This is a column by Sean Cooper.
With uncertain economic times upon us, pensions have been a hot button issue as of late. One of the major issues in this past federal election was pension reform. The federal government isn’t alone; a number of provinces have reformed their pension legislation, such as Manitoba.
Pensions are important because they provide a major source of income for retired workers. Working as a pension analyst, there are a number of misconceptions out there about pensions that I would like to clear up.
Myth 1: My Spouse will Receive my Full Pension if I Die before Retirement
Unfortunately, it isn’t that simple. The benefits received by your spouse for a pre-retirement death and a post-retirement death can be totally different. For a post-retirement death, if you chose a 60% or 100% joint & survivor pension, you’ll know the exact amount your spouse will receive.
However, with a pre-retirement death, the amount isn’t so clear. Your spouse may receive nothing if your employer provides life insurance and the benefit of that exceeds the commuted value of your pension; it all depends on the plan text. If you would like peace of mind it’s a good idea to read your annual statement or talk with your pension administrator. You don’t want your loved one to have debts and have problems paying them when you aren’t around.
Myth 2: My Pension is Guaranteed
Again, in almost all cases this is false. One of the major disadvantages of defined benefit pensions is that they depend on the financial stability of your company. If you’re a young worker who is retirement eligible in 2045, you have to ask yourself, will the company still be around and in good financial shape in 2045 when it’s time to collect your pension?
You also have to consider that your pension formula can always change. A lot of employers are switching from the generous final average earnings formula (your pension is based on the average of your three or five highest earning years) to the more certain career average formula; this helps make the pension more stable, but it also can significantly reduce your accrued pension. That’s why it’s still a good idea to invest in RRSPs and other retirement vehicles because it can be risky and doesn’t make good financial sense to depend solely on your company pension.
Myth 3: If I Remarry, my New Spouse will Receive my Pension Upon my Death
Marriage breakdowns are very complicated when it comes to pensions. If you die before retirement and you’ve remarried, depending on what the court order says your ex-spouse may be entitled to a portion of the pension for the years you were married.
However, if you’ve elected a 60% or 100% joint & survivor pension and you divorce and remarry, in most cases your ex-spouse will be entitled to the pension. The reason for this is that your monthly pension amounts are calculated using the date of birth of your ex-spouse and you. It’s a good idea to keep this in mind if you remarry.
Myth 4: Defined Benefit Plans are Better than Defined Contribution Plans
If you plan to stay with a company your entire career, in most cases a defined benefit plan will provide a more valuable pension than a defined contribution plan. However, if you plan to switch employers as you move up the corporate ladder, a defined contribution plan can offer more flexibility and a greater benefit.
Defined contribution plans are a lot easier to transfer to a new employer because the value of your pensions is simply the assets in your plan. With a defined benefit plan, the formula can be complicated. You also have greater choice with defined contribution because you get to choose the investments your money goes into and see the return.
Myth 5: My Commuted Value will Increase as I accrue more Service with my Employer
In most cases this is true. There is a direct relationship between employee age and the commuted value; the older you get, the higher your commuted value. However, that’s only one of the factors.
The commuted value is also determined using current interest rates. There is an inverse relationship between the commuted value and the interest rate. As interest rates fall, the commuted value goes up and vise-versa. Since, in most cases, the only thing you have control over is when you leave your employer, it’s important to realize that your commuted value may be lower when you decide to leave even despite your age.
This has only been a very high-level review of pensions. It’s very important to speak with a financial advisor and consult with your pension administrator regarding your pension before making any major decision.
About the Author: Sean Cooper is a single, 20-something year old, first time home buyer located in Toronto. He has experience in the financial sector as a Pension Analyst, RESP administrator and Income Tax Preparer. He holds a Bachelor of Commerce in business management from Ryerson University.