# Deferred DB Pension vs. a payout now



## frugalmom22 (Feb 15, 2015)

Hi
I am self-employed but have a small pension. I received a termination package from HOOP and must choose between a deferred pension later or a payout now.

Details:
Current age: 50
Earliest Unreduced pension at age 60 = 868/month
vs.
Payout=Locked in (94,000) + non-locked (97,000); (I will be taxed this year on the $97,000 - less any I can put in RRSP)

Not sure if it is best to take the money and invest in ETFs (couch potato) myself or defer the pension and take the guaranteed (inflation adjusted) monthly payment at age 60.

Any advice would be welcome!
Thanks.


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## OnlyMyOpinion (Sep 1, 2013)

I think you will hear a chorus of "Keep the indexed DB Pension". 
It would be a challenge and would carry risk for you to take the payout and grow it in 10yrs to match the indexed $868/mo the DB pension will pay with no work on your part. E.g. If you take the payout and can end up with $160k after tax, and if you can average a 5% real rate of return for 10 yrs you'll have $260k at age 60. If you withdraw that at 4% per year, it would give you $867/mo. - about the same initial amount, but not indexed, and subject to several 'if's.
And in terms of security of pension, HOOPP should be fine.


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## GreatLaker (Mar 23, 2014)

Here is another thread where I made a detailed response with some links that you should find helpful:
http://canadianmoneyforum.com/showthread.php/44130-To-Commute-or-not-to-Commute-Help!?p=687362&viewfull=1#post687362


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## birdman (Feb 12, 2013)

Without doing a detailed calculation of which could be better one point is that the defined benefit option eliminates the investment risk of doing it yourself. I have a small defined benefit plan and its sure nice to have the income with the risk.


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## My Own Advisor (Sep 24, 2012)

Go with deferred DB pension. You also avoid a heavy tax hit now.


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## CalgaryPotato (Mar 7, 2015)

One of the big advantages of a defined benefit plan is it takes the guess work out of trying to figure out how long you're going to live. You may live until an average age of 75 and that payout is based on that. 

If you live shorter you'll obviously get less, but the real risk is living longer. Taking the payout every month is the safer road. It won't make you rich but that is a nice chunk of change every month to pay your basic expenses. Plus of course the taxes (again depending on how much RRSP room you have)


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## Eclectic12 (Oct 20, 2010)

+1 to keep it.

Even the easiest of portfolios takes some effort. In comparison, HOOP reports that last year was a 17.7% gain where the pension funded ratio is 115%.

Unless one has already proven they are Warren Buffett ... I'd be keeping it simple by taking the pension.


Cheers


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## Retired Peasant (Apr 22, 2013)

+1 deferred pension, especially since it's indexed.
I took a payout years ago, and regret it.


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## Beaver101 (Nov 14, 2011)

Eclectic12 said:


> +1 to keep it.
> 
> Even the easiest of portfolios takes some effort. In comparison, HOOP reports that last year was a 17.7% gain *where the pension funded ratio is 115%.
> *Unless one has already proven they are Warren Buffett ... I'd be keeping it simple by taking the pension.
> ...


 ... how do you know or where can you verify that the pension plan funded ratio is 115% (most likely is considering it's a HOOP plan).


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## sags (May 15, 2010)

The HOOPP website has lots of information on it, including their financial statements.

With the plan in surplus, they recently raised the cost of living benefit to 100%, and made a retroactive payment to retirees.

The HOOPP plan also offers a spousal benefit............up to 100% of the pension. There is a small cost but guarantees benefits for the lives of both pensioner and spouse.

The decision is made at retirement.

The plan also has provisions in the event of an employee passing away before they retire.

The beneficiary would have the choice of a lump sum or a stated number of pension benefits.

It is administered by a joint committee of employee and employer representative, which appears to be a concept that works well, and is probably responsible for the array of benefits it offers.


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## frugalmom22 (Feb 15, 2015)

Thanks very much to everyone who replied and for the links to other resources. After reading through all of it, it seems my decision is pretty straightforward...i.e., take the deferred pension option.
Thanks again for the advice.


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## RBull (Jan 20, 2013)

Wise decision frugalmom22. 

Some great contributions on this thread.


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## Eclectic12 (Oct 20, 2010)

Beaver101 said:


> ... how do you know or where can you verify that the pension plan funded ratio is 115% (most likely is considering it's a HOOP plan).


