Life expectancy of men and women in Canada after 65 continues to increase. The average age we’re expected to live to in Canada is 82 years old (as of 2019 data). If you’re 10 or more years away from retirement, that number may go up by the time you retire.
So what does this mean for your pension? Let’s take a look.
The most popular type of pension in Canada is a defined benefit pension. This is where your employer (or former employer) has calculated how much your monthly pension payments will be based on factors like your age, years of service and your salary history (among other things).
One of the key assumptions that’s used to calculate your monthly pension payments is your life expectancy. The longer you’re expected to live, the more money in the plan since the pension plan has to last longer. That means that the plan has to be richer. That points to increases in contributions by you and your company. That’s why commuted values are higher for younger employees [and higher for women].
So, as life expectancy increases, your monthly contributions must rise. Ex. if your pension promises you a monthly income of $4,000 AND your life expectancy is 30 years, then the pension must set aside an amount of money. BUT, if your life expectancy is 35 years, clearly the pension must set aside a greater amount of money. Therefore, payments into the pension are higher.
This assumes, of course, that everything else stays the same. If there are other changes to the pension plan (e.g., the interest rate used to calculate benefits goes down), then that could offset any change in monthly payments due to changes in life expectancy. Clear as mud? Don’t worry. It’s complicated for everyone.
If you’re close to retirement, it’s a good idea to keep an eye on your commuted value so you can adjust your financial plans accordingly. Remember the teeter-tooter: rates up = commuted value down.
Should You Still Consider Taking The Commuted Value Of Your Defined-Benefit Pension If You Have High Life Expectancy?
You may have the choice to take the commuted value cash option when you retire. Commuted values are paid out as a lump sum and are adjusted for changes in life expectancy, infrequently. This means that if you have a long life expectancy, you need to calculate the rate of return [on your commuted value] necessary to generate pension income for life. Our illustrations look to age 95.
Click here to read our article about taking the commuted value of your pension.
The commuted value is calculated using a number of assumptions about factors like interest rates and mortality rates. As these assumptions change, the commuted value could be lower or higher than expected. In the past 2 years, we have seen commuted values drop dramatically.
Risks of Defined-Benefit Pensions
One of the most serious risks with a defined-benefit plan run by your employer is that the returns on the investment might rise or fall, and it’s up to your employer to make sure that the pension fund is able to cover your defined-benefit pension amount when you retire.
This is a very important! You have a choice whether to leave your pension with your past employer, or take it elsewhere. Yes, you can take your pension elsewhere such as an insurance company (Canada Life, Sun Life, Desjardins) via the copycat annuity.
Is your company in a stable industry? Is your company financially strong? Do you foresee your company potentially going bankrupt in the next 10, 20, or 30+ years? or leaving Canada?
Example: Sears Canada’s Pension Fund was short $133 million, according to court documents, and 18,000 retirees had their pensions cut by 20 per cent after the retailer folded and left behind an underfunded pension plan. This resulted in a lawsuit.
You can minimize this risk by moving your defined-benefit pension plan to a secure financial institution via a copycat annuity. We can explain this option with you so you know what choices you have upon retirement. Book a call with us to discuss this option.
In the video below, we explain the differences between copycat annuity and taking the commuted value.
Does Life Expectancy Affect Pension Liabilities?
While changes in life expectancy can affect pension liabilities, life expectancy is already factored into pension calculations.
For example, defined-benefit plans provide employees guaranteed income for life when they retire, so factors such as life expectancy don’t play a role because you are guaranteed a fixed amount until you die – no matter what age you live to.
Difference With A Defined-Contribution Pension
In a defined-contribution plan, the employer has no obligation to provide the employee with an income upon retirement. The employee is responsible for making their own investment decisions and ensuring that there will be enough money saved up to cover their costs in retirement.
With a defined-contribution plan, your monthly payments are not affected by changes in life expectancy because you will only receive what you have contributed into the account, plus any interest or investment gains.
Click here to read our article comparing the two types of pension plans.
Book A Call With Us
Pensions can be complex, with outdated tax legislation and rules put in place to make it difficult. We’re here to help! With over 20 years experience, we’re here to help you navigate the pension process each step of the way. We provide you with a variety of options, including taking your money out to create your own investment for retirement. Click here to schedule a virtual zoom call.