So you and your employer decided to part ways. Maybe you decided to go explore greener pastures with a new employer, or maybe your employer had to downsize and let you go. Either way, if you have a pension plan with this employer you will now receive a Termination Package which will give you options about what to do with your pension plan. Your options will be:
This is not an easy decision to make and there are pros, cons and risk with each option. How can you properly assess the merit of each option and decide what is best for you? Ultimately, you are the one who knows what is best for you, but we will give you advice on what to consider, the benefits, and the pitfalls of each option so hopefully you can make the best decision for your situation.
Basic math to consider: One thing to consider is to compare the lump sum value you are being offered VS the monthly benefit you would receive at retirement, and assuming you have a normal life expectancy and how the math compares.
Let’s use a real world example from a client that we recently assisted. His name has been changed to protect his privacy. “Bob” was 43 years old when the factory that he worked with shut down. When the factory closed, he was offered to either leave the funds with the employer’s pension plan administrator and he would be eligible to receive $419.35 per month at the age of 55 OR he could take plan’s actuarial value which was set at $37,265 and transfer that into a LIRA.
There are many considerations to making this decision. One option provides guaranteed returns (leaving the plan with the employer) but has little flexibility and has no room for capital growth.
Lets first determine the value of the amount of money “Bob” can expect to receive from the employer’s pension plan if he lives until the average male life expectancy in Canada, which is currently 80 years old. Then, lets compare what kind of returns that “Bob” would need to achieve to match that value. Let’s look at both of these scenarios in detail below.
Option A – Leave money with employer and take a monthly pension of $419.35 with the expectation to live until the age of 80. In this Scenario “Bob” would receive a total amount of payments worth $125,805.00, which is substantially more than the $37,265.00 that his employer is offering him to transfer to a LIRA. Sounds like a slam dunk? Not yet…let’s look at option B.
Option B – Take the lump sum, transfer into a LIRA and invest it. So in order to make that $37,265 grow to $125,000 in 9 years (when “Bob” will reach 55) he would need to achieve a return of little bit less than 13% per year which is most likely not realistic unless “Bob” is an investment genius or his stockbroker is. Now, this comparison is not really fair since the $125,000 from the pension plan was achieved via 25 years VS “Bob” 9 year of investments.
Additionally, realistically speaking a 13% return is not reasonable to expect. Based on the last 10 years of the average stock index return was:
6.9% for the Canadian TSX ;
10.7% for the Nikkei ;
16.1% for SP500 ;
8.1% for Euro Index ; AND
16.7% for the NASDAQ
Unless Bob got really lucky and put all his money in either the SP500 and/or NASDAQ then his plan value would be less than the 125K.
So what would be fair to use as a return for “Bob”? How about we average out the return of all these indexes assuming that “Bob” believes in diversification and spread his money around across all of those 5 indexes. The average return then would be 11.7% and “Bob’s” LIRA would be worth almost $113,000. Is it worth taking the risk to potentially lose your money or a good portion because of the volatility of the market for what amounts to more or less the same total value?
Most people would agree that it doesn’t but there are other things to consider such as:
If “Bob” doesn’t touch the $113,000 and keeps it in the LIRA and earns the same average of yearly interest (11.7%), he can pay himself a pension of $13,000 a year VS the $5000 his employer’s pension pays him. If “Bob” keeps that pace until the age of 80, he will then have received $325,000 plus still have $113,000 in his bank account so a total of $438,000 vs the $125,000 from the employer. The truth is that the above is just a scenario and nothing else. There are many more factors to consider before making a decision. An employer’s pension plan offers security and a guaranteed monthly amount for life. LIRA provide more flexibility and opportunities for growth. Also the numbers matter. If “Bob’s” pension plan would have been a monthly amount of $325.00 VS $419.35 then the math would be different. The table below summarizes the pros, cons, and risks of each option.
| SCENARIO | PROS | CONS |
|---|---|---|
| Keep pension with employer And receive $419.35 from the age of 55 until age 80 (average life expectancy) |
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| Put money in a LIRA an invest it |
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In a nutshell, each person risk tolerance and needs are different, and it is important for you to consider all of the pros and cons before making a decision and running some simulations using our “simulation calculator”. You are able to access this calculator by clicking here.
