Guaranteed monthly payments for as long as you live, or a lump sum today? If you have a defined benefit pension plan, that question may be on your mind as you consider whether to leave the pension in place, or remove your funds from the plan and go it alone.
Over the past decade, with life expectancy gaining ground each year, the value of a defined benefit pension plan has increased. At the same time, though, increased life expectancy and low interest rates have also contributed to a decline in the overall "health" of defined benefit plans.
For example, in recent years the Canadian media has reported on the underfunded status of defined benefit plans for large employers, such as Canada Post Corp., and, in the direst cases, the uncertain status of pension payments for a plan where the employer has gone bankrupt, such as Nortel Networks Corp.
Taken together, employees with defined benefit pension plans may be weighing the benefit of a large lump sum available today versus a stream of payments that may have some risk of falling short of the pledged amount.
Understanding pension values
If you're thinking about retirement and contemplating whether to take or exit your defined benefit pension plan, you can ask your pension administrator for your options at retirement, which may include the option to take the funds out as a single lump sum amount.
That amount is called the "commuted value," and it represents the amount today required to fulfill the pension's future monthly payment obligations to you. Its value is based on assumptions such as how long you might live, whether you're male or female, whether you're retiring early or at the normal retirement age set out in your plan, what long-term interest rates and inflation rates might look like, and specific features of your pension plan, including whether it would pay a survivor pension to a spouse if you predecease them.
In order to take your funds out of the plan, generally you have to either retire or terminate your employment. However, even in these circumstances, a lump sum commuted value is not always available.
In theory, because the commuted value of your plan (if you leave) is equal to the expected value you'd receive if you stay, you should have no financial preference between the two options. However, the choice is rarely that simple. What are the issues you should consider if this is a decision you're facing? We checked with a few pension specialists to ask their opinion about how to deal with the "leave or stay" decision.