In general, where I've participated in a DB pension, I ask whether the pension is fully funded. 
Being in private DB pensions, I tend to get a yes or no answer instead of a funding ratio. Where it's been "no", there's usually talk of the schedule to get top-ups approved and when the top-ups happen, the numbers are given.


HOOP on the other hand, provides on it's web site the general description to the public:


> The full report gives details on our results announced earlier this month, which included our: 17.71% rate of return, $60.8 billion record net assets and 115% funded ratio.


http://hoopp.com -> News Update -> May 16th, 2015 entry


The URL attached to the description gives on the choice of the annual report through a "fast facts" style PDF, a video or a full blown Annual Report (including auditor's report as well as actuarial opinion).

http://hoopp.com/investments/annual-report/



Cheers


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## jaybee (Nov 28, 2014)

Quick question on this topic. Lots of great input on this thread.

*To what extent should age be considered in this decision? *Suppose the OP was 35 or 40 years old, and had accumulated the same amount. Wouldn't it be more tempting to take the payout if the OP was 20 or 25 years away from the earliest reduced pension date?


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## Eclectic12 (Oct 20, 2010)

How likely is the younger person with the same earned pension going to invest successfully to overcome the economy of scale the DB pension enjoys and the indexing built into the plan?

The payout allows one to make more concentrated investments than the pension could but likely at a higher transaction cost. Any mistakes made means other sources of income are needed.


My impression of who qualifies suggests that taking on the care/feeding of the pension may not be at the top of where they want their time to go.


Cheers


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## jaybee (Nov 28, 2014)

^ Thanks Eclectic. The reason that I ask, is that I could see myself in a very similar position to the OP. However I am younger (say 10-15 yrs younger). Also, I do have other income streams for the future. Such as a non registered portfolio of Canadian dividend paying stocks, and a maxed out TFSA and RRSP.

I have a defined benefit pension (8 years and counting) and I'm under 40. I love stock picking, although I do some indexing a well.

Given what I stated above. How different (if at all) is my situation than the OP's


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## OnlyMyOpinion (Sep 1, 2013)

Jaybee, I'd say the situation is similar - diversity of income streams is good to have in retirement. DB pensions are a rare beast these days. Your CPP, a DB pension and your RRSP/TSFA/non-reg portfolio will give you great income coverage. The 'guaranteed' and fixed income aspect of your CPP and DB pension allow you (if inclined) to be more aggressive with your own investments. The only instance I'd consider taking a payout is if for some reason the plan is considered to be at risk (grossly underfunded, etc.).
(Note: I do not have a DB plan)


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## Eclectic12 (Oct 20, 2010)

jaybee said:


> The reason that I ask, is that I could see myself in a very similar position to the OP. However I am younger (say 10-15 yrs younger). Also, I do have other income streams for the future. Such as a non registered portfolio of Canadian dividend paying stocks, and a maxed out TFSA and RRSP.


If you have other streams already - why wouldn't you want the employer to be taking on the longevity risk for part of the retirement income?

Taking the payout means you are 100% responsible - any mistakes you will have to deal with (ex. cut retirement lifestyle or replace the funds). 
If the DB pension is at risk (think Nortel) or it pays poorly, then the payout becomes more attractive.


Note that as the OP's pension is a top end pension with benefits/choices I'd like to have in mine, I am biased towards keeping the pension. Another factor to swing me this way is I've had co-workers focus on the reduced RRSP contribution room who wanted to dump their DB pension *without* running any numbers or scenarios. The one eventually did was shocked to see that the DB pension paid out for lifetime with an early death payout of ten years worth. By his target calculations for what the payout plus additional RRSP contribution room would do for him - he was out of money in 6.5 years. There are a lot of variables plus one has to know how disciplined one is and how much work one wants to take on.

As another example, knowing what my parents were like with the expenses of five kids plus my dad's aversion to equities ... there's no way a pension payout in addition to RRSPs being managed by the two of them would have covered twenty one years the pension paid him before he died plus the nine years Mom's been collecting the pension since his death.




jaybee said:


> Given what I stated above. How different (if at all) is my situation than the OP's


Are you in a similar high end DB pension that pays out well?
Does it have good inflation protection?
Does it have features built in such as bridge benefits? (I'm not sure for HOOPPs but the Federal pension includes a bridge benefit where in my private DB pension, if I want it, I have to contribute the money to pay for it to a supplemental pension.)

If it is a high end, well paying, well protected and well managed (i.e. well funded) DB pension - I would keep it and be a bit more aggressive with my other income streams.

