Question. I’m planning to retire next year and wondering about my pension. I have been with the same employer for about 25 years, and have a defined contribution (DC) pension plan. What are my options when I retire?
Answer. That’s a great question, and a very important decision regarding your retirement. While retirement with a defined benefit (DB) pension plan is fairly straightforward, your options with a defined contribution (DC) pension plan are very different. Let’s first start with a quick overview of the key differences between DB and DC pension plans.
Pension Basics – Defined Benefit (DB)
A defined benefit plan is the more traditional type of pension plan, and often what comes to mind when we think of a pension. In a DB plan, the amount you will receive from your pension, typically paid to you on a monthly basis in retirement, is known in advance. This amount, your pension benefit, is determined by a formula. And while there are different DB pension formulas, the amount your will receive from your pension is generally determined by your age, the number of years you’ve worked and contributed to the plan, and your earnings during those years. Notice that, in a DB plan, you have no decisions or control regarding the investments within the plan. Really, your only decision is the age at which you retire – and the formula tells you what your retirement pension will be at that age.
Pension Basics – Defined Contribution (DC)
A defined contribution plan is still a registered pension plan, but more closely resembles other group savings plans, such as a group RRSP. In a DC plan, you contribute a portion of your salary to the pension plan, and your employer matches your contributions at a specified rate. The amount you and your employer contribute to the plan varies from one DC plan to the next. For example, you may contribute 6% of your salary to the plan, and your employer also matches your contribution and contributes 6% to your plan. Now, what happens to those contributions inside the DC plan? This question highlights a key difference between DB and DC plans. Namely, in a DC plan, you are responsible for the investment decisions, and you determine how the money in your plan is invested. To this extent, your employer makes no promise as to the amount that will be available upon retirement – that is purely a function of the amount contributed to the plan, and the subsequent performance of the investments you have chosen.
In short, with a DB plan, you simply decide when to retire, and the stream of pension payments commences accordingly. With a DC plan, you end up with a pool of money at retirement, and then have to make the decision that you’re now faced with – What do you do with that pool of money?
DC Pension – Options at Retirement
Upon retirement, your options with a DC plan depend on a few different factors – First and foremost, your age. While pension regulations vary somewhat, in most provinces, the earliest age be begin receiving your pension is age 55.
If you’re terminated before the age of 55, you can transfer the funds in your DC plan to a LIRA – Locked-in Retirement Account. A LIRA is a special type of account, designed specifically to accept transfers from pension plans. Generally speaking, you cannot withdraw from a LIRA. The transfer from your DC pension plan to a LIRA has no tax consequences, and you can continue to control the investment decisions in the LIRA account.
If you’re 55 or older, and don’t want to start receiving a pension income, you can still transfer to a LIRA. But you now have a couple of options for income as well. In particular, your DC pension options from age 55 onward include a life annuity, and a LIF – Life Income Fund.
LIF vs Annuity – Which is Best for You?
Essentially, an annuity is a product designed to pay you an ongoing stream of payments. The gist of it is that you pay an insurance company a lump sum, and in return, they guarantee to pay an ongoing stream of payments to you. In previous discussions, we covered the basics of annuities, as well as the top advantages and disadvantages of annuities.
A Life Income Fund (LIF), on the other hand, is an investment account very similar to a RRIF. The first thing to note is that a LIF has maximum and minimum annual withdrawal limits. The rules regarding acceptable investments within the plan, as well as the minimum annual withdrawal requirements, are the same for both LIF and RRIF accounts. However, unlike a RRIF, a LIF is also subject to a maximum annual withdrawal limit. The maximum withdrawal limit is designed to prevent you from depleting your pension savings too fast.
Here’s a summary to help decide which option may be most appropriate for you:
- LIRA – you’re under age 55, or aren’t yet ready to begin receiving an income from your pension plan.
- LIF – you’re 55 or older, and want to receive an income from your plan. Further, you want to maintain control over your investments, and are willing to accept the risk, volatility, and uncertainty of doing so.
- Annuity – you’re 55 or older, and you want to receive an income from your plan. However, you no longer wish to be in charge of the decisions regarding your investments or the volatility of financial markets, and would prefer the stability and certainty of a guaranteed stream of payments.
Bottom Line: DC Pension
There are many different factors to consider when planning your retirement income and pension. For example, it’s important to consider other sources of income such as CPP and OAS, and the timing and amount of those payments, as well as other personal savings, family dynamics, and spousal income, just to name a few. If you have any questions about your pension or other retirement savings, or would like to have a discussion with a Portfolio Manager or Certified Financial Planner, just contact us.