Who Should Withdraw Their Pension?
Upon retirement or leaving a job, people with pension plans have the option to leave their employer-sponsored pension in place or withdraw the cash value and manage it themselves. This is a decision not to be taken lightly, as there are pros and cons to each option. The following are some considerations when planning for the best pension strategy.
How it works
When a person retires from their job, or leaves a job before their normal retirement date, they receive a pension statement listing their options. In most cases they can leave their pension in the plan or move it to a Locked-in Retirement Account (LIRA). The LIRA must be de-registered according to a schedule determined by the federal or provincial government. This structure is meant to emulate how the funds would have been paid out as income had they been left in the pension plan.
Financial discipline
A pension is designed to provide a stable, predictable income during one’s retirement years. Because of this, people with poor spending habits should not withdraw their pension. An exception would be those with very small pensions that won’t provide a meaningful amount in retirement.
Consider your spouse
When making decisions about one’s pension, it’s important to consider the retirement assets of their spouse. As a general rule, those who have very little in total pensions should not withdraw their work pensions, particularly if they have a defined benefit plan.
If one spouse has a modest sized pension and the other has a very good pension, and they have little in RRSPs other investable assets, it might make sense for the spouse with the small pension to withdraw theirs. The main reason is to increase financial flexibility. For example, if a couple has all their money tied up in pensions and little else saved, they won’t have access to lump sums for things like emergencies or large purchases. The same holds true for a single person who expects to receive multiple work pensions. As long as the single person or couple have a solid foundation of pensions, withdrawing a small pension can be beneficial in retirement.
Do the math
Simple math can come in handy when deciding if it’s in your best interests to withdraw your pension. Firstly, determine the pension’s expected annual rate of return using the pension’s commuted cash value, the annualized amount of the monthly payments and the number of years it will last. A financial advisor can help with this.
Next, compare the expected rate of return with long-term annuity rates. The pension plan will likely guarantee a higher rate of return than an annuity. In fact, the expected return is probably more in line with a very conservative investment portfolio. If this is the case, it might make sense to leave the pension as it is. If the return is in line with long-term annuity rates, one might consider withdrawing it.
Be sure to take note if the pension is indexed to inflation. According to the Bank of Canada website, inflation averaged 1.85 per cent per year from 1997 to 2017. In other words, a basket of goods or services that would have cost $100.00 in 1997 cost $144.37 in 2012. Many pensions, including government-sponsored pensions such as the Canada Pension Plan (CPP) and Old Age Security (OAS) are indexed to inflation.
Another important factor is whether an extended health benefits plan attached, subsidized or included with the pension.
Final thoughts
There are a few scenarios where withdrawing a pension makes sense. Young people often benefit from withdrawing their pension after changing jobs, however as a general rule, the closer a person gets to retirement the more beneficial it is to leave the pension alone.
When making a pension decision, consulting with your financial advisor. If they recommend withdrawing your pension, make sure they clearly explain how this would be to your benefit. Always exercise extreme caution with high risk strategies involving pension money.