Picking survivor and guarantee options

Q: I am considering retiring early from a job that entitles me to a pension. There are many options available depending on single or joint life and what percentage as well as how many years guaranteed, 5, 10 or 15. How does one decide which is the best option?

—Brenda

A: From experience, I know that making these pension elections can be daunting, Brenda. There are a lot of difference choices and they’re going to impact you for the rest of your life–and maybe even after you’re gone for your spouse or children.

The primary consideration relates to the survivor options. Some plans will offer a variety of options ranging from a single life pension payable only during your life to a joint & survivor pension payable after your death ranging from 50-100% of the original pension.

A single life pension is only payable during your life and on your death, there will be no further pension payments. It will result in the highest monthly pension, Brenda.

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A joint and survivor pension will continue after your death to your spouse based on the percentage you choose. The higher the survivor percentage, the lower your pension payments when they begin. The reason is that you’re increasing the odds the pension plan will make more payments and make them for longer if you choose a high joint and survivor percentage, so you get lower payments as a result.

A joint and survivor pension is kind of like an insurance policy and insurance has a cost. If you want to be strategic, you can even consider comparing the difference between a single life pension and a joint survivor pension’s monthly payments (ideally, what the difference would be after tax) and seeing how much life insurance you could buy with the difference.

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In other words, if you took the single pension and bought a life insurance policy with the excess after-tax monthly payments, would you end up with a bigger “payout” to your spouse (or other beneficiaries, for that matter) on your death than choosing the joint & survivor option, Brenda?

The reduction in your pension for the joint & survivor option will be based on life expectancy for an average person the same age as you. If you’re really healthy, you’ll end up paying too high a premium (too large a reduction in your pension) to buy the option.

Personally, I think the election to take 50%, 75%, 100%, etc. is more art than science. Depending on your province of residence, Brenda, your spouse may have to sign off on an election that is less than a certain pre-determined percentage (usually 60%). I think you need to consider your other retirement assets and if electing no survivor option (so a single life pension) or even just a lower percentage would leave your spouse in a tight cash flow position, you should err on the side of caution and elect a higher survivor option, up to 100%.

The guarantee options for 5, 10 or 15 years just mean your payments are guaranteed for at least that long, even if you die before the guarantee period ending. Once again, it’s like buying an insurance policy and that has a cost, meaning it lowers your monthly payments.

If you have reason to believe that your health is not good or that you may not live a long life, electing higher survivor percentages or higher guarantee periods could be a good option for your beneficiaries. On the other hand, good health for you and/or poor health for your spouse might be a reason to opt for a lower survivor option or no guarantee.

You may have other options for your pension, like taking an immediate or a deferred pension or even taking a lump-sum commuted value instead of your future pension payments, Brenda. I’ll crunch the numbers for a client in a case like this using all available information about their other sources of income, assets, liabilities, expenses and so on. Using conservative, but reasonable assumptions can allow you to compare two scenarios to see what makes you better off in the long run.

Sometimes, an immediate pension can help keep you in a lower tax bracket and benefit from the pension income amount and pension income splitting with your spouse. Sometimes, you’re better off deferring because you’re going to be working in another job or because your payments will be higher if you wait.

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And depending on how much of your pension could be transferred to a locked-in RRSP and how much would be taxable, coupled with your risk tolerance, it could be a compelling decision to take a lump-sum payout (or, to the contrary, leave the pension in the plan and collect your monthly payments instead).

In summary, Brenda, there are lots of different things to consider when making a pension election. I think it’s a good reason to get some professional input, but you can also at least consider some general guidelines. Start by considering what retirement income your spouse would need. If your health is poor, opt for higher guaranteed payments. And if you have options for deferring your pension or taking a lump-sum, run the numbers to try to make a decision with some perspective.

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Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.

About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.

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