For someone facing the choice of receiving a fixed monthly
pension income from a company or in the form of an annuity from an insurance
company, versus receiving a commuted value and having to invest the amount
oneself does present a dilemma.
Let’s look at the details using some very realistic numbers
assuming one is indifferent between monthly pension income or annuity.
|
Monthly Pension or Annuity (Option 1)
|
Commuted Value (Lump Sum) (Option 2)
|
Amount per month
|
$600 fixed, guaranteed for 5 years
|
$130,000. Invest conservatively in fixed income to yield 4% or $433
per month
|
Principal remaining at end of life
|
$0
|
$130,000
|
Monthly amount
|
About $167 more than option 2
|
-
|
Risk
|
Guaranteed by insurance company for 5 years, or in the case of
private company pension, guaranteed by PBGC
|
Default risk if company goes bankrupt. Can opt to invest in
Government of Canada bond, but yield 1% less . Also face reinvestment risk if
rates are lower. However, rates are at historic lows and can only go up.
|
Ancillary benefits
|
Some companies may tie in health benefits with monthly pension
|
May forgo health benefits if opt for CV
|
Dependents/(or surviving spouse)
|
Monthly benefits may be reduced (assuming company pension and opting
for Joint and Survivorship).
If opting for annuity, once guaranteed period ends, $0 for dependents
or surviving spouse)
|
Dependents or surviving spouse can inherit the principal balance if
included in will
|
Taxes
|
Taxable income; annuity may have some tax advantage
|
Taxable income or capital gains at a lower rate
|
Life expectancy
|
Based on mortality tables, would be advantageous to receive monthly
amounts if expected to live a long life (above 80 years of age)
|
Not applicable
|
So what is the conclusion? It all depends on the person’s
situation. If I were a betting person, have a spouse or dependent, and can
tolerate some risk, and assuming that we are in a historically low interest
rate environment, I would choose Option 2. I would choose to accept a lower income now,
wait for rates to go higher (or at least above the $600 per month in Option 1),
and then invest the whole amount and obtain more than $600 per month in later
years. When I pass on (hopefully many years later), my surviving spouse or
children can still inherit the principal amount of $130,000.
If one is in need of income and also cannot tolerate any
risk, then choose option 1. Mind you, in
addition to this pension ,there are also other government benefits such as CPP
(current maximum per month -= $1,114.17 at January 1, 2017) and also OAS (current
maximum per month -= $578.53 at January 1, 2017)
There are other options that I can think of, but for now, I
do think that this opportunity warrants further discussion with your financial
advisor before making a decision. Because rates are at historically low, and we
are starting to see the U.S. Federal Reserve Bank beginning to hike interest
rates, CV or lump sum payouts may never be this high again and one can reinvest
the CV or lump sum to one’s advantage.