# Company Pension Options



## 763ER (Jan 11, 2011)

I have recently started with a new employer and have the option to choose between 2 defined benefit pension plans. The required years of service are essentially equal, and there are other minor differences in terms of survivor benefits, early retirement penalties, etc.

Option A
Required Contribution - 9.5% of earnings less CPP
Payout - 2% of best years earnings per year of service

Option B
Required Contribution - Zero Contribution
Payout - 1.1% of best years earnings per year of service

The company provides tables that show a comparison of the 2 plans based on the employee taking the 9.5% and investing it themselves with various assumed returns. After 25 years of service, the retirement benefit of option A becomes equal to option B for a return of about 5%, (after inflation). In either case I plan to have a post retirement income in the highest tax bracket.

Aside from the obvious, (can you be discliplined to not spend the 9.5%, can you get a 4-5% return after inflation) what concerns or considerations should I have before making this one time decision?


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## LondonHomes (Dec 29, 2010)

1. How long are you planning to be with the company? I know you just started with them but can you see yourself retiring from the company? If you cannot then I'd go with option B.

2. Look at this from the company's point of view, it's sounds like they are pushing option B why would they do this? Is option A an older plan and they want new employees in Option B? Option B shifts a lot of risk to you.


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## MoneyGal (Apr 24, 2009)

I realize this question may be unanswerable at this point (depending on how far along you are in your career), but one way you might look at this is whether 1.1% of your best earnings would cover your basic living expenses in retirement. 

That is, what *proportion* of your (expected, basic) living expenses would be handled by a pension 1.1% of your best years' salary? 

If the answer is "all" or "most," I wouldn't choose an option which pays more than 1.1% of best earnings. I'm a big proponent of "pensionizing" enough of your nest egg to cover your basic living expenses, and not any more.


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## 763ER (Jan 11, 2011)

*Pension Option Questions*

_1. How long are you planning to be with the company? I know you just started with them but can you see yourself retiring from the company? If you cannot then I'd go with option B._

The company is an essential service so for all intents and purposes the job will be there until retirement. The question here is will I want to stay that long. I have a problem doing the same thing for a long time, though conditions here are great.

_2. Look at this from the company's point of view, it's sounds like they are pushing option B why would they do this? Is option A an older plan and they want new employees in Option B? Option B shifts a lot of risk to you._

Option A is the original plan and B is a new proposal by the company to reduce their market risk and liability. The union would never allow the company to eliminate A.

Option B is the dilemma of trading security for risk and control.


Thanks for the reply.


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## OhGreatGuru (May 24, 2009)

That's a tough one. Until recently defined benefit pension plans were like gold (and getting scarcer all the time). The usual advice would be to grab it with both hands.

However we have all seen how DB plans run by private companies have come crashing down lately, even those of giants like GMC, and we won't even talk about Nortel. Public service plans seem to be the only ones that are truly bullet proof ("public service" in the broadest sense, to include teachers, nurses, crown corps., etc., not just government employees). These employers cannot go out of business or declare bankruptcy. 

So, there is an element of risk in any private company's DB plan. You state the company is an "essential service", but does that mean that service will necessarily always be provided by that company? Or that the demand for this service might not change over time?

PS: The fact that the company is encouraging employees to consider Option B suggests the company itself is concerned that the nature of its business and/or size of its work force may change enough in 30 years to make the cost of pension plan A to be unbearable. Or that the pension liability may be a drag on it's market value that they want to reduce in order to be able sell - and if the company is sold would pension Plan A continue in its present form anyway? 

Having said all that, Plan B definitely transfers responsibility, liability, and risk to you. But then DB pensions seem not to be protected if a company goes into bankruptcy, so maybe you already have that risk.


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## OptsyEagle (Nov 29, 2009)

Hey, it's nice to have options. From what I can see, from a financial perspective, they are both the same. So the questions boil down to:

1) Do you want to take control and hence the risk, responsibility and discipline of providing part of your own pension. This gives you control, but if your ultimate goal is to provide income, why bother yourself. If you think you can do better ... well think about it a little longer and maybe you will come to a different conclusion...or maybe not. You decide.

the next question is:

2) Do you trust them to provide the pension? If it is the government, or perhaps a highly regulated utility, then don't worry about it. It's a pretty safe bet. If it is anyone else, then ask yourself if the diversification of having two pensions might be better. And here you need to finally ask yourself will you always contribute 9.5% of your salary to this plan? If not then it's you who can't be trusted.

Good luck. I wish I had your choices. I'm stuck with that damn stock market.


