Defined benefit (DB) pension plans have a reputation for their complex formulas for determining monthly pension benefits. Unfortunately, when you retire it doesn’t get any simpler. Depending on your employer and your province of employment, employees may be presented with a number of forms of pension to choose from upon retirement.
The various forms of pension are like insurance policies: the amount you receive is based the likelihood of plan members living to a certain age. Simply put: the greater the possible liability to your employer, the less monthly pension you will receive. Here are the most common forms of pension you’ll come across along with a fictional example of how much John Smith would receive under Company ABC.
Life Only Pension, No Guarantee
This is the most common form of pension under DB plans. The major upside is that you’ll receive the highest monthly pension, however, it’s not without its downside: your pension only continues until your death. You could retire and end up living 30 years or you could prematurely die in five years.
If you’re single and your children are grown up, this form of pension may be ideal since you’ll receive the highest amount, however, if you have a spouse or dependents, this form of pension won’t provide protection for them since it will cease upon your death.
Say that John Smith would receive $2,000 per month under this option.
Lifetime Pension with a Guarantee Period
If you have dependents or want to ensure your estate receives a payout from your pension if you were to die shortly after retirement, this option may be ideal. This form of pension is similar to the life only pension: you are paid a monthly pension until your death. Usually you’ll have the option of choosing from a 5, 10 and 15 year guarantee period. If you were to pass away before the guarantee period is over, your beneficiary will receive the remainder of the monthly pension payments owed (it will be paid out either in monthly installments or as a lump sum, depending on your plan).
For example, if you were to select a lifetime pension with a 15 year guarantee and you were to pass away 10 years after retirement, your beneficiary would receive your monthly pension for the remaining five years. However, if you were to die in 20 years when the guarantee period has elapsed, there would be no further benefits payable.
In this case, John Smith would receive $1,900 under the 5 year guarantee, $1,800 under the 10 year guarantee, and $1,700 under the 15 year guarantee. Your beneficiary would receive the remaining payments if the guarantee period hasn’t elapsed.
Joint & Survivor Pension
If you have a spouse you’ll be required to elect a joint & survivor pension (unless your spouse waives his or her rights with a signed spousal waiver form). In most provinces the minimum joint & survivor pension amount is 60%. For example if you are receiving a monthly pension of $1,000 and you predecease your spouse, your spouse would continue to receive a monthly pension of $600 until his or her death. You may also be able to choose a 100% joint & survivor pension.
The form of joint & survivor pension you choose really depends on your family situation: if your spouse is receiving CPP and has his or her own pension, you may decide to go with the lower 60% joint & survivor option (or waive the option all together). A major drawback with this form of pension is that in a lot of pension plans, the spouse at your date of retirement will receive your pension no matter what (if you divorce and remarry your new spouse most likely won’t be entitled to your pension).
The 100% joint & survivor pension provides the lowest monthly pension, but provides the greatest guarantee for your spouse if you predecease him or her. In this case, John Smith would receive $1,600 per month under the 60% joint & survivor option and $1,500 per month under the 100% joint & survivor option. If you predecease your spouse, he or she will receive your pension until his or her death.
Choosing a form of pension payout is very important. You’ve worked for many years to earn your pension, so it’s important to ensure you get the greatest benefit. Unfortunately, nobody has a crystal ball – you won’t be able to predict how long you’ll live or if you’ll outlive your spouse. It’s important to sit down with your loved ones and financial advisor and decide which form of pension will provide the greatest protection for your spouse and dependents.
About the Author: Sean Cooper is a single, 20-something year old, first time home buyer located in Toronto. He has experience in the financial sector as a Pension Analyst, RESP administrator and Income Tax Preparer. He holds a Bachelor of Commerce in business management from Ryerson University.
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