In Canada, we are fortunate to have some of the strongest financial institutions in the world and our financial system is extremely stable. Unfortunately, the same cannot be said of many medium to large companies that operate here. There are many reasons that might cause you to be worried about your defined benefit pension.
We have witnessed a parade of companies with defined benefit registered pension plans (DB RPPs) run into trouble with horrific consequences for some of the plan-holders.
Economic and political shocks to many Canadian industrial sectors such as Automotive, Energy, Agriculture, Trade & Logistics, Media & Advertising, along with the Retail apocalypse, have led to disruption, weak corporate earnings performance and compromised viability.
Worried about your pension?
It is legitimate to be nervous about whether your DB Plan sponsor will be solvent, or even still exist in 25-30 years. Will they be able to fulfill your pension promise? Causes for concern:
- Most DB RPPs are significantly underfunded. Some dangerously so.
- New leadership, management groups and/or strategic direction may not inspire confidence.
- US or multinational companies may orphan your Canadian corporate subsidiary, leaving the company vulnerable.
- Very large unfunded pension liabilities weigh heavily on corporate balance sheets and the low to negative interest rate environment appears to make some already aggressive return requirements unrealistic. As a result, many DB plans may face insolvency.
If you are a plan-holder, you have paid your dues in blood, sweat & tears. You don’t want to have to worry about your pension promise, or feel the need to continually monitor funding status, returns, company earnings, issues and solvency. So, what are your options?
Take Control of your Pension
It may be possible for you to commute your pension, which would leave you with a few alternative avenues:
- Maintain your plan – let sleeping dogs lie;
- Transfer – Directly transfer the commuted value (CV) to another DB plan or Individual Pension Plan which may be in place;
- Cash Buyout – If your pension is in a wind-up situation, you might receive a cash buy-out offer which, if taken, would come with a massive punitive tax hit;
- Registered Transfer – You could transfer your CV to a locked-in RRSP or RRIF, which would also require that you pay a monstrous amount of tax, thereby reducing the capital you would be counting on to generate income for your retirement; or finally
- Copycat Annuity – If permitted by your plan, you may be able to transfer your CV to a life annuity with a major insurance company, to create a copycat annuity, which would not be subject to a tax penalty.
Copycat Annuity Advantages
A copycat annuity is a very attractive option, allowing DB plan holders to avoid a staggering tax liability. This option works since all of the benefits & attributes of your original plan are replicated or copied with the copycat annuity, so the plan will remain registered, without penalty. After implementation, the same taxation applies to your retirement income stream.
The copycat annuity has a number of further advantages, beyond taxation, when compared to a buyout or transfer to locked-in RSP or RRIF:
- Longevity risk – copycat annuity income is guaranteed for life so you eliminate your risk of outliving your pension;
- Fire & forget – no need to actively manage the assets, and no market risk;
- Stability & peace of mind – your plan resides at a stable, well-capitalized financial institution;
- Protection – your copycat annuity is protected against failure under Assuris;
- Income splitting – you may be eligible for pension income splitting;
- Other rights – other plan rights can be replicated, such as the right to a survivor pension or a guarantee of payments over a specified period; and
- Legacy – a separate insurance policy can be added to pass wealth to your survivors.
Opportune Time to Commute
Because of the very low interest rates, the calculated commuted values of DB RPPs are very high, compared to in the past, making it an opportune time to commute your pension.
The first step needed to implement this strategy is to undergo a thorough analysis to determine;
- Whether a commuted value is available
- What options that are available to you;
- How much can be transferred; and
- How much tax must be paid.
Future Proof your DB Pension
So, if you feel you are at the mercy of your plan sponsor, or are concerned about the status of your DB plan, an attractive strategy might be to commute your pension to a major financial institution using a copycat annuity.
E. & O. E.