Over the last couple of months, we’ve taken a look at some of the reasons you should withdraw the commuted value from your defined benefit pension plan. (See: Five reasons you should take your pension as a lump sum payout and What happens when you withdraw your pension?) The best strategy always depends on personal circumstances, so today we’re looking at five reasons to choose the monthly pension option instead.
1. Spending habits
I’ve met with numerous people who were interested in withdrawing the commuted value of their pension plan, but have admitted that they are not the best at managing their finances. I often see people who have worked for 40 years and have not saved a dollar outside of their pension plans. They may still have a mortgage on their home with some personal debt as well.
By choosing the commuted value, they are putting themselves in a position where they have to manage a significant amount of money over the next 30 years. If they haven’t shown the ability to manage their finances in the past, what can be expected in the future? If they dip into the cookie jar on too many occasions, they could draw down their commuted value before they pass away. In this case, it may make sense to choose the monthly pension option as you will always receive a paycheque.
2. Long life expectancy
If you expect to live longer than the average person, then staying in the pension plan ensures that you don’t run out of funds in retirement. You will continue receiving an income until the day you pass away. If you take the commuted value from your pension, you need to be regularly updating your retirement plan to ensure you don’t outlive your nest egg.
By choosing the monthly pension benefit, you are guaranteed to receive a monthly paycheque for life. You don’t have to worry about investment fluctuations as your employer is tasked with managing the funds within the pension plan. If they make bad investment choices, they will need to top up the pension plan to ensure you continue receiving your payments. There is a concern, however, if your employer goes through financial difficulties and is unable to fund the top up. But if you are confident in the long-term viability of your employer, this shouldn’t be a concern.
4. Investment expectations
The value of the commuted pension is based on expected long-term interest rates. For example, your pension plan may project interest rates to average 3.5% for your life expectancy. All things being equal, by choosing the commuted value or monthly pension, both benefits should end up being the same if you average 3.5% on your investments, and you pass away as per your life expectancy. If your comfort level with investing is low, and you’d like to stick with GICs and savings accounts, you may not earn 3.5% in the long run. In that case, it would be better to take the guaranteed monthly income.
5. Survivor benefit
When choosing the monthly pension benefit, you can elect for your significant other to continue receiving a certain percentage of your pension once you pass away. The higher percentage you choose, the lower your monthly pension will be today. By having this option, you know that your significant other will be well taken care of once you pass away.
If you choose the commuted value and you are the one who primarily takes care of the family’s finances, you may be leaving your significant other in an uncomfortable position in the event you pass away. Having to deal with a million dollar portfolio all of a sudden could be extremely stressful, especially for someone who has never taken an interest in it before.
Wrapping it up
There is no right or wrong answer when choosing the pension option that works for you. By evaluating your personal circumstances, there may be some variable that pushes you in one direction over the other. If you’re looking for more retirement advice, don’t hesitate to reach out for a complimentary one-hour consultation.
Marc Sabourin is a Winnipeg based Financial Advisor with Harbourfront Wealth Management. His focus is on helping pensioned employees achieve their retirement goals. He draws on his real-life experiences to explain strategies that are often presented as intricate. He believes financial literacy is an integral part of one’s financial well-being and his goal is to make learning about these topics fun and enjoyable.