Then too, are there early retirement choices? 
When would you plan to retire?






OnlyMyOpinion said:


> ... The only instance I'd consider taking a payout is if for some reason the plan is considered to be at risk (grossly underfunded, etc.).
> (Note: I do not have a DB plan)


If the plan is to leave the company early, there's no indexing and the benefit earned is low ... I would want to spend more time on the decision. 

Returning to my first DB pension as an example, with no indexing, the benefit being capped at something like $210 a month and a thirty five year investment horizon ahead of me - I preferred to try to grow it in my LIRA/RRSP.


Cheers


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## jaybee (Nov 28, 2014)

Eclectic12 said:


> Are you in a similar high end DB pension that pays out well?
> Does it have good inflation protection?
> Does it have features built in such as bridge benefits? (I'm not sure for HOOPPs but the Federal pension includes a bridge benefit where in my private DB pension, if I want it, I have to contribute the money to pay for it to a supplemental pension.)
> 
> ...


Thanks for your input. My DB pension is fully funded (104 percent as of Dec 2014). It's public sector pension which which is indexed until 2020. I understand that there is a funded health review every five years in which the decision whether or not to grant indexing (COLA) is determined. I have no plans on leaving the job anytime soon, but an organizational restructuring is under way, and suddenly our jobs don't seem as secure

My first DB pension was similar to yours. The benefit being capped at some minuscule amount. Being 25 years old at the time I opted to put in TD e-series index funds.


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## My Own Advisor (Sep 24, 2012)

frugalmom22 said:


> Thanks very much to everyone who replied and for the links to other resources. After reading through all of it, it seems my decision is pretty straightforward...i.e., take the deferred pension option.
> Thanks again for the advice.


+1


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## cashinstinct (Apr 4, 2009)

A family member in Canada had the good fortune to choose payout on a pretty significant DB pension and invested starting in 2009-2010 (More or less) mostly in U.S. stocks... 

He is pretty happy with the outcome, but he took a big risk.

I would not recommend payout to most people.


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## HaroldCrump (Jun 10, 2009)

There is a huge push these days in many countries by the financial industry to convince soon-to-be-retirees to take a payout of their defined benefit pensions instead of waiting and collecting.
This push is particularly prevalent in the US, UK, and here in Canada.
In fact, the UK brought in pension reforms in 2014 that allows retirees (and soon-to-be-retirees) to liquidate their pensions and take a tax-free payout (up to certain limits, of course).
A whole new crop of financial advisers have come up that specialize in re-investing the lump sum proceeds from liquidating DB pension.

To some extent, this is encouraged by some underfunded pension funds themselves.
Paying out the commuted value reduces their balance sheet liabilities and they can use accounting gimmicks to show lower funding deficits.
In the US, a very large number of public sector pension plans are at dangerous funding levels (i.e. 60% or less, some as low as in the 40%s), such as in Illinois, California, Pennsylvania, etc.
These pension funds are equally complicit in encouraging employees to take the commuted value as lump sum payout.

Good decision by the OP to stay in the plan.


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## Beaver101 (Nov 14, 2011)

^


> ...* Paying out the commuted value reduces their balance sheet liabilities *and they can use accounting gimmicks to show lower funding deficits. ...


 ... how is this so in such a low interest-rate environment, possibly lowest in a decade or two. Don't dispute the part about accounting gimmicks used to show lower funding deficits (or possibly a magical surplus ... ). :biggrin:


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## HaroldCrump (Jun 10, 2009)

Beaver101 said:


> ^ ... how is this so in such a low interest-rate environment, possibly lowest in a decade or two.


Because many pension plans are not using this "_low interest-rate environment, possibly lowest in a decade or two_" to discount their liabilities.
They are using trumped-up, notional rates.
In their heart of hearts, they know the realities of the low interest rate environment but on the books they are carrying these liabilities at higher interest rates, and using wildly optimistic RoR projections.

Paying out the CV is better for them than carrying these liabilities when they know for a fact that their assumptions are not correct.

Ask yourself this - how many pension plans (esp. in the US) today would simply love to travel back 10 yrs. and pay out the CVs to the beneficiaries, instead of carrying them now.


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## Woz (Sep 5, 2013)

HaroldCrump said:


> Because many pension plans are not using this "_low interest-rate environment, possibly lowest in a decade or two_" to discount their liabilities.
> They are using trumped-up, notional rates.
> In their heart of hearts, they know the realities of the low interest rate environment but on the books they are carrying these liabilities at higher interest rates, and using wildly optimistic RoR projections.


