Understanding Your Employer Pension – What You Need to Know
If you are thinking of retiring in the next few years you definitely have to take some time to review your pension plan. Do you know the details of how much you will receive when you expect to retire? Don’t feel bad if you don’t know. Most people are wildly ignorant about their pension plans.
In the early days when you started with your employer, part of the huge benefits package you were given likely included some sort of employer-sponsored pension plan. Chances are you briefly glanced at the annual statements and then filed them away.
Related: Countdown to Retirement
Whether contributions were mandatory, or strictly voluntary, that’s your money working in the plan. You can’t get a fix on your retirement income goal if you don’t know how your pension plan fits into the scheme.
It’s time to revisit your employer pension plan
Pension documents aren’t the liveliest of reading material. However, it’s in your best interest to know what type of plan you have, how the money will be paid out, and at what age you will receive full or partial benefits.
The most common types of pension plans are defined benefit (DB) and defined contribution (DC).
Defined Benefit Pension Plans
DB plans have long been considered the gold standard of pension plans. Although they are now becoming increasingly rare in the private sector, if you work in the public sector, they are still the norm.
Members are guaranteed a specific monthly payment at retirement according to a formula that can vary from one plan to another.
A typical formula based on best earnings is this:
(2% x years of service) X average of best five years of income = Annual pension income
That amount would be guaranteed, assuming the pension fund remained solvent.
The formula may be based on the number of years of service plus an income factor. More generous plans define income as the average of your best three or five years. Many plans use a “career average,” a sad case for the employee who put in a lot of years on the lower-paid rungs that will drag down their average. Others use your final three or five years, so keep this in mind if you’re thinking about easing into retirement by working part-time.
It’s important to find out which approach your plan employs. How will the pension be calculated when the time comes to stop working? Ask for a calculation of your projected pension at retirement. The closer you are to retiring, the more accurate the projection will be.
Questions to ask about your benefits:
- Is the plan integrated with CPP? This means that benefits paid by the plan will be adjusted to reflect payments you receive under the Canada Pension Plan. Most DB pension plans are integrated with the CPP.
- At what age can I retire? Some pension plans allow for retirement after a certain number of years of service; with others, you must reach a specific age. A typical formula involves adding age to years of service; if the total is equal to or greater than a target number (e.g. ninety) you may retire with full benefits.
- Should I take the pension payments immediately on retirement or wait? Will your payment be reduced if you retire early? Is there an increased benefit to deferring the payment until age 65 or 70?
- Are benefits indexed? Very few offer this desirable feature, and those that do are mainly in the public sector. If you have an unindexed plan, the buying power of your pension cheque erodes, but if you know this upfront, you’ll be able to plan accordingly.
- Is there a survivor benefit for my spouse? The contracted payments could be for the pensioner’s lifetime only. Or, for a slightly lower payment, they may continue on to your spouse after death.
- Can I take a lump sum cash payment instead of the monthly pension? The lump-sum must be transferred to a Locked-In Retirement Account. This allows you some flexibility to spend lump sums if you want to do that or pass along an estate to your children or another beneficiary.
Defined Contribution Pension Plans
Most people who are fortunate to have a pension plan while working in the private sector will likely have a DC plan. Here, the onus has been put on you to manage the money to your best advantage.
The amount of money you will have at retirement is based on the amount of the contributions made and the earnings on these investments. There is no guarantee of what your total payout will be. At retirement, you use the money in your account to generate retirement income.
You can do this by:
- Buying a life annuity.
- Transferring your savings to a locked-in retirement income fund (LRIF).
Is a pension buyback worth it?
Many workers have missed years of service in their employment history. Years away from work to raise children, recover from an illness or injury, go back to school, or other absence can reduce future pension payments.
If you are enrolled in a defined benefit pension plan you may be allowed to buy back those periods during which you did not participate in the plan.
Since with DB plans your pension amount is tied to your earnings, age, and length of service (the pension factor), a pension buyback can:
- Increase your pension amount and survivor benefit, or
- Allow you to retire sooner with no pension reduction.
Allowable periods and the amount of the buyback purchase vary according to the plan. It’s important you do the math. You can get a rough estimate with an online pension buyback calculator such as this one for HOOPP. For greater accuracy on your particular situation, your pension benefits administrator will be able to calculate whether the cost is worth the increased pension amount.
Also, you have to still be employed by the company. You can’t have left your job, or be already retired.
Should you continue to make RRSP contributions?
If you have a generous pension plan, should you still make RRSP contributions? The pension adjustment (PA) significantly reduces your RRSP deduction limit, but there probably is still a decent amount of contribution room left over. The question is: Should you continue to take advantage of it?
If you have a large RRSP, there is the possibility that you will be earning more income in retirement than you are during your working years, meaning you could be paying more in taxes as well.
Instead of maxing out your RRSP it may make more sense to contribute to your Tax-Free Savings Account instead. The TFSA gives you the ability to top up your savings during your working years, and the flexibility to withdraw your investments on your own terms during retirement, tax-free, without possibly triggering OAS claw-backs.
The bottom line
If you are enrolled in any type of workplace pension, you can consider yourself lucky. According to Statistics Canada, only 1 out of 3 Canadian workers has an employer-sponsored pension.
No matter which type of plan you have, it is essential that you understand it thoroughly and have a good idea of how much you are likely to receive when you retire. When you retire and start receiving less money than you expected, it will be too late. So, take the time to review all your pension material and past statements so you can make an informed decision.
Your pension payment is a cornerstone of your retirement plan and will be part of your future income. Once you have a reasonably clear idea of what to expect, you’ll be in a better position to plan what you need from your investments.