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## Cal (Jun 17, 2009)

If it were my choice, option B. But I am very disciplined, and would definitely invest the 9.5% of my pay check (and then some) continuously on my own.

If you are not sure, or not disciplined, then option A may be the safe choice.


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## MoneyGal (Apr 24, 2009)

OptsyEagle said:


> From what I can see, from a financial perspective, they are both the same.


I think it is extremely important to underscore that these are NOT the same options. 

A set of parameters has been manufactured to demonstrate the conditions under which the payouts *could* be the same - but how likely is that set of conditions to occur? This is a big unanswered question. 

That is, the two payouts will be the same IF (1) 9.5% of total salary is contributed over time, (2) the funds achieve, over the long-term, a real return of at least 5%, and (3) the person lives as long as whatever actuarial assumption is used in the example. 

If, in reality, they live LONGER, the DB pension with the higher payout is the "better" deal financially. If they don't live AS long, the lower-paying DB pension MAY be the better option, so long as conditions (1) and (2) are met. 

If they live LONGER, then in order to achieve the same lifetime payout the pensioner must either (1) achieve a higher return on their investments over time than in the example specified, and/or (2) save more of their salary when working/retire later, and/or (3) live on less in retirement. 

One of the things to be clear about in making this kind of decision is what your goals for your retirement "nest egg" are. Are you most interested in maximizing the sustainability of your income in retirement (i.e., reducing your chance of running out of money before you run out of life?) Or are you most interested in creating and leaving an estate after your death? 

Your answer to the question about "who are these funds for, really?" will greatly influence what choice you should make.


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## OptsyEagle (Nov 29, 2009)

MoneyGal said:


> I think it is extremely important to underscore that these are NOT the same options.
> 
> A set of parameters has been manufactured to demonstrate the conditions under which the payouts *could* be the same - but how likely is that set of conditions to occur? This is a big unanswered question.
> 
> ...


Of course they are different or you wouldn't be given the choice.

But I will put it another way, from everything you can possibly know now, financially they are the same.


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## 763ER (Jan 11, 2011)

I am leaning toward option B.

The 1.1% should cover my bare bones living expenses. It is early to tell, but I plan to "die broke" and not leave a legacy.

Despite my position being highly specialized and the utility not going anywhere, I still have doubts as to whether 60 years from now the terms of the plan will be the same as today. More money in my pocket under my control is a good thing. It would also allow me to invest outside of "paper assets" 

The savings discipline is not a factor for me, with my lifestyle the plan is to save an additional 10% anyhow.

The assumptions used in the calculation are that the 9.5% less CPP was invested in a tax advantaged vehicle and a 4.5% post retirement rate of return was used for the annuity with "1994 uninsured pensioner mortality projected to 2015" Any idea what age this would be?

Am I willing to take control of half of my income at retirement? 

Thanks again for the advice.


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## MoneyGal (Apr 24, 2009)

Hmmmm. That tells you what life tables they used for the calculation (the UP-94 tables with a projection to 2015). There will be some calculation - somewhere - that gives an expected age at death for the scenario they've projected. 

But whatever age they've used in the scenario they calculated, it is important to understand that you might live (much) longer, and you might live (many) fewer years. 

This is why I have argued that the two scenarios are only "financially equal" under a limited set of parameters: that is, if you die whenever the scenario projects you are going to die. 

If you live longer or shorter (both of which are much more likely than you living to the exact age in the projection - there is a wide dispersion of results for mortality), the scenario is not equivalent. Instead, it's more like the broken clock that tells time accurately twice a day.


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## I'm Howard (Oct 13, 2010)

Our decision was to have our Retirement Revenue come from our RRSP's, from Government programmes, and from a DB Indexed Pension.

I wanted a steady stream of Income and to not have to worry about managing money in our later years.

We get seven paycheques at the end of each month.


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## Eclectic12 (Oct 20, 2010)

763ER said:


> I am leaning toward option B.
> 
> The 1.1% should cover my bare bones living expenses. It is early to tell, but I plan to "die broke" and not leave a legacy.
> 
> ...


Yes, in 60 years, the terms of the plan could have been modified.

Though - when you say "more money in my control is a good thing", I assume you know yourself well. I've seen too many people be excited about having control for a while and then in a few years time, as they get busy - it becomes work. In the DB plan, there are specific limits for what the funds are invested in. It might not be the investments you like but it is automatic.

