Things to consider when facing a pension buyout

Transcription

1 Things to consider when facing a pension buyout

2 Key Pension Considerations Bridging Benefits Your age and years of service Extended Health Benefits Inflation and Indexation Tax Implications How Your Advisor Gets Paid Pension Buyout Considerations Other Sources of Income in Retirement Leaving an Inheritance or Lump Sum to Your Spouse Debt into Retirement Financial Health of the Pension Plan Required Income and Rate of Return Flexibility of Financial Assets in Retirement Anticipated Life Span

3 Getting Started You are approaching retirement age and are probably contemplating the most important decision impacting your financial security and quality of life in retirement. It is very important to take the time to gather the information you need to make the right decision for you and your family. Remember every individual situation is unique. Here are thirteen factors to consider before deciding to take your monthly pension or the cash buyout (commuted value). You should consider: 1. The implications of your age and years of service 2. Your required extended health benefits in retirement 3. The tax implications of taking the buyout 4. Other sources of income in retirement 5. Debt carried into retirement 6. Your anticipated life span 7. Required income flexibility during retirement 8. The implications of rate of return and prudent investment management 9. The continued health of your company sponsored pension plan during retirement 10. The importance of leaving an inheritance or lump-sum to your spouse or children 11. The impact of bridge benefits 12. The impacts of inflation and indexation 13. How your financial advisor is compensated

4 1. The implications of your age and years of service. Both the amount of your monthly pension and the corresponding commuted value of the pension are directly impacted by years of service to your employer. Your age also plays a critical role in your ability to access Federal Government retirement programs (Canada/ Quebec Pension Plan, Old Age Security and the Guaranteed Income Supplement) and it could determine your ability to access the commuted value of your pension; as typically this option expires once you turn 58, depending on your years of service. 2. Your required extended health benefits in retirement. By accepting the monthly pension you are eligible for retiree extended health benefits. Please keep in mind that the level of these benefits is often lower than those provided to you during your active working years. These benefits are not available if you take the commuted value (buyout) option. Several important considerations include: Spousal coverage in retirement The cost of acquiring a private health insurance plan The cost to self-insure (pay for medical expenses out of pocket) MSP premiums Corporate sponsored life insurance 3. The tax implications of taking the buyout. Typically if you choose the buyout option your funds will be transferred to you through several different investment accounts, as mandated by the Canada Revenue Agency. A portion of your funds will be transferred into a Registered Retirement Income Fund (RRIF), a portion will be transferred into a Locked-In RRSP (LRSP), and the remaining portion is paid out directly in cash. The funds transferred into the registered accounts will occur on a tax deferred basis (you will only pay income tax on amounts withdrawn, not at the time of deposit). Please note any growth in these accounts will also occur on a tax deferred basis. While the transfers to these accounts are mandatory, it is ultimately done to ensure your pension assets are preserved for your retirement.

5 Additionally, by taking the buyout, the cash portion will be taxable in the year received. Some of these taxes could possibly be deferred by utilizing any unused RRSP room while remaining funds not contributed into your RRSP will be considered taxable. For a large pension this could result in taxable income in the year received in excess of one hundred thousand dollars. Fortunately there are some additional tax strategies which can ease the tax impact on that lump sum, effectively reducing the overall tax bill, after taxes have been paid. Two such examples include: Utilizing your spouse s unused RRSP contribution room to potentially provide the family with a tax refund in the subsequent calendar year. Maximizing available Tax Free Savings Account (TFSA) contribution room (for both you and your spouse), so that future growth occurs on a tax free basis. You should also note that these accounts are flexible enough to fund periodic needs as no withdrawal restrictions apply. 4. Other sources of income in retirement. The monies paid to you as the commuted value (buyout) of your pension are meant to sustain you in retirement. One of the critical factors to consider prior to making your decision is what other sources of income you will have in retirement. For instance: Does your spouse have a pension? Do you have rental income? Do you have other assets that can generate revenue? What will your CPP and OAS look like in retirement? Do you plan on continuing to work after taking the pension buyout? It is critical to make a fully informed decision after evaluating your options and gaining a clear understanding of your financial situation. 5. Debt carried into retirement. One of the critical things to look at is what level of debt you will have heading into retirement. Will you have: A mortgage? Vehicle or personal loans? Excessive credit card debt?

