Downsizing. Restructuring. Cost-cutting. As a result of considerable government deficits and a tough economy, these have become current reality across the public and private sector.
What does it mean for you? Perhaps, the offer of an exit package. And, if you have a company pension plan, you may face an important decision: Are you better off staying with the plan and getting a pension when you're eligible or taking a lump sum now?
The answer depends on many factors, including your age, marital status, risk tolerance, expected expenses, income needs before and in retirement, and other financial goals and objectives. Your CIBC Financial Advisor can help you build a strategy that makes the most of your package, but here are some reasons you might prefer one option over the other.
Pension pros and cons
Whether you have a defined benefit plan or a defined contribution (money purchase) plan, it's designed to provide you with income for life. With a defined benefit plan, the amount will usually be based on a percentage of your full-time earnings; with a defined contribution plan, the amount will depend on how much you and your employer have contributed over the years, plus growth. If you should pass away, your spouse or common-law partner may be entitled to a survivor benefit for life.
Assuming the plan and the employer are solvent, no matter what happens to interest rates or the financial markets, with a pension you can count on that money coming in, month after month and year after year. Furthermore, to address inflation, some plans are indexed, effectively giving you an annual "raise" based on the Consumer Price Index.
With a pension there's no possibility of accessing the principal, instead you will receive your regular payments. Based on your financial situation, it may be necessary to make sure you have other sums available to help you cover unexpected expenses. That said, remaining within a pension plan may give you continued access to valuable health care, dental and insurance benefits that would be expensive to buy separately. In addition, at any age, you can split up to 50% of pension income with your spouse or partner, which may provide significant tax savings.
Questions to ask your employer:
- How much pension income will I receive before and after I turn 65?
- Is the pension indexed to inflation?
- How much will my surviving spouse or partner be entitled to?
- Are there other benefits I can keep, regardless of pension decision - and are these available to my family too?
- Will my pension payments change once my Canada Pension Plan (CPP) payments begin?
Depending on the amount of your pension and any other income you may earn in a given year, your Old Age Security (OAS) payments may be affected. Your CIBC Financial Advisor can provide guidelines concerning potential OAS clawbacks and identify if there are any strategies that could minimize the impact.
Lump sum pros and cons
A lump sum represents the future value of a defined benefit plan expressed as a dollar amount today. If you are a long-time employee, the number may be in the hundreds of thousands of dollars.
Depending on the terms of your package, taking a lump sum may give you more control over your money, including the ability to choose investments that are appropriate for your time horizon and risk tolerance. It may also be the safer road to take if you think your employer may not have the financial strength to continue to fund the pension plan.
However, a lump sum is not necessarily available to you right away. Federal and provincial legislation may require funds to be locked in, with restrictions placed on the amount you can withdraw each year, or used to purchase a life annuity. Most jurisdictions have special provisions to unlock 50% of a locked-in plan for transfer to a Registered Retirement Saving Plan (RRSP) or a Registered Retirement Income Fund (RRIF).
Full or partial lump sums that are not locked in are generally subject to withholding taxes, and taxed at your marginal tax rate when you file your income tax return, unless they are deposited directly into your RRSP. If you don't have enough contribution room available, you may be able to negotiate with your employer to split the payment over two or more tax years to reduce the tax impact - but the tax bill could still be significant.
Questions to ask your employer:
- What assumptions did you make to calculate the lump sum?
- How much access will I have to my money?
- Can I split the lump sum over two years?
- How much can I transfer to my RRSP as a retiring allowance? (You may be able to transfer up to $2,000 for each year you were with your employer prior to 1996, plus an additional $1,500 for each year prior to 1989 in which employer contributions have not vested. These transfers would not affect your regular RRSP contribution room.)
Speak with your CIBC Financial Advisor
If you're offered an exit package, it's important to make a well-informed decision about how to take the money. Your CIBC Financial Advisor can help you weigh the pros and cons so you can make the best choice for your personal situation.