Changing employers by force or by desire can make a huge impact on your financial life. I outlined some financial considerations when leaving an employer in my previous video “Switching Employers”. Today I’ll be focusing on what to do with your Defined Benefit Pension Plan when you leave your current employer.
When you resign or are let go from a company prior to retirement, you have to make a decision around what you would like to do with your current employer pension plan. You will receive a letter from your pension administrator giving you the relevant information to select an option for your pension plan. Once you receive that letter you have a certain period of time to make a decision, otherwise you’ll be stuck with the default option. The letter often indicates this deadline. This is why it is important to change the address on file if you have left your employer in order to take a job in a different city, so that you don’t miss this deadline.
You can keep the defined benefit pension plan and collect your benefit upon retirement. This is usually the default option. Your benefit is calculated using your current years of service and your current salary and won’t increase since you won’t be adding more years of service. Watch my previous video on Defined Benefit pensions for a review of these types of plans.
You may be able to transfer your pension to another employer pension plan.
You can transfer your benefit out of the plan into an account at a financial institution. You’ll most likely have to transfer this into a Locked-in Retirement Account (LIRA) unless your accumulated pension is small. There also may be an excess of funds you are entitled to that cannot be transferred into a LIRA. You will be taxed on this amount as regular income in the year it’s paid out, unless you have sufficient RRSP room to transfer it over tax-free. Here’s an example, let’s say the taxable portion that cannot be transferred to a LIRA is $20,000 and your salary is $60,000. If you have no RRSP room, you’ll have to pay tax on $80,000 in income that year. If you have sufficient RRSP room, you can transfer that $20,000 to your RRSP and your net income is only $60,000 (the $80,000 less the $20,000 RRSP deduction). You can learn more about RRSP contribution room in my video RRSP Deduction Limit vs. Contribution Room.
The first consideration is whether you will be eligible for certain benefits if you receive a retirement pension. For example, many government pensions offer health care benefits to retirees. You’re only eligible for this if you keep your defined benefit pension within the plan and don’t transfer it out. Receiving health care benefits in retirement could drastically improve your retirement finances if you are eligible for things such as home care in old age that you would otherwise pay out of pocket. There is a risk that the government may come under pressure from taxpayers to remove this expensive benefit for government employees.
The second consideration is the financial health of the company you are leaving. You need to be confident that the company will be around for a long time and be able to keep up with their pension benefits. If the company goes bankrupt or gets into financial trouble, they may not be able to top-up the plan and you may not receive the benefits initially promised to you. Sears is a good recent example of retirees being shafted.
The third consideration is whether you think you can outperform the retirement plan by investing on your own. If you are a very conservative investor, then this is unlikely. Even if you are a more aggressive investor, be sure to use realistic expected returns when estimating how you might compare to the pension plan (10% is not reasonable, especially if you reduce your risk over time as you get closer and into retirement). I’ve linked a paper outlining what PWL uses for their expected returns in the description below. Defined Benefit pensions offer lifetime income no matter how long you live, and often provide survivor benefits and inflation protection. Pension plans are able to pool this risk, so if you live longer than expected that’s offset by those who have died earlier. If you live longer than you expect and you transferred your plan to a LIRA, you may be out of luck.
Finally, the last consideration is convenience. If your benefit is going to be small in retirement, you might just prefer pooling the commuted value (the lump sum you receive if you transfer the pension out) with other investments you or your advisor manages. This way you don’t have to worry about different little retirement pieces all over the place and can better keep track of your retirement savings.
As you can see, the decision to keep your defined benefit pension in the plan comes down to many factors. Your current age can also drastically change which option is better from a numbers standpoint. If you’re in this situation and need help making a decision, feel free to let me know in the comments below.
In my next post, I’ll be looking at the decision to transfer Defined Contribution Pension Plans.
PWL’s Expected Returns: https://www.pwlcapital.com/pwl/media/pwl-media/PDF-files/White-Papers/2016-03-07_-Kerzerho-Bortolotti_Great-Expectation_Hyperlinked.pdf?ext=.pdf
