Defined Benefit Pensions: Take it or leave it?

If you belong to a defined benefit pension plan, you will eventually need to make a choice between:

1. Guaranteed monthly payments from your employer and
2. A lump sum, or “commuted value”, that you invest to provide a retirement income stream. 

In the first case, the risk is born by the employer to pay the guaranteed amount for as long as you live, no matter the market conditions.  

In the second, the pensioner bears the risk but also potential rewards of market performance.

The choice can be difficult. The pensioner must not only crunch the numbers, but also consider a number of uncertainties and intangibles.

Making the choice

Did you know that from an actuarial standpoint, taking a monthly pension is equivalent to the commuted value?  That’s because the commuted value already takes into account your gender, average life expectancy, expected interest rates, age gap between spouses, inflation and more.  

So while that may take some of the pressure off, the key is to view your situation in light of those factors, as well as others.

Here are some typical considerations when making the “leave or stay” decision:

1. Tax implications – When you take the commuted value, sometimes a portion of the funds are not eligible to be transferred to a tax-sheltered account.  Instead, this portion would be taxable in the year received. Depending on the amount and your tax rate, the tax payable could be substantial. 
2. Longevity – Do you or your spouse have longevity in your family?  If so, you may have a better chance of “winning” the pension game by collecting long beyond the average life expectancy. 
3. Simplicity – Some retirees may enjoy the comfort and simplicity of a life-long guaranteed income that is hands-off and requires little decision making.  Pensioners can spend right up to the last dollar each month without worrying the money will run out. 
4. Risk tolerance – Conservative investors may lean toward a pension, while more risk tolerant investors may feel they can achieve a higher retirement lifestyle by managing their own investments. 
5. Other assets – Your financial plan may show that you already have enough assets and/or guaranteed income to achieve your retirement objectives, without the need for a defined benefit pension payment. 
6. Pension splitting – Pension income can be split between spouses prior to age 65. Income derived from a commuted value can be split as well, but not until after age 65.   
7. Legacy goals – Since a pension generally dies with the member (or the member’s spouse), a retiree with a strong desire to leave a financial legacy may gravitate toward the commuted value option. On the other hand, having a pension may allow an investor to take more risk with their other investments, potentially leaving a higher inheritance!
8. The funding status of the plan – Over the past decade, the public has seen the failure of some high-profile pensions. Depending on the solvency of the pension plan, a pensioner could potentially be lowering their risk exposure by taking the commuted value.
9. The source of your financial advice – There is the potential for bias when asking an investment advisor which option is best for you.  An advisor focused on managing more of your investment assets might be (consciously or subconsciously) over-emphasizing the benefits of the commuted value option.

While it may be tempting to duplicate what those in your peer group have decided, the commuted value decision is highly dependant on many factors unique to you and your pension.  

An independent financial professional can analyze your options, and help you make the right decision.  And don’t delay! If you’re within five years of having to make a pension decision, talk to an a trustworthy advisor.