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Understanding Early Retirement with Defined Benefit Pensions

If you have a defined benefit plan at work and you’re considering early retirement, then this article is for you. Early retirement can come about in two ways – you can choose to retire early by handing in your resignation, or you are terminated by your employer. If you’re retirement eligible (usually age 55, but it depends on your pension plan), you usually have the choice of starting your pension now (an immediate pension) or waiting until later (a deferred pension).

Starting your pension now may seem like a good idea if you’re out of work, but there’s a catch – your pension is usually reduced, often substantially, for early commencement. Here’s what you need to know when retiring early.

Earliest Retirement Date (ERD) vs. Earliest Unreduced Retirement Date (EURD)

Your ERD and EURD are two crucial dates you need to know before retiring early. Your earliest retirement date is the earliest age in which your pension plan allows members to retire. Early retirement can vary by plan – early retirement can be as early as age 45 in some plans and as late as age 60 in others.

How do you find out these two important dates? They should be found on your annual pension statement in your tombstone data (your name, date of birth, date of hire, date of membership, etc.). You can also find both dates on the pension package you receive when your employment ceases.

Your ERD and EURD can be the same, but often they’re different. While your ERD is the earliest age you can start your pension, your EURD is the earliest age you can start an unreduced pension. If your plan is less generous or you’ve only been with your employer for a short time, your EURD may be the same date as your Normal Retirement Date (NRD), when you’ve attained retirement age and you’re entitled to an unreduced pension.

Early retirement incentives offered by defined benefit plans today are typically a lot less common and generous than they used to be. In my article on the history of pensions, I mentioned that during the 1970’s, faced with a labour surplus, employers offered early retirement incentives to free up positions. In our current low interest rate environment, with many pensions severely underfunded, employers can no longer afford these early retirement subsidies for workers.

How Pension Reductions Work

Pensions are typically reduced based on two methods: the Early Retirement Factor (ERF) and the Actuarial Reduction (AR). The ERF is pretty straightforward – it’s a percentage reduced based on the difference between your NRD and your actual age. At Company ABC (a fictional company), your pension is reduced by 3 per cent per year for early commencement. If normal retirement is age 65 and you start your pension at age 57, your pension would by 24 per cent (3% X (65 – 57)). If your pension at NRD is $650 per month, it would be $494 ($650 X (1 – 0.24)) if you decide to start it at age 57.

The actuarial reduction (AR) is a lot more complicated and difficult to understand. The AR is the amount of pension decrease you receive calculated based on actuarial assumptions in case of early retirement. If you’re retiring from active status and you’re retirement eligible (you’ve reached your ERD), most pension plans give the better of the ERF and AR. In most cases the ERF offers the better reduction.

If you’re a deferred member, you left your employer before retirement age and you’re coming back years later to collect your pension when you’re retirement eligible, your reduction is usually based on the AR. If you’re not retirement age and you’re faced with the decision to take a lump sum payout or defer your pension, this is something to be aware of, as deferred members often have their pension reduced more than active employees when they start their pension early.

Unreduced Early Retirement

Defined benefit plans typically reward long-serving employees by offering them unreduced pensions at an earlier age. The points rule is common, where you’re offered an unreduced pension when you’ve attained a specific number of points. Not all plans have this provision; the number of points required also varies from plan to plan. Points are typically based on a combination of age and service.

At Company ABC, there is the “Rule of 85.” Your pension will be reduced for early commencement before age 65, unless you’re at least age 60 and you have 25 years of continuous service. For example, if you’re age 61 and you have 24 years of continuous service, you’ve reached the 85 points (61 + 24) that you need for an unreduced pension.

Hopefully you have a better understanding of early retirement. If you have a defined benefit pension plan at work, do you understand how early retirement works?

About the AuthorSean 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. You can read some of his other articles here.

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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. You can read some of his other articles here.

{ 12 comments… add one }
  • SST December 28, 2013, 1:23 pm

    I have a DBP with a provincial gov’t and very definitely plan on the earliest possible retirement (@55) with full knowledge I will receive maximum reductions (-15%).

    With pension reform being inevitable (and already happening), I’m quite willing to take my money and run.

