Who Can You Trust with Your Retirement Income?

You keep your commitment. You show up for work with the expectation that in return you will one day receive a comfortable retirement benefit.  You hold up your end of the deal.  But something goes wrong…figuratively (and financially) speaking. Nothing you did caused this.

Types of Pension Plans

People who are fortunate to work for a company that offers a pension plan generally have either a Defined Benefit Plan (DBP) or Defined Contribution Plan (DCP).  The Defined Benefit Plan comes with a promise to pay a retirement income for life based on a specific formula based on a percentage of your income and years of employment.  A Defined Contribution Plan, also referred to as a money purchase plan, is one in which contributions made by both an employer and employee are invested into a pension plan in a similar way investments are made to a personal RRSP (Registered Retirement Savings Plan).   What you see is what you will get at the end of your working years.

 

Quite often people know they have a pension plan but they are uncertain about the plan’s details. If they do open their annual pension statement, they usually glance only at the breakdown of pension benefit. 

When your pension statement is dropped on your desk or arrives in your mailbox, it’s imperative to look at your statement to understand what you are entitled to receive upon retirement.  You may get to the end of your career only to discover you are not as “rich as you think you are”.

Are all pension plans equal?

One of the biggest news stories lately has been the financial welfare of defined benefit pension plans.  A Defined Benefit Pension Plan (DBP) promises retirees a lifetime benefit.  They are depending on this steady stream of income in the years when they are no longer able to work.

We don’t often talk about the solvency ratios of pension plans.  When you don’t understand something you assume that if something is wrong, “they” will fix it. 

Here’s the simplified version. The financial terminology for “solvency” is the ability for one to pay their debts.  It is not complicated. If you were to stop doing what you are today, do you have enough cash to pay all your debts?  If you were no longer in business today, would you be able to meet all your debt obligations?  The formula is straightforward:

Assets – Liabilities = Surplus or Deficit

The expectation for Defined Benefit Pension Plans is their ability or inability to fulfill their commitment to pay the promised retirement benefit.  The most overlooked section on a pension statement is the section, Plan Funding, which addresses the financial health of a pension fund.

The Pitfalls Associated with Pension Plans

I read a recent pension statement that didn’t provide the specific details about its solvency ratio.  However, the statement clearly indicated that the plan’s assets would not have been sufficient to cover its liabilities if the plan had been wound up on the last valuation date.

This particular pension plan is a Public Defined Pension Plan. Any shortfall in these types of pension plans has the backing of the government and will be picked up by the taxpayers.  On the other hand, Private Defined Pension Plans do not have this kind of luxury.  If there is a deficiency in their pension plan, no one picks up the pieces to replenish the plan to fund 100% of the promised benefits.  When a business goes bankrupt, the assets are liquidated and are distributed firstly to secured creditors.    Unfortunately, retirees are like an unsecured creditor; they come at the end of the line.  Whatever amount of cash is held in the pension pool is theirs to be divvied up.

The deficiencies (shortfalls) in pension plans have analysts scrutinizing the demise of Sears Canada.  Because their case is recent and unexpected, many want to know what went wrong. The greatest discovery was the extravagant amount of money doled out to the shareholders rather than directed to the pension plan’s deficit. Where do the obligations reside?  Who has a greater entitlement to the company’s retained earnings:  the shareholders who made a sizable investment into the company or the employees who worked for the company to create the profits?

An insightful observation into the status of Defined Benefit Plans is outlined in the report, The Lions Share, Pension Deficient and shareholder payments among Canada’s largest companies. Cole Eisen, David Macdonald, and Chris Roberts identify the need for policy reform to protect the beneficiaries of defined benefit pension plans.   

Their research included this alarming observation:

The recent news that Sears Canada will shutter all remaining stores as a result of its insolvency leaves its DB pension plan with a $267 million funding shortfall on a wind-up basis.  Since 2010, Sears Canada paid back $1.5 billion to shareholders in dividends and share buybacks.  In other words, Sears Canada paid back five-and-a-half times more to its shareholders than it would have cost to entirely erase the deficit in its DB pension plan. As Sears proceeds to liquidate its entire Canadian operations, it will be Canadian retirees who are left to deal with that decision.  Regulators, policymakers, and Canadians will quite rightly ask whether this disaster could have been avoided.  

Equally alarming are comments made by Sears retiree, Ken Eady.   In the Money Sense’s article, What Sears retirees can do about the reduced DB pension, employees were aware of the events that were transpiring in the company.  

Mr. Eady shared, “They sold the assets, took the capital and did not make any meaningful investment in the business, including the pension plan. They let the company drift into a very bad spot and stripped it of many revenue-generating assets. If they had invested in the company, built a new online sales platform or other revenue-generating enterprises, Sears would still be operating and we wouldn’t be talking about this.”

