Should I Transfer My Work Pension? Can I Move My Workplace Pension?
Should I Transfer My Work Pension? Can I Move My Workplace Pension?
Important Things YOU NEED to consider when thinking about transferring out of your workplace Defined Benefit Pension Plan!
You have worked hard all your life, and now you are ready for retirement? You are just months away from officially pulling the pin, and you are asking yourself: Should I transfer my pension? Can I move my workplace pension? How does it all work?
Well in today’s article we are going to walk you through some of the most important considerations you need to think about prior to making the move. Hopefully, I can help you make a great decision.
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We Will Focus On Defined Benefit Plans
When it comes to retirement, one of the most crucial decisions individuals face is whether to transfer their pension. This decision becomes even more complex when considering the differences between defined benefit and defined contribution pensions. In this article, we’ll be focusing specifically on defined benefit pensions and delving into the reasons why someone might consider transferring such a pension. We’ll explore the potential advantages and disadvantages, providing readers with a comprehensive understanding of the factors at play in this important financial choice.
We’re focusing solely on defined benefit pensions because they pose more complex considerations when it comes to transferring. Unlike defined contribution plans, which are often easier to transfer due to their flexible nature, defined benefit pensions involve guaranteed income and other factors that require careful assessment before making a decision. Our aim is to provide clear guidance specifically tailored to those navigating the transfer process for defined benefit pensions. So for that reason we are tackling the Defined Benefit Plan you have at work. However, throughout the article we will touch on DC plans, when it makes sense to do so.
Commuted Value of a Defined Pension — Definition
The commuted value of a defined benefit pension represents the lump sum value of all your future pension income today. This lump sum value represents the present value of the future monthly pension income you would otherwise receive for your lifetime upon retirement. Now this is important to remember because we are going to talk about interest rate levels and how they can affect the amounts you will receive — more on that later.
Can I Transfer My Defined Benefit Plan?
In Canada, when leaving an employer with a defined benefit plan, you CAN generally transfer if you are below age 55. If you are over 55 generally you cannot, but let’s assume that you are. Here are your options:
A) Leave the pension with the former employer
B) Transfer it to a new employer’s plan (if available),
C) Choose a copycat annuity, or
D) Transfer part of the pension into a personal retirement account, such as a Locked-In Retirement Account (LIRA) or a Life Income Fund (LIF) (along with a lump sum), depending on provincial or federal regulations.
Each option has implications for taxes, investment choices, and future income, so it’s essential to consider these factors carefully before making a decision.
BUT FIRST!
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NOW BACK TO THE ARTICLE!
Now Let’s Go Through The Choices!
Choice A — Leave the pension with the former employer — Well since this article is about transferring we will assume you aren’t leaving it in, however, we will look at a few pros and cons here.
Should I Even Transfer My Defined Benefit Plan?
There are several Pros and Cons to moving your pension. Let’s examine IMPORTANT CONSIDERATIONS you need to take into account!
Who is Behind Your Pension?
Deciding whether to move a defined benefit pension primarily boils down to whether it’s considered safe. The safety of the pension, ensuring that promised benefits will be received over time, is the key factor driving this decision. It’s all about trust in the pension provider. Is it a Government entity backed by the federal or provincial government? Or is it a pension that is provided by a company like Ford or General Motors. Government pensions are generally well-funded and unlikely to run into payment issues, so insolvency should generally not be a worry if you have a pension plan from a level of government. If your pension plan is backed by a public or private company, even though the pension funds are usually kept separate from the company’s finances, the perceived risk of insolvency can make the decision pretty straightforward for employees. In such cases, many Canadians choose to transfer these pensions to help safeguard their savings. They just don’t know how long, or even if the company will be around for the 30-plus years of their retirement. So, ultimately, the choice to transfer hinges on how secure individuals feel about the company or entity providing that future retirement income.
In general, the less creditworthy you feel your employer is, the more likely you would consider moving it.
The Major Pro — When You Transfer, 100% of your assets can transfer to a spouse upon death, whereas only 66.67% of payments will be made from your pension if you pass away…
Staying with a pension often means that upon your death, your spouse may only receive two-thirds of the payment unless you opt for a reduced payment initially to ensure equal payments for your spouse in the event of your passing. However, transferring the entire lump sum, along with your locked-in portion, is generally a better option when it comes to your spouse. By doing so, you can avoid losing a third of the payments upon your death — as all of the remaining assets would transfer without any tax obligation to your spouse. Additionally, the payments can continue seamlessly regardless of whether you’re alive or not, offering more financial security for your loved ones.
The Major Con — You Assume The Risk When You Transfer
When you transfer out of a pension plan, you’re taking on the market’s ups and downs. Previously, the pension administrator guaranteed a set payment for your retirement until you passed away. But by moving your pension, you’re now exposed to the uncertainties of investment returns. While this shift gives you more control over your savings, it also means your retirement income can vary based on how the market performs. If you go through a massive downturn in the markets — your pension money will also likely be negatively affected and it could affect your retirement. It’s a trade-off between potential growth and the security of a guaranteed payout.
