Can you retire early?

Early retirement has become a symbol of baby-boomer liberation with employer pension plans playing a pivotal role in this anticipated freedom. Many people, however, are lulled into complacency by the words ‘company pension.’ “People often take employer pensions for granted,” says Jeanie Quirt Brown, a financial planner with Money Concepts in Kingston, Ont. “They don’t really know how their pension works. They get close to retirement before learning that there won’t be as much money as they thought.”

Employer pensions form the backbone of Canadians’ retirement plans. According to Statistics Canada, the total estimated value of private pensions, which includes RRSPs, RRIFs and earnings through employer pension plans, annuities and deferred profit-sharing, is a little more than $1 trillion. Some $604 billion of that total is in employer pensions, invested on behalf of nearly 47 per cent of Canadian families.

Plans vary considerably
Pension plans are as varied as the employers who offer them and having one doesn’t guarantee security for life. Benefits Canada reports that the country’s pension funds lost money last year for the first time in nearly quarter of a century. While company pensions will have the resources to honour their commitment to fund retirees from age 65, the market correction may have put a strain on the money available to underwrite early retirement.

It’s best if, long before you plan to retire, you get familiar with what your company is offering to see how it dovetails with the rest of your retirement picture — savings (sheltered and non-sheltered), government pensions and assets. This will help you plan how comfortably — and how soon — you can retire. For some people, maybe freedom is still in sight at 55.^

What’s in it for you?
Defined benefit packages specify in advance what your pension will pay, typically a percentage of your income at a certain age or after a set number of years of employment. Defined benefit funds are the wealthiest funds in the country, which comes as no surprise since they’re guaranteeing the payout to their retired employees.

While these plans offer guarantees to employees in retirement, their critics fault that the money-making potential of individual plan members is sacrificed for the benefit of the group—defined benefit plans must adhere to strict investment guidelines—which pension regulators hope will help ensure plan sponsors fulfill their obligations to all members.

Next page: Collecting your benefits

A larger number of Canadian companies, however, provide a defined contribution plan. These funds are built on contributions from both the employer and the employees which are locked in until retirement, but there is no guarantee about end-of-the-line benefits. The employee bears the risk of the fund’s performance but can also reap its benefits during boom years. Even though the employee carries the “risk” of the fund, he is often limited to choosing from a set of investment vehicles offered through the employer. One advantage to this type of plan is that you can transfer your plan from one employer to another or roll your money into a locked-in retirement account (LIRA) or registered retirement plan (RRP) in the event you leave your job early.

Some companies also offer company or group RRSPs, which are a loose pension program designed to encourage employees to save. In these cases, employers may match the employee contribution, but selection and management of funds is at the employee’s discretion during their working years and after they leave the company. While the money is in a group RRSP, an individual employee has the right to withdraw the money at any time—subject to the same rules that apply to a regular RRSP.^

Collecting your benefits
In a defined benefit package, employees who fulfill their obligations to retirement age typically receive unreduced pensions. Whatever the specifics of the package, most pensions are based on a variation of the formula set by the Income Tax Act — two per cent multipled by the number of years of service multiplied by the average of your best five years of earning. Sticking it out to end of your job is the key, as companies often take advantage of an early departure to pay an astonishingly small lump sum.

Public sector and large corporations, however, often make early retirement packages available so that employees of long standing can take a full pension at a younger age. The Ontario Teachers’ Pension Plan is a good example. The teachers’ plan uses an “85 age factor,” which means you can retire before 65 if your years of service plus your age equal 85. Many baby boomers who started teaching in their 20s have easily reached the 85 factor in their 50s.

In many cases, early departure from a job is also available if you are willing to accept a reduced pension. The teachers’ plan, for example, deducts 2.5 per cent of the formula value of your pension for each point you are away from the 85 factor or five per cent for each point you are away from 65, whichever is less. So retire at 60 with only 20 years of service and you are going to lose a minimum of about 12.5 per cent of your pension.

Next page: Managing your pension on your own

Managing your pension
In almost all pension scenarios, you have the option of keeping the pension in the company plan or taking its “commuted value” and putting it in the hands of your financial adviser. There are pros and cons to each option.

Staying in

Pros

• Guarantees your income.
• Indexed for inflation. 
• Provides a reduced survivor benefit when you die.

Cons

• You don’t have control over the pension or access to its full value.

Opting out

Pros

• You control where and how your pension is invested, including purchasing an annuity, which pays you a guaranteed income.
• Your survivor or estate will receive the full capital value when you die.

Cons

• Unpredictability of market activity and pressure on you to generate good results.
• May be subject to taxation.
• Time lag in transferring the pension into your hands.^