My hearts goes out to these retirees or near-retirees. For many, the clock has run out on their working years.  These veteran employees trusted their employer. They trusted the pension regulators, The Office of the Superintendent of Financial Institutions (OSFI), to watch over their pension funds.  Who failed them?  Knowing there is a deficiency in the pension plan and providing too much leeway to make up the difference are the makings of a disaster. Someone made an incorrect assumption, claiming the company needed time to restructure and then they would rebound. 

I also questioned the role and responsibility of the actuaries.  They advise trustees and companies on the management of their pension schemes. Pension actuaries are on the scene to purposely check the financial health of the Defined Benefit Plan and ensure its viability to withstand the test of time to meet its obligations to plan members.  Their valuation is reported annually or triennially to the Office of the Superintendent of Financial Institutions (OSFI) who supervises federally regulated pension plans.   

With so many checks and balances in place, one would expect an alarm to be sounded during this rigorous process. But obviously, the rules around best practices haven’t been firmly established. The potential problem has been compounded with lower-than-ever-expected interest rates and the longevity of retired employees. The pension fund may have been depleting more rapidly than anticipated.

Looking After Your Retirement Income

The take-away from this unfortunate circumstance is that promises can be broken.  Things can and do go wrong with the financial operations of any business.  If the business has a pension plan, like Sears Canada and others did, there can be detrimental effects to people’s retirement income.  There is minimal comfort in knowing a benefit, even if it is 19% less than originally anticipated, will be forthcoming.  Any reduction will be a severe blow to a retiree living on a fixed income while inflation affects the cost of living expenses. 

If you are relying too heavily on your pension plan to provide income in your retirement, the simple answer is “Don’t”.  In CBC’s news article, Sears Case Shows the Risk of DBP for Employees, personal financial experts say there is a risk with this kind of dependency.  I couldn’t agree more. 

The outcome is your lack of control over your future.  You are allowing someone else to drive your destiny. When your pension statement appears, make the time to understand your pension plan and its projections. If necessary, speak to a CERTIFIED FINANCIAL PLANNER® professional to make sense of your retirement plans.  What you see on paper today might not be what you get in a pension benefit tomorrow. 

The Fork in the Pension Road

Most Canadians will encounter an all-too-familiar fork in the retirement planning road.  The big question is, “Do I start my Canada Pension Plan benefits at age 60 or wait until 65?”  The dilemma is that when you elect to receive benefits at 60 you face a reduction of 36% (0.6% for each month prior to age 65).  Once you do the math, this is 64% of the amount you would have received at 65 if you’d waited.  Again, the question for which everyone begs an answer, “Do I start early and receive less (or) do I wait and receive more?” To make matters more complicated, you are given a third choice.  If you wait beyond 65 to start the Canada Pension Plan, the retirement benefit increases by 0.7% each month.  At age 70, you would receive 42% more than at age 65.

The Canada Pension Plan provides all three values to help with your decision. For example, a typical retirement plan statement indicates:

If you were 65 today,

·         you could receive a monthly retirement pension of:  $917.17

If you apply at the age of 60,

·         You could receive a monthly retirement pension of: $587.00

If you apply at the age of 70,

·         You could receive a monthly retirement pension of $1,302.38

The best way to quantify these values into dollars and cents is using a side-by-side comparison. Just as pictures are known to “say a thousand words”, so do the numbers. Whether you elect to receive your benefits as early as 60 or later at age 65, eventually, the amounts will cross-over as shown below in Year 14.   Obviously, the longer you live, if you choose to wait “to get more”, you will “get more”.  However, the unknown “X” in the algebraic equation is how many years will you live?   Since there is “no sure” answer, you have to do what’s best for you.

Using the retirement benefits from the example, the calculations below show only the present values. Indexing Canada Pension Plan benefits or accounting for any earnings was not applied. If you would like more detail, financial planning software can create these values.

Year	Age	CPP Commence @ 60	Cumulative Total	CPP Commence@ 65	Cumulative Total	CPP Commence@ 70	Cumulative Total
1	60	7,044		0		0
2	61	7,044		0		0
3	62	7,044		0		0
4	63	7,044		0		0
5	64	7,044		0		0
6	65	7,044	42,264	11,006	11,006	0	0
7	66	7,044		11,006		0
8	67	7,044		11,006		0
9	68	7,044		11,006		0
10	69	7,044		11,006		0
11	70	7,044	77,484	11,006	66,036	15,629	15,629
12	71	7,044		11,006		15,629
13	72	7,044		11,006		15,629
14	73	7,044	98,616	11,006	99,054	15,629	62,515
15	74	7,044	105,660	11,006	110,060	15,629	78,143
16	75	7,044		11,006		15,629
17	76	7,044		11,006		15,629
18	77	7,044		11,006		15,629
19	78	7,044		11,006		15,629
20	79	7,044		11,006		15,629
21	80	7,044		11,006		15,629
22	81	7,044		11,006		15,629
23	82	7,044		11,006		15,629
24	83	7,044		11,006		15,629
25	84	7,044		11,006		15,629
26	85	7,044		11,006		15,629
27	86	7,044		11,006		15,629
28	87	7,044		11,006		15,629
29	88	7,044		11,006		15,629
30	89	7,044		11,006		15,629
31	90	7,044	218,364	11,006	286,157	15,629	328,200

Are You Confused?

