Pension or Lump Sum? How to Decide
by Marc Sabourin on 06.26.2018
For those of you lucky enough to have a defined benefit pension plan, you may have to decide whether to take your pension as a guaranteed income or as a lump sum upon retiring. There isn’t a unanimous answer when deciding between these two options as it mostly depends on your circumstances. Just because a retired coworker chose to take one option, it doesn’t mean the same choice is correct for you.
Once you choose, your choice cannot be reversed. If you decide to take the guaranteed income for life, you can’t ask your pension for an extra lump sum payment the next time you want to go on a vacation. In much the same way you can’t pay back the lump sum to your pension if you eventually feel like managing it yourself is too much work
So how do I decide?
A good place to start would be to build out a financial plan with a side by side comparison of both options. This will indicate your expected overall retirement income between your pension and savings. There are additional factors to consider which may affect your choice.
In regards to taking the guaranteed income some of these factors to consider are:
Choosing this option allows you not to rock the boat. You received a regular income while working and you will continue to do so in retirement. You don’t need to be concerned with running out of funds as your pension will keep paying you for life. This allows you to spend every dollar you make because you know there’s another cheque coming just around the corner.
By choosing the income option, you are putting your trust in the pension’s hands. You are relying on your previous employer to continue operating a profitable business. This isn’t always the case as we’ve seen from Sears and Nortel. Another issue that arises is your inability to adjust your regular payments. You may want to spend more at the beginning of your retirement while you are still healthy and take a lower income in your later years. A good reason to spend more at the beginning of your retirement is that you can’t take your pension plan with you upon death. If you have a spouse, they will likely continue to receive payments, but upon their death, all payments stop. That means there’s no residual amount leftover for your kids or your favorite charity. All the funds you were promised would remain in the pension plan. I’ve read through a lot of wills and I have yet to find one that names the pension plan as one of their beneficiaries.
As for the lump sum option.
By choosing the lump sum option, you are giving yourself lifestyle flexibility. You can increase your income in the early years of your retirement to allow you to do things while you are still healthy. This flexibility allows you to manipulate your income which in the long term can be more tax efficieint. If you have a reason to suspect your lifespan will be shorter than the norm, you can adjust your income to reflect this. The funds which remain once you and your spouse pass away can be used to help your kids, grandkids, or favorite charity.
Due to the historically low-interest-rate environment, we are in; there will likely be a portion of the lump sum which is immediately taxable as income. If you don’t have the means to shelter this income in an RRSP account, you will have less in your pot to draw down due to taxes. The lump sum option forces you to stick to a disciplined withdrawal plan. If you are the type of person who spends everything at their disposal than this option isn’t for you. There is also an investment component related to taking the lump sum. If your investments don’t grow as anticipated or if you take a significant loss, you could find yourself running out funds in retirement.
This isn’t a decision which you should make without careful analysis. A built out financial plan along with a review of the pros and cons of each option will allow you to determine the best option for your circumstance.
Feel free to get in touch if you have any personal questions about your situation. There’s no better time to start planning than now.
Disclaimer: The information contained herein was obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. This report is provided as a general source of information and should not be considered personal investment advice or solicitation to buy or sell any securities. The views expressed are those of Marc Sabourin, Certified Financial Planner and Investment Advisor and not necessarily those of Harbourfront Wealth Management Inc, member of the Canadian Investor Protection Fund.