Should you take your pension or a lump sum?
In an age of financial uncertainty and economic downturns, many people are beginning to consider taking a lump sum, or transferring their monthly pension to a commuted value in a locked-in retirement account (LIRA). For Canadians with a monthly pension plan through their employers, this is often an option that they can pursue. There are benefits to both forms of retirement planning that should be considered when evaluating this decision.
Your pension planning is impacted by the stability of your employer
This is some of the most important pension advice that we, as financial advisors, can give. Your pension is not always guaranteed, and much of it will depend on the stability of your employer.
You need to evaluate the security of your employer when considering if you should pursue a lump-sum or monthly pension plans. Ultimately, you need to ask yourself the following question: will this company continue to exist 20 – 30 years into the future? While government and teacher’s pension plans are very secure, many other corporations are not.
If you are worried that the company is insolvent, or if you are being laid off due to corporate struggles, pursuing a lump sum may be a more secure option for you. Additionally, if your company is struggling, then your pension could be reduced in the future due to financial issues within the firm. However, even when companies go bankrupt, most monthly pensions are still paid out, unless they were significantly underfunded upon bankruptcy.
Life expectancy will influence your pension plan
Life expectancy can play a significant role when considering which pension option to pursue. A monthly pension protects you from outliving your retirement funds – a protection which disappears when pursuing the lump-sum option. If you think you and your spouse will live into your 80s or longer, then monthly pension plans are a more secure option. If you predict a shorter life expectancy, then pursuing a lump-sum is ideal.
While your spouse would still be entitled to a percentage of your monthly pension benefits after your death, your children will not. As such, choosing the lump-sum option when you have a shorter life expectancy could allow you to provide for your children after your death. This isn’t to say that you cannot reinvest your lump sum payment but it does not give you the lifelong guarantee that a typical pension does.
Pension tax implications
A major factor in the decision to take a lump sum instead of a monthly pension plan are the tax implications. Many people do not consider that they will be taxed on the commuted value. In the year of receipt of the lump sum, your income taxes will be much higher, and so you may end up losing a significant portion of your lump sum to increased taxation. This is a risk that we have touched on before, and is a one of a major benefits of an RRSP, but it an important consideration for planning your retirement.
Luckily, there are some ways around this. Depending on the pension plan available to you, you may be able to transfer some of the lump sum into your RRSPs – usually, up to $2,000 for each year you were with your employer prior to 1996, plus an additional $1,500 for each year prior to 1989 in which the employer contributions have not vested. These transfers would not affect your regular RRSP contribution room – but for most people, they won’t be nearly enough to cover the lump sum.
Other factors that you should be considering when deciding between a lump sum and your monthly pension plan include the corporate benefits of being within the plan, your control of investment decisions, and the current level of interest rates. Staying within the monthly pension plan may give you access to health care, dental and insurance benefits which may be expensive to buy separately. If you are reliant on these benefits, then it may be better for you to stay within the monthly plan, rather than pursue the lump sum.
The decision to take a lump sum becomes more attractive when interest rates are low. The calculation of a commuted value has an inverse relationship with interest rates, which means that the lower interest rates are when you take the lump sum, the higher the commuted value will be.
Finally, you should consider that choosing a lump sum means you have control over your investment decisions. If your investment (risk) profile is conservative, then you are unlikely to match the returns on your pension income to be able to create a higher monthly income with your investments. However, if you’re a savvy investor who believes they can outperform the return on your pension plan, then choosing the lump sum to be able to make those investments on your own is a better decision.
While this is a good start for your decision-making process, remember that this is a complicated decision to make. Meeting with a financial professional can help you review your options, and come to an informed decision.
Thanks for reading!
If anything on this blog interests you further, please do not hesitate to reach out to me via email at [email protected] I’d love to talk about my financial services and advice in Vancouver, British Columbia’s lower mainland, and Canada in general.
- Brad Blair, CFP, CIM, FCSI, CHS.