of either leaving it in the plan or transferring the value to your personal accounts. The review should include information on the following seven points:

  1. The funding status of the current pension plan and its prospects for the next 35 years. By leaving your pension with the company you trust them to manage the funds and meet their commitment to you, a long way into the future.
  2. Life expectancy.  This is a question we do not know the answer to but you can make some assumptions based on current health and family history. Once the plan member dies, only a % goes to the survivor (if they exist), which approximately usually 60%. This is not usually acceptable for many people. If you have a shortened life expectancy, i.e. your mid 70`s, then the commuted value can offer an opportunity to pass on some pension funds to your family.
  3. Anticipated retirement needs and timing of income. Some people expect to spend more money early in retirement on travel and less as they get older.  Having a fixed pension for life may not suit these plans.
  4. How close you are to retirement.  If you are age 55 and eligible for a full buyout but have plans to continue working, you could invest the pension and defer income until a later date.  
  5. Your tolerance for risk. Are you comfortable in accepting the investment risk required to get the returns needed to beat the pension plan income?
  6. The amount of the commuted value offer and how much can be transferred to a locked-in retirement account and your RRSP account. When interest rates are low as they are now, commuted values offered are significantly higher than a few years ago.  In some cases not all of your pension can be moved tax-sheltered to retirement plans.  This will impact the net amount you receive and also will reduce the future tax payable.
  7. The rate of return needed to outperform your pension plan.  In many of our calculations we see that a 3% return is all that is needed to meet the pension offered.  If you think that you can earn 4% or more over the long term then it makes sense to take the commuted value. You could enjoy a higher retirement income and leave funds for your heirs.

Your Financial Planner will need a copy of the latest pension statement, the buyout offer and a recent annual report on the pension plan to begin the process of reviewing your options and to establish if commuted value or the pension itself is the better option for you and your family.


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