  • Sean Cooper, Freelance Writer and Blogger December 29, 2013, 12:54 am

    @SST
    That’s probably a wise move. Although your employer cannot go back and retroactively change your early retirement provisions, they can increase them for future service. I guess Freedom 55 is only something for Baby Boomers – my generation will be lucky to retire by 75!

  • SST December 29, 2013, 12:42 pm

    Get real.
    Most boomers are already at 55+ and most boomers are not retired.
    “Freedom 55” was just another marketing scam utilized by the financial industry. We are not richer than we think.

    Interesting cultural/societal phenomenon, both retirement and investing. Most people want to retire so they don’t have to work; and most people want ‘passive income’ so they don’t have to work…too many people who don’t want to work, in my opinion.

    I experienced pension reform in my first year of (increased) contribution, I know it can, does, and will continue to happen. Why would I stick around for another 10+ years just for fifteen cents on the dollar?

  • SST December 29, 2013, 12:47 pm

    Open question:

    If I have a future DBP worth, let’s say $20,000 a year (100% joint life; ~40 years), can I monetize this (i.e. take a loan against, sell bonds, etc.)?

    Thanks.

  • AFD December 29, 2013, 4:05 pm

    @SST interesting comment “… Most people want to retire so they don’t have to work; and most people want ‘passive income’ so they don’t have to work…too many people who don’t want to work, in my opinion…” but I have to disagree.

    Its more about choice, freedom and respect in my opinion. I believe most folks do like work, but they do get tired of being someone else’s or some companies chess piece. If you have been part of an outsourcing deal you know what I mean. If you haven’t, then your missing all the fun. Typically, your given no option other than to move to the new company (which isn’t a real adult choice) then over the course of one year your laid off. How this is tolerated by society I’ll never understand.

  • Tri-Guy December 30, 2013, 12:27 pm

    I have an Omers pension that will let me retire after 30 years with no penalty. I highly doubt that will be the case in 19 years when I reach my 30 year retirement date. with more municipality’s using contractors (who don’t pay in) for garbage pick-up, plowing, etc. the pot is only going to get smaller.

  • tren December 31, 2013, 3:26 am

    to sst q4:
    pv can be caculated. some people can do it for you at a cost.
    however, you cannt take a loan against, or anything against it.( only cra has access to their bite.)

    to all readers:

    final buyout is not a smart move as there will always a loss.(yes, i know).

    however, if you need to use the money (i.e. not interested in the fix income pension), way to go.

    ==

    if the interest rate is going up, take the money and run. factoring in the health issue or pre-retirement death etc.

  • SST December 31, 2013, 3:07 pm

    Hi tren: is there a CRA rule (Fed law etc) which states I cannot monetize my pension? Anyone have a citing for this?

    I am thinking in terms of “Bowie Bonds”. Unlike the original BBs, my future earnings/income (pension) have already been calculated and are known, thus easily valued.

    Thanks.

  • canucktuary January 3, 2014, 3:15 pm

    @SST, your future income is tied to whether or not you and your spouse are living. If you died tomorrow, the lender would be out the principal of their loan

  • SST January 17, 2014, 11:51 am

    @canucktuary: how does my wanting monetize my future pension differ from a financial deal such as this:

    “In 2009 [Detroit] reached a deal with Bank of America and UBS promising the banks the future flow of casino tax money in return for $300 million.”

    The “future flow” could have been zero, and with the city being insolvent, the flow is currently materially less ($0) than what the banks calculated when they entered the swap deal in 2009.

    When I have more time I’ll look into the possibilities of this.

  • Confused July 25, 2014, 1:16 am

    Hello,
    I have an option to buyback 1 year of service under OMERS for 10k. My question is that is it better to transfer money from RRSP. or from my Non-RRSP. Not sure if one method is more favorable than other for tax purposes. I just started working for an employer that offers OMERS very recently. Can anyone help?

  • CraigM September 16, 2014, 10:35 am

    @Confused

    It will depend on how much contribution room you have – generally you’ll need to have contribution room for your buyback, so transfer from RRSP is what you’ll have to do if you don’t have any outstanding contribution room (which I assume is the case if you have significant non-RRSP accounts)

    Disclaimer – that’s how my pension works. You should check with your administration.

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