When changes to Canada Pension Plan were being introduced, the Government of Canada devised the chart below outlining that choices depend on an individual’s wants and needs. Like I have always said, everyone’s retirement plan is unique to match their unique circumstances. Below are possible scenarios which can help in the decision process. {For your information CPP RTR refers to “Canada Pension Plan Retirement.”}

 

Choices depend on individual wants and needs – maximize retirement benefits?
Consider taking CPP RTR benefits early if	Consider taking CPP RTR benefits at normal retirement age if	Consider taking CPP RTR benefits later if
Sick and  can’t qualify for CPP disability	Average health	Healthy
Life expectancy is below average	Average life expectancy	Life expectancy is above average
Low income, no other sources of income	Medium income with some other sources of income	High or medium income, some other sources of income
Laid-off and unable to find another employment	Unable or unwilling to work beyond 65	Continue working with your average or above average earnings
Continuous employment history	Continue working with lower than your average earnings	Employment history with considerable gaps
No divorce and no credit split	Continuous employment history with some gaps	Divorced and lost some pension credits upon credit split

These options are presented for your consideration by the Government of Canada.   However, we also learn from the best of the best.  Experts like Daryl Diamond, who has the knowledge, experience and “who has seen it all” from working with clients, has his reasons why you may consider taking Canada Pension Plan benefits early. In his book, Your Retirement Income Blueprint, several pages are devoted to this topic. Some reasons are:

(1) The Canada Pension Plan does not have any significant estate value.  The death benefit is equal to six months’ worth of the monthly pension amount to the maximum of $2,500. This clearly indicates there is no advantage to starting later.  

(2) Your spouse will receive a survivor pension derived from a share of your Canada Pension Plan retirement benefit. However, the danger is when you both wait until age 65 to receive the higher CPP benefit, then the survivor’s entitlement may only be a portion which tops up to the maximum amount. A CPP recipient is allowed to receive a retirement and survivor benefit, but the sum of these two payments cannot exceed the maximum retirement benefit at age 65. In 2015 the maximum benefit amount is $1,065.00.

Hide the Money

If you continue working and are concerned about being taxed on the Canada Pension Plan benefits, the easiest solution is to hide these benefits inside an RRSP, providing you have available contribution room. The only way to know your RRSP deduction limit is to check your Notice of Assessment.  If you have maximized RRSP contributions, then hide CPP benefits inside a TFSA to shelter the earnings from taxation. If you tell me that you have maximized contributions to both, an RRSP and a TFSA, then “Congratulations!”  Since you do not have any place to hide your CPP benefits, then you may choose to wait especially when the CPP benefit pushes income into the next tax bracket.    

Canada Pension Plan Perks

The greatest advantage for CPP recipients is the removal of the years when the contributions to the Canada Pension Plan may have been low or contributions were not made. By removing these values from the calculations, the overall retirement benefit is bolstered in favor of providing a higher income.   With the General Drop-out Provision, up to eight years of your lowest earnings will automatically be dropped from the calculations.  With the Child-Rearing Provision, an eligible parent is allowed to have additional years excluded when they stopped working or received lower earnings to raise your children.  Both of these perks ensure the highest possible payment is granted.  

Don’t be Fooled

Although the General Drop-out Provision may certainly be a benefit to increase your retirement benefit, you need to be aware of how this process may work against you. Let’s assume you stop working at 60 with the intention of waiting until 65 to start drawing Canada Pension Plan.  You believe you should be rewarded for waiting; however, you might be surprised to learn the retirement benefit is not as significant as you thought.  When a person does not work between 60 and 65, these additional 5 or 6 years are automatically included in the General Drop-out Provision for the purpose of disqualifying the years when earnings were low or zero.  Guess what? These years between 60 and 65 match the criteria.  To receive specific details of monthly retirement benefits, contact the Canada Pension Plan office for projections and explain your intentions.

Your Turn

When your turn comes and you are faced with the fork in the road that millions of others faced before you, you will need to decide which path is appropriate for you.    When you pull all the above information together, you may draw your own conclusion with help from a Certified Financial Planner.  Weighing your options carefully is the only way you can make an informed decision.  Once you choose to start your retirement benefits at age 60, the decision is irreversible and the benefits remains the same for your lifetime. Certainly the disadvantage of receiving retirement benefits early is if you became disabled between the ages of 60 and 65.  The Canada Pension Plan Disability Benefit is higher than a retirement benefit.  You will not have an option to switch.  Regardless which path, you take, be sure it’s right for you.