Pension plan options

Whether a client’s retiring, starting a new job or taking time off, leaving an employer can often be an emotional time. Financial concerns and the need to make some important decisions, such as what to do with the company pension, may add to his or her stress level.

If one of your clients has been a member of a pension plan for many years, the benefits he or she has earned in the plan could likely be the largest source of income he or she will receive in retirement. Deciding what to do with this income involves many variables and can be quite confusing. And once a decision is made, it’s often irreversible.

The process

To properly prepare your client to make the right decision, he or she should first understand the process.

According to Dan Sexsmith, an investment advisor at RBC Dominion Securities, the first thing an employer will do once a termination of employment has been initiated is send the employee a written summary outlining the company pension plan options.

Your client will be required to select one of the options by a specific deadline, and if he or she doesn’t act before the deadline, the employer may consider that one of its preferred options has been chosen by default, which may or may not be the best one for the employee.

Staying with the plan

One option might be to keep the retirement funds with the pension plan. Sexsmith believes the Number 1 reason to stay in a pension is the high degree of certainty of what the client will receive in retirement.

In this case, the employer takes on all the investment risk and the benefit paid is predetermined and sustainable. However, this decision may not be so straightforward if the company is under financial strain and the pension funding is at risk.

Another reason for opting to stay in the pension plan is not so much a financial factor; it’s more related to benefits coverage such as medical and dental.

“Some employers continue to offer full benefits if you remain with the pension. This is a benefit you should not overlook when making the decision to commute your pension,” says Sexsmith. One course of action that eliminates this perk, though, is a partner who can add your client to his or her benefits plan.

Commuting to a LIRA

Another attractive option your client should consider is commuting his or her retirement funds to a locked-in retirement account.

With a LIRA, “control is the biggest motivator,” says Sexsmith. “When you’re in your retirement years, you have greater control of how you use your savings.

“This is further enhanced when you consider special unlocking provisions that allow you to roll funds from your LIRA to your regular RSP account. Again, this means more control.”

While lump-sum withdrawals aren’t possible when a client opts to stay in a defined benefit pension plan, LIRAs allow them within certain limits. On the other hand, a client can decide to withdraw less in a given period to manage around government benefits that have clawbacks, such as Old Age Security.

A client’s family members and their dependency on his or her income is another big area of consideration. If your client passes away prematurely, the benefits paid from his or her pension will be cut by up to 40% for the surviving partner. With a LIRA, the funds can be rolled into the surviving partner’s RRSP with no tax consequences.

However, LIRAs are not without their downside.

Making the decision

“If you do decide to move your funds to a LIRA, you take on the risk of running out of money in retirement,” Sexsmith cautions. “To partly address this, you can allocate some funds to specialty insurance products that offer income for life. It’s like buying a mini-pension that creates a minimum floor on your retirement income.”So how do you determine which option is best for your client?Beyond the first step of helping clients understand exactly what options are available — and the associated pros and cons, Sexsmith says advisors should obtain access to pension calculation tools and explore the scenarios and underlying risks associated with each option. The decision of whether or not to commute a company pension involves many complex variables, and the details can be overwhelming to a client without concrete examples of the ramifications of each choice.

Company pensions are a fundamental piece of any client’s financial plan, and the choices he or she makes on what to do following termination of employment have long-term implications.

So with that in mind, ensure your client understands the importance of getting an investment professional involved to assess the options. In the end, can he or she afford not to?

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Mark Borkowski is president of Toronto-based Mercantile Mergers & Acquisitions Corporation. .

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