As for the "9.5% less CPP was invested in a tax advantaged vehicle" comparison, something to consider is that the db plan is going to limit the options for a tax advantaged vehicle - specifically, your RRSP. As the DB benefit is guaranteed, the Pension Adjustment (PA) reduces your RRSP contribution room. It is not a dollar for dollar proposition, though. In a previous life, my contributions for the year were about $600 but the PA reduced my RRSP room by $2400. If it were a defined contribution (DC) plan, it would be dollar for dollar (i.e. $1 from you and $1 from employer reduces your RRSP room by $2).

So I'd want to check the calculations. They may assume you've got 50+ years to contribute an RRSP that might not be true. Significant growth in your salary will also grow amount of the pensions contributions and the PA. There is a point where the PA will equal or exceed the RRSP room earned. From that point onward, RRSP contribution room stops being earned. If that happens, the recent TFSA gives another option but it also has limits.

The question is could you reach that point? If you reach that point at 40 years, it's probably not a concern. If you reach that point at 15 years, it may change the numbers significantly.

Cheers


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## 763ER (Jan 11, 2011)

I have run some numbers and the ones provided by the company paint a better picture than reality.

For comparison assume 100,000 in income that won't ever increase, I work 25 years and earn 5% on my own investments after inflation, Start at age 30 and plan to live to 90.

Plan A
2% x 25 Years x 100,000 = $*50,000 per year for life indexed to inflation*

Plan B
1.1% x 25 Years x 100,000 = $27,500 per year for life indexed at co's discretion

9.5% x 100,000 - 2211 (CPP) = 7289 Available to self invest each year at 5% compounded is $191,634 in an rrsp

Put this into an Annuity that returns 5% and to make it last 90 years pays $11,703 annually

Total for *plan B $39,200 per year NOT indexed*.



Based on this simplified comparison Plan A has the better cash flow, indexing protection. The spreadsheet the company provided showed the self invested annual cash flow to be almost double my above calculation. Unless my math is way off, they must have assumed a much earlier mortality. Personally I wouldn't be comfortable planning on living any less than 90 simply for the peace of mind of not running out of $.


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## OptsyEagle (Nov 29, 2009)

You lost me somewhere. My first confusion is why is CPP subtracting $2211 from your savings? In fact if your total pension is CPP integrated, option B would provide more money because you would have less of a reduction due to CPP integration, then you would have in option A.

2ndly, $7,289 saved and compounded for 25 years at 5% equals $347,883.
3rdly, the amount paid from your annuity will vary depending on when it starts, but since most pensions start at age 60, if that age was used you could look forward to closer to 6.25% from an annuity. In the above example, that provides $21,742.

As you can see, like I said before, financially they are the same with the only variation coming from your 5% return projection.


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## 763ER (Jan 11, 2011)

I re-ran the numbers in a different calculator and got a result close to yours. Essentially 50,000 under each plan for 5% post-inflation.

I subtracted the CPP figure because to get the 2% option A pension, my personal contribution is 9.5% of salary minus CPP payments.


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## OptsyEagle (Nov 29, 2009)

OK, sounds good. By the way, is your pension reduced at age 65 (CPP Integration), since this would also create a reasonable financial difference.

All that being said, I suspect your employer costed it out pretty good and that financially there will be little difference, from what we can know today.

So the question is: Do you want to take control of about 1/2 the program or not? Do you feel you will be disciplined to contribute to this plan on your own? etc.

One other thought is if you do not need all the income your option A would provide, then by splitting it up with option B, it gives you the ability to leave it to some of your heirs. The total pension does not. Now this is not extra money, since it comes from you electing to not take it all in income, it is just another option to allow you to organize it into your life better.

Anyway, good luck.


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## 763ER (Jan 11, 2011)

At 65:

Plan A reduced by .7% of CPP earnings per year of service

Plan B reduced by .5% of CPP earnings per year of service

I'm not really sure of the implications of this.

Thanks for the help!


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## Bupp (Nov 13, 2009)

What is the lifespan like for people in your family? Any relatives die in their 50s? How about their 60s? 

The longer you expect to live the more attractive option A becomes relative to option B.


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## OptsyEagle (Nov 29, 2009)

763ER said:


> At 65:
> 
> Plan A reduced by .7% of CPP earnings per year of service
> 
> ...


Well, as I suspected, another reasonable difference. I suspect that is how much reduction your pension takes at age 65. As I would calculate it, since maximum CPP earnings is around $41,000 I think, then Plan A would be reduced: 0.7% x 25 yrs x $41,000 = $7,175 and
Plan B reduced: 0.5% x 25yrs x $41,000 = $5,125

a difference of $2,000 less reduction with plan B.

It's possible that it is calculated differently. I actually would have thought the difference would be much bigger, closer to 1/2 of the $7,125. They are actually reducing B more than they should, in my opinion, but it is still a very good plan.


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