Josh wants to change jobs after 15 years with the same company. At 44 years old, he's making $75,000 a year, or $6,250 a month. He's a full member of his defined benefit plan. His new company also has the same type of plan. What are his options?
Option 1: Leave the money in the old plan
First, he figured out what he would get if he left the money in his old plan. His plan formula was simple:
For every year he had worked with the company, the plan would pay 1.5% of his average earnings over the last five years. That means that at age 65, he'd get a yearly pension of: 15 years x 1.5% x $75,000 = $16,875 (before taxes) or about $1,400 a month.
Of course, Josh would also earn extra pension at the new company if he worked until age 65. Let’s say his plan formula stays the same, but his yearly wages rise to $85,000 a year (or $7,083 per month). Here's how much additional pension money Josh figures he will get from his new employer: 21 years x 1.5% x $85,000 = $26,775 a year (before taxes) or $2,230 per month.
Josh’s total yearly pension at age 65 under Option 1: $43,650 a year, or $3,637 per month
Option 2: Transfer the old pension to his new plan
Next, Josh wanted to see what would happen if he could get his new employer to transfer his old pension over with full credit for his 15 years of service. He also figured he would be making at least $85,000 a year, on average, by the time he retired. So, with everything moved over to the new plan, Josh’s pension at age 65 would be:
36 years x 1.5% x $85,000 = $45,900 a year (before taxes) or $3,825 per month.
His total yearly pension at age 65 under Option 2: $45,900 a year, or $3,825 per month
That means Josh gets paid an extra $2,250 every year, or $187 per month, compared to Option 1 (leaving the money in his old plan). Not bad, but could he do better with a life annuity?
Option 3: Buy an annuity
Josh talked to his life insurance agent about buying a life annuity. His agent advised him against it since he was planning to work for another 20 years or more. Interest rates could be different by then, and he may be better off if he waited. Once he buys an annuity, he can’t get his money back. So Josh eliminated the annuity option and moved on to Option 4.
Option 4: Transfer his old pension to a Locked-In Retirement Account (LIRA)
From the math he did under Option 1, Josh knew he would receive $16,875 a year from his old plan when he retired at age 65. Of course, that's not what he'd get today. Today, his company sets the value of his pension at about $87,664. This is called the commuted value. Josh could take that sum and invest it in a LIRA. If he does this, how much could he make it grow by the time he retired at age 65?
Josh figured he could earn 6% each year over the next 21 years. Using a special retirement income calculator, he figured he would have about $298,000 by age 65. He could use that money to give himself a pension of about $20,390 a year, or $1,700 per month, to age 100 (before taxes).
On top of that, Josh will get money from his new company plan. He’ll get around $26,775 more each year, or $2,231 a month. (He did that math when he looked at Option 1.)
When Josh adds the two numbers together, his total yearly retirement income at age 65 rises to $47,165 (before taxes).
His total pension at age 65 under Option 4: $47,165 per year or $3,930 per month
Josh decides what to do: Josh reviews all the options. Based on the numbers so far, it first looks like Option 4 is the best one.
There is some risk, though. What if the money from his old plan doesn't grow as fast as he hopes? Even worse, what if he loses money on his investments?
Here’s what happens when Josh applies different growth rates to Option #4:
|$10,620/yr to Age 100||4%||$200,000|
|$20,390/yr to Age 100||6%||$298,000|
|$37,600/yr to Age 100||8%||$441,000|
Clearly, if his investments don’t work out, Josh could end up with a much lower income under Option 4. To avoid that risk, he decides he's better off with Option 2. He can join his two plans together into one and have a bit more peace of mind.
Note: The examples above are for simple illustration only. It does not reflect any tax savings or the impact of inflation and salary increases on contributions. Actual interest earnings may be more or less than the rates shown here.
Content in this section is provided in partnership with Investor Education Fund, a non-profit organization founded and supported by the Ontario Securities Commission that provides unbiased and independent financial tools to help Canadians make better money decisions. To find out more, go to: GetSmarterAboutMoney.ca
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