The great pension debate that is gaining momentum in Canada is focusing attention on the issue and bringing to light some of the stark realities of the retirement preparedness of Canadians.
For example, it now is estimated that fewer than 40 per cent of Canadians are covered by a registered pension plan.
A recent report by the Certified General Accountants Association of Canada (CGAAG) concludes that “the ability of Canadians to maintain a financially-comfortable and healthy lifestyle after retirement has become one of the nation’s most vexing challenges.”
Canadian workers will at some point in time in their careers have to make a choice about their pensions – whether they keep it with their employer or whether they take their contributions in a lump sum cash payment.
“What’s the best choice to make?” asks Scott Gerlitz, a financial adviser with Edward Jones in Calgary. “It’s a big question. Unfortunately, many people don’t know all their options and all the factors they should consider.”
Mr. Gerlitz says there are some critical factors that should go into making that decision.
The first is longevity. How long do you expect to live? Although no one can answer that question, statistics show that Canadians are living longer. And the longer you live the greater the chance you could outlive your money.
“If you have a family history of people dying early, and you don’t expect to live long yourself, it may make sense to have the cash now,” Gerlitz says. “Some folks may want to spend money on travel and other things while they are still healthy enough to enjoy them.”
Then there’s the issue of inflation.
Many pensions don’t have inflation protection. Inflation can erode your retirement income over the years. Most Canadians can expect to live in retirement for 30 to 35 years. An annual inflation rate of three per cent a year over 30 years can significantly reduce the buying power of a fixed pension at the end of that 30-year period.
Some options include taking your lump sum and rolling it into a personal RRSP or Locked-in Retirement Account (LIRA) and investing it in income generating investments such as GICs, bonds or blue chip dividend-yielding equities, which can grow over the years and provide some protection against inflation.
You’ve also got to think about the long-term future and viability of your pension payer. Just think of Nortel and Enron. “If people had drawn their pensions they’d have all of it instead of zero,” says Mr. Gerlitz. “As well, defined benefit pensions are going the way of the Dodo bird. That’s why people need comprehensive financial advice from a trusted adviser.”
“The pension system in Canada has produced pension ‘haves’ and ‘have-nots’ – at one end of the spectrum are public sector employees who enjoy the security of government-guaranteed DB pension plans and on the other end private sector employees having no income or retirement security whatsoever,” says the CGAAG.
There are basically two types of retirement plans.
Defined Benefit plans pay fixed amounts, typically between 60 to 70 per cent of the worker’s salary.
Defined Contribution plans, however, have a fixed contribution, usually based on a percentage of the employee’s salary and a portion of that matched by the employer, with the employee taking full responsibility for managing the money. “You need to know what kind of person you are and how responsible an investor you are,” Gerlitz says.”Studies have shown that people spend more time planning their vacations than they do their retirement.”
Another thing to consider is what happens to the money on your death. Depending on the plan, the surviving spouse usually is entitled to between 50 to 66 per cent of the pension. If the money had been withdrawn from the plan, then 100 per cent can be transferred to the surviving spouse.
Upon the death of the second spouse, whatever money is left in the pension plan goes back to the employer, whereas it can be transferred to children, tax free, if it had been withdrawn.