6 Costly Pension Mistakes and How to Avoid Them
Written by Sean Cooper
If you have a pension plan at work consider yourself fortunate. Only about a third of Canadians have a workplace pension plan today – a far cry from a couple decades ago. Workers face a number of retirement challenges today. The low interest rate environment coupled with longer life expectancy means we need to sock away even more money for our golden years or face a drop in the standard of life we’ve become accustomed to.
If you have a decent pension plan, there are still mistakes you can make along the way. Having worked as a pension analyst for five years, I’ve seen my fair share of costly pension mistakes. Here are three costly pension mistakes that can cost you dearly and how to avoid them.
Not Returning Your Paperwork on Time
When you decide to retire or your employment comes to an end, you should receive a pension benefits statement in the mail shortly. If you’re eligible for an early retirement, the package will include forms of pension to choose from, such as life only, guaranteed periods and joint and survivor options. If you’re too young to retire (and not considered a small benefit), you’ll be able to defer your pension (start it at a later date) or transfer your commuted value.
Mistake #1: 90 Day Deadline: Deferred Pension
While you should take the time to carefully review your package for any errors and carefully consider your options, it’s important to watch the deadline on your package. You’ll usually only have 90 days to return your completed paperwork. If you fail to return your paperwork your pension could be deferred until retirement.
For a 30-something-year-old this can be a costly mistake. If you’re not going to retire for another 30 years or longer, your pension will have lost a lot of its purchasing power by then. Remember the rules of 72 – if inflation only goes up by a modest average of 2 per cent per year, prices will double in 36 years, while your pension will be frozen. $1,000 per month may seem decent today, but when you go to retire it may not be a lot. Most private sector pension plans don’t offer indexing in retirement.
Mistake #2: 6 Month Deadline: Recalculation
Although some pension plans still allow you to transfer the commuted value after 90 days, there’s another important deadline you should be aware of. If you fail to return your paperwork in 6 months (90 days in Quebec), your commuted value will be recalculated. Depending on current interest rates, your commuted value could go up or down .
The commuted value represents a lump sum payment you’ll be able to invest to end up with an equivalent pension at your normal retirement date (NRD). The commuted value and interest rates have an inverse relationship. When interest rates go down your commuted value will increase (you’ll need to invest more money to end up with an equivalent pension at NRD), but if interest rates go up your commuted value will decrease (you’ll need to invest less money to end up with an equivalent pension at NRD).
If interest rates go up by a lot by the time you return you paperwork, you could see your commuted value drop by hundreds or thousands of dollars. If you had simply completed it on time, you would have received your full commuted value with interest. If you’re transferring your commuted value to a financial institution, it’s important to follow up to ensure the paperwork is completed. You should phone the pension administrator to make sure your completed paperwork has been received and is being processed. It is your responsibility to make sure your financial institution returns your paperwork on time.
Mistake #3: Quitting Before You’re Fully Vested
Before you decide to leave your employer, it’s important to know the date you’ll be fully vested. What’s vesting? It’s the date you’re entitled to the full value of your accrued pension when you leave the pension plan. Leaving prior to reaching your vesting data can result in leaving hundreds or thousands of dollars on the table. Instead of receiving the commuted value, you’ll only be entitled to your contributions with interest. If it’s a non-contributory plan you won’t receive anything.
How do you find out your vesting date? Your vesting date can be found on your annual statement of pension benefits. Your vesting date depends on your work province, as well as how generous your pension plan is. In most provinces the legislated minimum is two years before you became vested. That’s slowing changing as the provinces look to modernize. Provinces like Ontario and recently Alberta provide for immediate vesting. That means as soon as you join your company’s pension plan you’re vested.
To get around the new vesting rules, some employers may look to extend the eligibility for joining the plan. Instead of being able to join immediately, you may have to wait two years to be enrolled. If you’re a new employee, it’s important to ask if you’ll be enrolled in the pension plan right away. If you’re unsure, be sure to ask human resources or your pension administrator.
3 More Costly Pension Mistakes and How to Avoid Them
Written by Sean Cooper •
Last month we looked at three costly pension mistakes to avoid. Common pension mistakes include not returning your paperwork on time and quitting before you’re vested. This month we look at three more pension mistakes that can cost you dearly. Although it may not seem like a big deal, simple things like not updating your spouse and beneficiary and not joining your pension plan right away can come back to haunt you. Here are three more costly pension mistakes and how to avoid them.
Mistake #4: Not Updating Your Spouse and Beneficiary
It’s important to keep your spouse and beneficiary on file up to date. If you pass away in retirement and elected a pension with a guarantee period (i.e. 5, 10 or 15 year guarantee), you’ll want to make sure the remainder of the guarantee payments goes to the person you want. Just because you chose your daughter to be your beneficiary when you retired, doesn’t you won’t want to change it. What if you get remarried and decide to make your new spouse your beneficiary? Unless you complete a new beneficiary form, your beneficiary will stay the same. That means your daughter will still be entitled to your pension death benefit when you pass away, leaving your new spouse with nothing.
Things get even more complicated if you pass away before retirement. The pension death benefits for a pre-retirement death (or active death) depend on your pension plan and province of employment. Your spouse is usually entitled to the death benefit even if you beneficiaries on file. Even if you have a spouse, it’s still a good idea to name beneficiaries; if your spouse and you were to pass away at the same time (for example in a car crash), your beneficiaries would receive the death benefit instead of your estate. Again, it’s a good idea to complete a new beneficiary form.
Mistake #5: Not Joining Your Company’s Pension Plan Right Away
While a lot of employers enroll their employees in the pension plan right away, some employers leave it up to their employees to enroll. If you have a defined contribution plan, sometimes your employer will only deduct the minimum contributions off your pay cheque (for example, 2 per cent instead of the maximum 5 percent of your earnings).
As soon as you’re eligible to join your company’s pension plan, you should walk, no run, to your company’s human resources department to sign up. By not joining right away, you’re leaving free money on the table. You may prefer to invest your own money in your RRSP, but if you’re one of the lucky few with a non-contributory gold-plated defined benefit pension plan, there’s no good reason not to join.
Mistake #6: Not Starting Your Pension When You’re Entitled to An Unreduced Pension
If you choose to defer your pension (leave it in the pension plan) instead of transferring it to your RRSP, it’s important to make sure you keep your address up to date with your former employer. When you’re approaching your normal retirement date, your former employer will usually try to contact you, but only if they have your most recent address on file.
If you’re approaching age 65, it doesn’t hurt to take the initiative and contact your former employer about starting your pension. You’ll want to make sure you start your pension on time; although you may still be able to collect your pension retroactively to age 65 if you commence it later on, in most cases you won’t receive interest.