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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.
Nortel
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.
Sears
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.
Invest Outside of Your Employer
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.
Know Your Own Numbers
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.
Your Legacy
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.
What Should You Do?
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.
💬 Do you have an old pension in Canada? Have you talked to your Financial Advisor?
When we heard Amanda’s story, we knew it should be shared with other Canadians who may not be aware of their choices for an old pension when switching jobs.
We asked Amanda and her financial advisor to share their story.
Wealthtender: Amanda, can you tell us a little more about how you were able to cash out an old pension with the help of a financial advisor?
Amanda: When I switched jobs, I was told by both my former bank’s advisor and pension services manager that I was not allowed to touch this money until my retirement. So when I suddenly received an unsolicited email that included my pension termination options, I contacted my new financial advisor, Sarah Smith, because I thought it might be a scam. I am so glad I did! She immediately told me that I’ve received bad advice in the past, and moved my old pension money into a mutual fund. Instead of making only a few dollars a year on interest, I am now earning a few thousand thanks to her help!
We also heard from Amanda’s financial advisor, Sarah Smith who offered her perspective on the matter.
Sarah: Amanda is a newer client who, unfortunately, has been given bad financial advice from professionals in her past. I was able to open a small mutual fund for her earlier this year that was never offered to her by her previous advisors. When she contacted me about her pension termination, I couldn’t believe that she was advised to just leave it alone when she could be investing this money, too! So that’s exactly what we did, and now her financial future is much better off.
Wealthtender thanks Amanda Kay of My Life, I Guess for sharing her story and Sarah for her guidance that resulted in a great outcome.
About the Author
Derek Condon, CFP®
To make Wealthtender free for readers, we earn money from advertisers, including financial professionals and firms that pay to be featured. This creates a conflict of interest when we favor their promotion over others. Read our editorial policy and terms of service to learn more. Wealthtender is not a client of these financial services providers.
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