Pension decision can come down to numbers

“Derek, I’m ready to retire and I need to decide whether to take regular monthly payments from my company pension, or get paid out a lump sum and invest on my own. What should I do?

“Derek, I’m ready to retire and I need to decide whether to take regular monthly payments from my company pension, or get paid out a lump sum and invest on my own. What should I do?

Retiring employees or employees who otherwise leave their jobs are often faced with a tough decision regarding their employee pensions.

In many instances, companies will offer their employees the choice between taking their pension in a lump sum form or taking the pension in the form of a monthly payout.

Unfortunately, very little support is given to the employee to help them make this choice, and as a result, much stress ensues.

It’s important to discuss your personal situation with a qualified financial adviser prior to making a decision.

That said, the decision really comes down to understanding the numbers.

So, is one better off taking the lump sum or sticking with the monthly payment from the pension?

Receiving payments from your company pension is pretty straightforward. Usually your entitlement in a defined benefit pension is based on a formula which takes into account how long you worked at the company, your average salary, and a certain percentage (usually one to two per cent).

The resulting calculation tells you how much you’ll receive on a monthly basis.

Receiving a lump sum is a little more complicated. By taking the lump sum payout, you forfeit all your monthly payments from the pension.

The lump sum is based on the present value (or commuted value) of the monthly pension payment that would have been received.

The calculation makes assumptions about your life expectancy, inflation, and uses a discount factor to determine what the lump sum should be.

The lump sum is supposed to represent what a lifetime of pension payments would be if they were received all at once in today’s dollars.

So back to your question — should you take the lump sum or take the pension payment?

Since the monthly payments from the pension are guaranteed, you need to consider the amount of the lump sum to help with your decision.

Your tax rate, rate of return, time horizon and many other factors need to be considered when looking at these options.

Ultimately a qualified financial adviser should work with you to crunch some numbers and by doing so should be able to help you in the right direction.

In some cases, you may only need to earn a consistent five per cent from the lump sum to provide a similar pension payment to last all the way to age 90. In other cases, your rate of return needs to be much higher.

With this example, an investor who feels they can achieve five per cent or more on an annual basis would be inclined to take the lump sum.

However, a risk-averse investor who is not comfortable in trying to earn five per cent would be better off taking the monthly payments.

Once the math is done, you need to look at your personal preferences. Keep in mind the pension payment is guaranteed — that guarantee provides you the comfort of knowing that the money will always be there.

Furthermore, by taking the payments, you may still qualify for dental and medical insurance through your employer.

Some retirees prefer taking a lump sum as it’s much more likely to create an estate value.

When you pass away, whatever value remains from that lump sum can be passed on to your beneficiaries, while the pension payment will end once your guarantee period is over.

The thinking here is that you spent years saving this money through your company plan, so it should be passed on to your estate rather back to the company itself.

The decision to take the lump sum value of your pension or the monthly payments can affect your financial security for the rest of your life. Weigh your options, do the math, and find some advice.

Finally, congratulations on your upcoming retirement and all the best in your retired years!

Happy investing,

Derek Fuchs is a wealth adviser with ScotiaMcLeod in Red Deer, and a certified financial planner, financial management adviser and a fellow of the Canadian Securities Institute. He can be contacted at derek.fuchs@scotiamcleod.com.

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