I’d expect people taking the CV would hurt the pension plans balance sheet then. If they’re using notional rates to calculate their liabilities but paying CV based on the actual low interest rates then when someone takes the CV the reduction in assets would be greater than the reduction in liabilities.



HaroldCrump said:


> Paying out the CV is better for them than carrying these liabilities when they know for a fact that their assumptions are not correct.


Likewise, as the CV is paid out based on actual interest rates the accuracy of their notional value would have no impact on their true liability.



HaroldCrump said:


> Ask yourself this - how many pension plans (esp. in the US) today would simply love to travel back 10 yrs. and pay out the CVs to the beneficiaries, instead of carrying them now.


It would depend if they’re returns were higher than the interest rate used for calculating the CV. The interest rate used for calculating the CV in 2005 was 5.55%. The total return of the S&P500 was 7.28% during that time. TSX Composite was 7.6%. Unless they were heavy in short term bonds, most companies 10 years ago would’ve been better off if they didn’t pay out the CV.


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## HaroldCrump (Jun 10, 2009)

Woz said:


> I’d expect people taking the CV would hurt the pension plans balance sheet then. If they’re using notional rates to calculate their liabilities but paying CV based on the actual low interest rates then when someone takes the CV the reduction in assets would be greater than the reduction in liabilities.


They would use the same rate on both sides, of course.
Why would they use different rates?



> It would depend if they’re returns were higher than the interest rate used for calculating the CV. The interest rate used for calculating the CV in 2005 was 5.55%. The total return of the S&P500 was 7.28% during that time. TSX Composite was 7.6%.


Pension funds are not 100% invested in equities, so why compare against S&P500 alone?
In fact, I believe, worldwide pension fund investments in public equities are at multi-year lows, possibly all time lows.



> Unless they were heavy in short term bonds, most companies 10 years ago would’ve been better off if they didn’t pay out the CV.


The reason they are happy to pay out (and would have been so any time in the last 10 - 15 years), is that it is progressively getting worse for them.
Solvency ratios are falling, longevity is increasing, health care costs are increasing, etc.
The deck is stacked against them.

The real solutions - i.e. massive increase in contributions and/or reductions in benefits - are not politically expedient.


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## Beaver101 (Nov 14, 2011)

HaroldCrump said:


> They would use the same rate on both sides, of course.
> Why would they use different rates? ...


 ... why should they use the same rates, when the commuted value is defined as the "present" value of their pension? Do regulations allow companies and public pension plans to use notional rates on commuted values?


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## Woz (Sep 5, 2013)

HaroldCrump said:


> They would use the same rate on both sides, of course.
> Why would they use different rates?


Because by law the CV needs to be based on the Bank of Canada rates which is currently lower than the notional value used by most pension funds when they calculate their liability. 

I've simplified it a bit, but say your pension makes you eligible for $10k per year with an expected life expectancy of 20 years. Using the 3.60% rate that they'd be required to use for the CV, your CV would be $141k. However, when calculating their liability they use a notional rate, typically ~6%. Therefore, their liability is only $115k. By paying out the commuted value their assets have decreased by $141k but their liabilities have only gone down by $115k.



HaroldCrump said:


> Pension funds are not 100% invested in equities, so why compare against S&P500 alone?
> In fact, I believe, worldwide pension fund investments in public equities are at multi-year lows, possibly all time lows.


It was to illustrate the ballpark return. If I use the Province of BC’s asset allocation then the annualized 10 year return would be 6.2% excluding their 21% alternative investment allocation which I have no way of knowing the returns for. (2% short-term bonds, 5% real return bonds, 22% universe bonds, 16% Canadian Equity, 18% US Equity, 13% International Equity, 3% Emerging Markets, 21% Alternative/Illiquid)



HaroldCrump said:


> The reason they are happy to pay out (and would have been so any time in the last 10 - 15 years), is that it is progressively getting worse for them.
> Solvency ratios are falling, longevity is increasing, health care costs are increasing, etc.
> The deck is stacked against them.
> 
> The real solutions - i.e. massive increase in contributions and/or reductions in benefits - are not politically expedient.


I can understand companies paying out as part of converting from a defined benefit to a defined contribution plan, but that’s a case of being willing to take a loss on the pension benefits that have already been earned in order to shift the risk of future pension benefits that have not yet been earned onto the employee.


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