And On to Our Next Choice!
Choice B) Transfer it to a new employer’s plan (if available) — Transferring your pension to a new employer’s plan might not be an option, especially if you’re moving from a federally regulated job to one under provincial jurisdiction in Canada. Federal and provincial pension rules differ, so it’s unlikely you can transfer a federal pension to a provincial one. So in short, if you are switching jurisdictions you may have to transfer — making this choice easy! However, if you have a Manitoba government pension and switch to another Manitoba government job, it’s likely the same pension administrator manages both, making a transfer more feasible — but it’s not always possible.
Choice C) Choose a copycat annuity
A copycat annuity with a financial institution mirrors the benefits of a defined benefit pension by providing a steady stream of income in retirement. Essentially, it’s a type of annuity purchased from a financial institution that aims to replicate the payment structure of your original pension plan. This arrangement offers retirees the peace of mind of receiving regular payments, similar to those they would have received from their pension. While a copycat annuity may not provide the exact same benefits as the original pension plan, it can still offer a reliable source of income throughout retirement, helping individuals maintain their financial stability in their later years. It’s worth noting, however, that while this option is available, I’m generally not a fan of this choice, as it may not always be the most advantageous route.
We will Assume You Are Thinking About…
Choice D — Transfer part of the pension into a LIRA or LIF, along with a lump sum.
For the purpose of this article, let’s assume a scenario where you’ve decided not to do any of the above choices, and instead, you’ve opted to take the lump sum payment or the commuted value of your pension and transfer it to a financial institution.
How It Works!
Now, when you have an option to transfer your pension, there are two components, and you will see this when you get your package from your employer. You will see in general two amounts. One part can be transferred to a locked-in RRSP, which you can access starting at age 55. The other portion will be disbursed as cash. Part of that cash you will be able to roll over into your RRSP based on years of service calculation, and the other part if you have room in your RRSP you can roll that directly in without any tax implications. Otherwise, it will be treated as taxable income. So you will have to have a LIRA opened with your investment advisor portfolio manager or other financial institution, an RRSP and possibly a cash account.
Tips on Getting THE MOST when you Transfer AND How to MINIMIZE TAXES:
Transfer when INTEREST Rates ARE LOW!
Remember how earlier I told you the level of interest rates were important? Well here is why. The LOWER the interest rate in general THE HIGHER the amount your commuted value will be! When interest rates are low, the commuted value of your pension tends to be higher. This is because the commuted value represents a lump sum of all your future pension payments, and low interest rates mean that more money is required to generate those payments at the current rate. In other words, when interest rates are low, pension funds need a larger sum to produce the same income stream. Conversely, when interest rates are high, less money is needed to generate the same income, resulting in a lower commuted value. Therefore, transferring your pension when interest rates are low can allow you to maximize the value of your commuted pension, giving you more funds to manage and invest for your retirement.
Retire On January 1st !
Why January 1st? Retiring on January 1st can offer potential tax advantages compared to retiring on December 31st. If you continue working until December 31st, you’ll have a full year’s income. If you receive your pension payment or lump sum on top of that income, you could end up paying a significant amount in taxes due to the higher total income. However, if you retire on January 1st, you likely won’t have any additional income for that tax year. This means that any lump sum you receive, if not rolled into your Registered Retirement Savings Plan (RRSP), could be taxed at a lower rate since your overall income for the year will be lower. In essence, by retiring on January 1st, you minimize the risk of being taxed heavily on your pension payments due to lower total income for the tax year.
Here is an Example:
You’re contemplating retirement, and you have the option to retire either on December 31st or January 1st. Let’s break down the implications. If you retire on December 1st with a yearly income of $150,000 and receive a lump sum payout on December 31 of $50,000, your total income for the year becomes $200,000. This pushes you into a higher tax bracket, resulting in a substantial tax bill. Conversely, retiring on January 1st means you haven’t earned any income for that tax year. So, when you receive the $50,000 lump sum in the following year, it becomes your only income, likely placing you in a lower tax bracket. This strategic timing could potentially save you thousands in taxes, making retiring on January 1st a more financially advantageous choice. It’s a simple yet effective way to maximize your retirement funds and minimize tax burdens, ensuring a smoother transition into your golden years.
The Bottom Line
Navigating the decision to transfer your workplace defined benefit pension requires careful consideration of various factors. From understanding the complexities of defined benefit plans to weighing the implications of transferring, each step demands attention to detail. While the choice to transfer may offer advantages such as increased control over your retirement savings and potential tax benefits, it also entails assuming market risks and forfeiting the security of guaranteed payments. Ultimately, whether to transfer your pension hinges on your individual circumstances, risk tolerance, and long-term financial goals. By arming yourself with knowledge and seeking professional advice, you can make an informed decision that aligns with your best interests and secures a prosperous retirement journey.
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Joe A. Macek, FMA, CIM, DMS, FCSI
Investment Advisor, Portfolio Manager
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