Working for an employer that offers a defined benefit pension plan is undeniably an advantage, to the point that some will sometimes choose to stay in this “golden cage” even if they no longer like it as much as before. Others will prefer to take the plunge towards new professional challenges. So what should you do with your pension: transfer it or keep it?
This is the question that Sandra asked us: “Following a career change, to my great surprise, the calculations made by my advisor did not show any obvious advantage to keeping this accumulated amount in an annuity. The only one was the peace of mind of knowing exactly what the amount will be paid until my death. I still haven’t made up my mind, and it’s heartbreaking since I have a good risk tolerance and I’m only 45 years old. Should I choose safety or cross my fingers that the markets will pay off for my new locked-in retirement account (LIRA)? My hesitation also comes from the fact that I learned that of the accumulated amount, only a 60% portion can be transferred to a LIRA, while the rest will be taxable. My advisor presented me with a “solution” related to the purchase of flow-through shares in the mining sector. A product that could reduce this tax bill, but which is heading towards very risky investments.
The surprise of the taxable portion
When transferring to a CRI, tax rules stipulate that the amount transferred will be calculated by multiplying your annual pension by a present value factor based on age. This factor does not take into account the various ancillary benefits of the plan, such as indexation. Like our reader, many people are surprised to find, at the time of transfer, that they received a recorded amount lower than the actual cost of the benefits acquired.
This is because part of it is received as taxable income. To the extent that contribution room for a registered retirement savings plan is still available, the tax bill can be reduced, but this is rarely the case for people with a pension plan. In fact, each year, their contribution limit is reduced by the value of the benefits in their plan. The only way out they then have is the presence of a corrected pension adjustment.
Testing the robustness of comparison scenarios
In her message, Sandra explains to me that, according to her comparative analysis, it would be more profitable to transfer her plan, since she will obtain a return of 5% per year between now and retirement. Unfortunately, it is impossible to decide solely on this basis. First, this return is not guaranteed. It corresponds to the return of a growth-oriented profile. In addition, we must know if this is the return required once retirement begins. Will our reader maintain this growth portfolio composition until death?
It is imperative that robustness tests be carried out in order to compare this scenario with other, less favourable ones, and a reduction in the projected return on retirement.
Sandra must understand that by keeping the money in the pension plan, she is delegating the investment risk. Regardless of the comparisons made, by transferring the expected value, she is agreeing to take the market risks. Without knowing her entire file, I hypothesize that if the transfer is advantageous only by taking the risks of the flow-through shares, this is a risky conclusion.
It’s not just about comparing yields
Estate planning must be considered in particular in this decision. Indeed, if you die young, your estate will obtain much more from a plan transferred to a LIRA than from the annuity retained. Health status is a more subjective indicator in this decision-making, but it remains important to consider it.
The financial stability of the employer and the solvency of the scheme are also important additional avenues of analysis in this situation. The transfer may appear more natural if the future of the company is uncertain. It will be less so if the scheme is a public pension scheme, for example.
If one spouse is in business, or manages their own portfolio, an annuity income can balance the risk for retirement. Spouses with income gaps must take into account the fact that pension income is splittable from age 65, whereas this is not the case for a CRI.
Here are some ideas for reflection if you have this type of decision to make.
— Is it a defined benefit or defined contribution plan? In the latter case, the transfer is more often advantageous, because it allows you to have access to better investment choices by transferring it to an individual account.
— What is the amount in question and what proportion of the assets does it represent?
— What assumptions should be made for the comparison? Beyond the projected return to accumulate the amount required for a comparable pension at retirement, what rate is required to maintain the same pension, up to life expectancy?
— How many years before the expected payout? The younger you are, the more time you will have to take advantage of market growth. But if you transfer just a few years before retirement, your risk of short-term volatility is greater.
— What is your family financial and tax situation?
— What is your state of health? If you believe that your life expectancy is reduced, transferring to a CRI makes perfect sense since the balance will be paid in full to your estate.