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Everyday Finance – What Pension Option is Right for You?

July 16, 2015

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To read Everyday Finance part one When should You Take CPP? click here

We all know people who work for the government. They may be teachers, police, nurses, or provide services to the public for municipal, provincial or federal agencies. While being a public servant generally provides an average salary given their skill set, they are usually eligible for a pretty good pension.


A client of ours is retiring this fall and was provided with a document that outlined ten choices as to how they might receive their pension benefits. The choices were varied, and the whole selection process appeared daunting. However, by using everyday finance, we can help take these options and put them in a context that is much easier to understand. In our example below, the retiree is 55 years old.

The first and more important part of the analysis is for us to select a discount rate. That is, the rate that recognizes that money today is worth more than money in the future due to risk and inflation. As most pensions are government-based we believe there is little risk in not getting the money, so most of the rate relates to inflation. Based on this, we believe the Government of Canada’s twenty-year bond rate of 2.337% is a reasonable discount rate.

In our example the retiree was given the following choices:

Chart 1

It is important to note that the above pension offering represents an integrated pension plan, where payments are front loaded (a bridge), and then drop after the age of 65, when individuals become Canadian Pension Plan (“CPP”) eligible. This CPP integration is common for most public or private sector pension plans as it helps to smooth the combined pension and CPP pension received by the pensioner.

By applying the 2.337% discount rate to future cash flow, we can convert the value of that cash flow into a current value. For example, say we selected the first option of a single life pension guaranteed for five years. If you were guaranteed to live to 85, you would be indifferent to accepting $462,536 now rather than receiving the scheduled pension payments.

Let’s look at selected amounts for our 55-year-old retiree:

Chart 2

It should be no surprise that as you get older the most limited of the pension options yields the highest net present value. However, there are a couple of other things to be aware of. First, the pension is a lot like insurance where the ‘pool’ of pensioners shares the risks and rewards of those dying early and those who live a long life. Therefore, if you reduce the risk to the pension in terms of payout, then your immediate payment will be higher. Second, and probably the most important, is the fact that there really is not a significant difference between the various options.

Our recommendation would be to consider your health and the financial needs of your spouse when selecting your pension option.

If you are interested in getting a copy of our pension option spreadsheet please contact us.

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