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Sometimes when I talk to people about financial planning, their response is ‘Oh I have a pension plan, I don’t have to worry about that stuff’. Although having a pension plan can be good, having that mindset can be detrimental.
There are essentially two types of pension plans: Defined Contribution (DC), and Defined Benefit (DB).
With a DC plan, your employer agrees to contribute a percentage of your pay, typically you will be allowed to contribute too, and the more you do (to a certain point), the more they will too. This type of pension plan depends entirely on how much is contributed, and how the investments perform. This pension plan is not guaranteed at all.
A DB plan is usually one you see with big companies or government jobs. It is based on your years of service, highest pay, average pay, age, etc. The company essentially says that depending on your work history with them, they will pay you $XX every year in retirement. But even though the company says they will do this, this pension plan is also not guaranteed.
In 2000, Nortel was the most valuable publicly-traded company in Canada, accounting for more than a third of the total value of all companies traded on the Toronto Stock Exchange (TSX). This is an almost insane fact. Nortel had over 93,000 employees worldwide and seemed like a company that no one could slow down. But in 2009, Nortel filed for bankruptcy.
When a company goes bankrupt, it’s similar to when a person passes away. What I mean by that, is although the person or company might look big and rich, they might owe a lot of money to people. So when they pass away, their estate isn’t just passed on to the beneficiaries, but the estate needs to be settled (a lot of people want to get their money).
From filing bankruptcy to actually getting things sorted out took seven years, and in the end past Nortel employees were informed they’d be getting 55–70% of the pension they anticipated. So if someone had expected to survive just on their pension plan, that’s a tough pill to swallow. Not to mention if they were about to retire, having to wait seven years while things get figured out, could put a huge strain on someone financially.
A similar story happened to past employees of Sears when they filed for bankruptcy in 2016. After everything else was settled, they’d be receiving about 70% of the pensions they were entitled to. Again, devastating news, especially for those people who were close to retirement.
After taxes, most people get somewhere around 70% of their earned income. So if you’re now only entitled to get 70% of it, you’ll have to pay taxes on what you get, so it’s essentially like paying taxes twice on the same income. Paying taxes once is enough I would say.
Just like Nortel, Sears was a huge company. You couldn’t go to a mall that didn’t have a Sears attached to it, and it was typically the biggest store in the mall. If it can happen to these powerhouse companies, it could really happen to any company. These aren’t that common, but if you spent your entire adult life working for one company, depending on that pension, and then it’s delayed, or cut in half, it’s not like finding another job would be easy.
When a company offers a DB pension plan, it means the company is funding and investing the money needed to pay for it. What can happen, is the fund is either underfunded or the investment performance doesn’t meet their assumptions.
On top of pension plans, some employers might have a stock option. Where you could get the companies shares at a discounted price, or receive compensation for owning shares. Now when things are good, the program is great. But if you had worked at Nortel, invested in Nortel stock, and paid into a Nortel pension plan, you lost a lot, probably almost everything.
When we invest smartly, we invest in a diversified approach. That means, not all of your eggs in one basket. So even though in the case of Nortel and Sears, everything was going great, that’s often the most dangerous time to put all of your eggs in one basket.
I think what most people do, is if part of their benefits includes a pension plan, they assume the pension plan is all they need.
Let’s pretend two people have the exact same jobs and are entitled to the exact same pension. Is that pension automatically the exact amount each person needs to be able to retire? Of course not.
One person could have a lot of debt, an outstanding mortgage, lots of dependants, an expensive lifestyle, they might want to travel, or treat themselves. One person might have a spouse with or without a pension or savings of their own. Retirement planning is far too complex to just assume you’ll be fine with the pension plan offered by your employer.
Having a pension plan can be great because it helps you save for retirement, but it doesn’t mean it’s all you’ll ever need for retirement.
Another thing to consider is what happens to the pension plan if you pass away? If you leave behind a spouse, most pensions will transfer to them, usually at a reduced benefit. If you don’t have a spouse, the rules for how pensions transfer to a beneficiary can become complicated. Depending on the value of the pension, it might be better to transfer the money out to a registered account and control the money yourself or with the help of an advisor.
Not all pension plans are the same, they will have different rules or procedures for some situations. I guess the main point here, is don’t assume. People can get into trouble when they just assume. Especially since it’s your future, your retirement, take the time to understand your plan, and understand if it’s in your best interest.
Even if you have a pension plan through your employer, you should still take steps to ensure you have a comprehensive financial plan in place. You should look at the numbers with your pension plan benefit, and without it, and see what makes the most sense. In most cases, saving on top of your pension plan wouldn’t be a terrible thing. You could save in a Tax-Free Savings Account (TFSA) so when you withdraw the money you don’t have to pay taxes. If everything goes well if your pension plan, then you have some extra money to spend your retirement how you want — that’s not a bad thing at all.
It’s also important to understand what type of pension plan you may have access to (DB or DC), and how it works. Even if retirement is a long way away for you, the sooner you know about these things, the sooner you can ensure you’re doing everything you can to help your money go as far as it can. Don’t wait until you’re 10 years from retiring to find out you could have been doing more, and now you have to stress out about trying to fund your retirement.
Be proactive, not reactive.
Disclaimer: The information in this article is not intended to encourage any lifestyle changes without careful consideration and consultation with a qualified professional. This article is for reference purposes only, is generic in nature, is not intended as individual advice and is not financial or legal advice.