6 Debt management is an important aspect of retirement. If you opt to take the buyout and then subsequently pay off your debts you may find that the residual asset base is insufficient to meet your ongoing financial needs in retirement. Similarly, if you decide to withdraw large lump sums immediately after receiving the pension buyout for new purchases (i.e. vacation property, vehicles), you will negatively impact the ability of any remaining funds to replace your income in future years. Remember the commuted value received is meant to replace your pension income in retirement. 6. Your anticipated life span. This is a serious and often uncomfortable question. Your current health plays a significant part, along with an understanding of the health of your parents, siblings and spouse when you are making the decision to take the commuted value of your pension. A traditional pension provides a set level of income in retirement, but most often results in reduced benefits to your spouse if you pass away. Subsequently after your spouse passes, the benefits disappear and the effective value of your pension is $0. If both you and your spouse die within ten years of retirement a significant amount of money will disappear or be left on the table so to speak. In a nutshell, if you think you will live well past 85, taking the pension is a more appealing option. If for some reason you think your lifespan could be shorter, due to family history or personal health challenges, then taking the cash may be the better alternative. 7. Required income flexibility during retirement. While taking the pension amount provides you with a high degree of income certainty during retirement, it may not suit your family s retirement plans. For instance, what happens if you decide to continue to work during retirement? You will not have the ability to turn-off the taxable pension income. Many individuals continue to work in retirement and the combination of employment income and pension income may impact their marginal tax rate. Also what happens if you want more money in your early years of retirement to travel or enjoy other activities and then want to reduce your income when you become older and typically spend less? The inflexibility of a set pension makes lifestyle planning more difficult. What if you require $50,000 for an emergency purchase or family need today? For some this won t be a meaningful issue, but for others, financial flexibility during retirement may be important.

7 8. The implications of rate of return and prudent investment management. Financial calculations need to be made based on your life expectancy to determine what rate of return is required on the commuted value to result in a similar monthly pension payment. Low interest rates present a unique opportunity when calculating the commuted value and may create an opportunity to outperform in the long term. It is vital to pay attention to interest rates. If the interest rates used to calculate commuted values increase, the commuted value of your pension is likely to decrease making it more difficult to obtain your desired level of income in the future. Similarly, the investment approach taken with your commuted value can have a significant impact on your retirement. These funds are meant to replace your pension in retirement and should be managed in a similar manner to a pension. Excessive risk and losses can be detrimental to the value of your funds. Sound investment management implemented by experienced financial professionals can be a critical component to your long-term success. If you do not believe you can consistently earn investment returns greater or equal to what is assumed in the commuted value calculation then sticking with the pension will likely make more sense. 9. The continued health of your company sponsored pension plan during retirement. One important question to ask is how well your pension plan is funded today. If your company or its pension is underfunded, there is a possibility that your pension may be reduced. This could mean accepting 90 or 70 cents on the dollar, or having reduced health benefits in retirement. Pension legislation requires that pension fund assets be segregated from an employer s assets and protected from the employer s creditors. The pension plan s ability to make monthly pension benefit payments depends on how well the plan is funded. A well funded plan will have sufficient assets to meet all pension obligations if the plan was to be wound up. In 2016 the Financial Services Commission of Ontario released the 2015 Report on the Funding of Defined Benefit Pension Plans in Ontario Overview and Selected Findings The findings of the report concluded that: Of the 1,283 plans that were analyzed, which together cover 1,835,156 plan members, 396 plans (31%) were less than fully funded on a going concern basis. These 396 underfunded plans cover 1,109,485 (60%) of the total plan members.

8 10. The importance of leaving an inheritance or Lump-sum to your spouse or children. One of the most often raised concerns regarding taking your pension is that when you are gone, so is the pension, or a significant portion thereof. Typically survivor s benefits range between 50-80% of the initial pension entitlement. Should you pass away early into retirement, the residual amount left to your spouse will be significantly diminished. Subsequently, when your spouse passes your total pension value and benefits disappear. Some of these risks can be mitigated through the purchase of life-insurance policies, but they come at an additional cost. Depending upon your personal views, this can be a significant determining factor in your decision. Based on your lifestyle needs and portfolio performance taking the commuted value may leave you with more of an estate, especially given that the pension is essentially worth $0 upon the death of both spouses. An additional consideration for couples where both will have a defined benefit pension, is for one to keep a pension and the other to take the commuted value. This will ensure your family has a guaranteed minimum monthly income while increasing retirement financial flexibility. Both the health of the potential pensioner and the underlying pension plans should be considered when making this decision. 11. The impacts of bridge benefits. If your pension has a bridge benefit (this is a temporary benefit payable until age 65 when Canada Pension Plan and Old Age Security benefits can start) this should be taken into consideration when determining whether to commute your pension or not. Retiring prior to 65 and commuting your pension may put you in a position whereby it is necessary to take reduced CPP/QPP. With pension plans it is typical that your bridge benefit will stop at age 65 regardless of when you start your CPP/QPP pension. 12. The impacts of Inflation and Indexation. It is no secret that over the mid to long-term the cost of living continues to rise, as evident by the Consumer Price Index (CPI). Once you enter into retirement for the most part you are living on a fixed income. The longer you live into retirement the greater impact inflation is likely to have on your standard of living. Should you be looking at taking the pension, it is critical to determine if the pension is adjusted annually for inflation (indexed), if not: What will your $3,000 a month pension buy you or your spouse in 20 years? Can your spouse survive on a non-indexed, reduced pension should you pass in retirement?

9 The recent average annual inflation rate in Canada in the last 20 years has been roughly 2%. Over the past 40 years we have seen annual inflation as low as 0.17% (1994) or as high as 12.47% (1981). Simply put, if current inflation rates remain consistent (2%) your non-indexed pension of $3,000 a month will have the purchasing power of $2,261 (today s dollars) in 15 years. Should you pass away this would translate to the equivalent of $1,356 per month for your spouse (based on the above mentioned inflation and a 60% survivors benefit). 13. How your financial advisor is compensated. Should you decide to take the commuted value of your pension (buyout) it is critical that you gain a reasonable understanding of financial services industry compensation. There are numerous ways that your advisor is compensated for managing your retirement assets. It is important that you understand the various ways so you can ensure that your financial advisor s actions and interests are aligned with yours as the investor. Simply put, a fee based advisor charges an annual fee based on the size of your account (assets under management), and he/she gets a raise as your account grows, or correspondingly takes a pay cut if the value in your account declines. The rationale is that the level of compensation is tied to the performance of your account. In a commission based relationship you pay the advisor for every buy or sell trade. In an account where there are limited transactions this can be in the client s best interest. However, should the need arise to be more responsive to market conditions (frequent buys and sells ), commission costs can escalate and be detrimental to your financial success. When purchasing mutual or segregated funds there are sales charges that compensate your advisor for the services they are providing. Funds may be offered on a front-end load, back-end load, low load or no load basis. These charges are set by the mutual fund manufacturer. Below please find a summary of the four standardized sales charges as provided by the Ontario Securities Commission s GetSmarterAboutMoney.ca website. 4 types of sales charges Front-end load or initial sales charge (ISC) Some mutual funds charge a fee when you buy your units or shares. This is a percentage (up to 5%) of the amount that you are investing in the fund. The fee is paid to the investment firm that sells you the fund. You can negotiate this fee with your advisor. Low load or low sales charge (LSC) Low load funds charge a lower sales charge (up to 3%) when you buy your units or shares, and a lower redemption fee (up to 3%) when you sell them. You usually won t have to pay a redemption fee if you hold your units or shares for at least 3 years.

10 No load A no load fund doesn t charge a fee when you buy or sell its units or shares. A no load fund may not always be a better deal than a load fund. You should compare the MER and performance of each fund before you decide. Back-end load or deferred sales charge (DSC) Some funds charge a fee of up to 7% when you sell your units or shares. Here s how it works: The longer you hold a fund with a DSC, the less you ll be charged when you sell it. The fee declines every year according to a fixed schedule. If you hold it long enough (usually between 5 and 7 years), you won t pay a fee when you sell your units or shares. Some fund companies may also let you take some of your money (usually 10%) out of the fund each year without charging you a fee. Your advisor s firm receives commission (usually about 5%) up front from the mutual fund company when you buy the fund. Your advisor receives part of this commission. Any deferred sales charge you pay goes to the mutual fund company. In addition to the above sales charges, many mutual funds pay a trailing commission (or trailer fee) each year to the company that sold you the fund. They pay this commission for as long as you hold the fund. The rate of the trailing commission is set by the fund company. Here s how it works: It is paid out of the fund s management fee, and it reflected in the fund s MER. It typically ranges from 0.25% to 1.5% of the value of your investment each year. It is to pay for the services and advice the company and the advisor provide to you. The company may pay all or part of the commission to your financial advisor. It is important that you become knowledgeable about how your advisor is compensated and ensure that your interests are mutually aligned. Industry regulations require that your financial advisor disclose to you how they are compensated and provide you with information on any mutual fund purchase they make on your behalf (most recent Fund Facts document). Please note: this document has been created by MP Wealth Advisory, Canaccord Genuity Wealth Management for information purposes only. Please contact our office ( ) or your financial advisor for a detailed analysis and review of your situation.

11 Take the next step... We have developed a screening tool to assist you. Take the MP Wealth Quick Screen A Preliminary Screening Tool for Teck Metals Defined Benefit Pension Plan Participants This tool, available via or on our website, is designed to help you determine if you should further investigate taking the commuted value of your pension. Upon submission of the completed screening tool we will provide your score along with related commentary to assist you with this important decision. Contact our office today at mpwealth@canaccord.com, or visit our website at mpwealthadvisory.com to find out how you score.

12 MP Wealth Advisory 1277 Cedar Avenue Trail, BC V1R 4B9 T: F: TF: E: mpwealthadvisory.com canaccordgenuity.com Canaccord Genuity Wealth Management in Canada is a division of Canaccord Genuity Corp. Member Canadian Investor Protection Fund Member of all Canadian stock exchanges and the Investment Industry Regulatory Organization of Canada Independent Wealth Management advisors are registered with IIROC through Canaccord Genuity Corp. and operate as agents of Canaccord Genuity Corp. canaccordgenuity.com