Many investors pay into or have access to one or more pensions—for example, a workplace pension, a personal pension or a government pension. If you plan to use income from pensions to fund your retirement, it is important to be aware of how your payments are being invested. You should also understand the tax position, whether you have any control in the selection of investments and how the different pension schemes will provide income during your retirement.
The earlier you begin retirement planning how you will fund your retirement, the better. When evaluating your pension income, you should carefully consider if it will be able to cover the full cost of your retirement or if you may need to generate cash flow from other sources. Failing to plan ahead for additional cash flow sources that you may need could increase the chance of a funding shortfall during your retirement.
There are several types of pensions and pension providers available to investors in Canada. Below are some details on the pensions and retirement accounts that we come across the most, as well as some considerations to keep in mind when evaluating how your pensions fit into your financial plan.
Old Age Security (OAS) [i]: Is a basic pension plan that is available for eligible seniors in Canada who meet the appropriate legal status and residence requirements. In order to qualify, you must be over the age of 65 and have lived in Canada for at least 40 years after the age of 18. Those who do not meet the requirements are eligible for a partial pension as long as they have lived in Canada at least 10 years past the age of 18. Those who rely solely on their OAS pension for income are eligible for additional assistance through the Guaranteed Income Supplement. Individuals who decide to retire later have the opportunity to delay their OAS pension for up to five years after the age of 65. Those who elect to do this can see their value increase by 0.6% for each month they choose to delay payments.
Canada Pension Plan (CPP) [i]: Is an earnings-related pension scheme based on average lifetime salary. Most who qualify for the CPP elect to start distributions at the age of 65, however they have the ability to take reduced distributions at 60 or increased distributions up to 70. In addition to the age requirements, full benefits require around 39 years of contributions in working years. The CPP targets a replacement rate of 25% of earnings up to the Yearly Maximum Pensionable Earnings, which is based on the average lifetime salary. To balance out early working years, pay is re-valued in line with economy-wide earnings. The Quebec Pension Plan (QPP) has many similarities to the CPP but is exclusive to those who work or have worked in Quebec.
Occupational Pension Plans [i]: These are plans offered through an employer to enable investors to save for retirement beyond the government provided plans. These plans are defined benefit schemes (employer contributes), defined contribution schemes (employee contributes) or a mix of both.
Registered Retirement Savings Plans (RRSP) [i]: These are government-assisted retirement savings plans offered by banks and insurance companies. Contributions, interest and capital gains are all tax exempt until withdrawn. Investors have the ability to contribute 18% of their annual earned income. Employees still working have the opportunity to make contributions until the age of 71. Once an employee reaches the age of 71, funds convert into an annuity where they are disbursed yearly according to the minimal withdrawal schedule. The funds within an RRSP can be withdrawn penalty free prior to 71, but will be subject to pay taxes based on the amount withdrawn. The Home Buyers Plan and the Lifelong Learning Plan allows investors who are using the funds to purchase their first home or to fund their own education to take withdrawals tax-free. Once the funds have been withdrawn, they have to repay the funds within 15 years. Otherwise, it will be considered taxable income.
Registered Retirement Income Fund (RRIF) [ii]: These accounts are typically funded by a RRSP holder rolling over their assets into RRIF. RRIFs are most often utilized to provide a constant income stream to the account holder. The account is held by a financial institution where they can advise on the type of investments within the account. The year after the account is established, the pensioner is required to take an annual minimum distribution. The plan holder will establish the minimum to be withdrawn based on the pensioner or their spouse’s age.
Locked-In Retirement Account (LIRA)[iii]: As the name suggests, the funds within a LIRA are locked in until the time of retirement. These accounts are most commonly used to hold the pension funds for a former plan member, spouse or a surviving partner until the age of 71. Most often LIRA investors choose to transfer the funds into a life annuity, a Life Income Fund or a Locked-in Retirement Income Fund—all of which provide a set income stream for life.
Regardless of which pensions you may have, you should be aware if there is tax relief available. Personal pension contributions may qualify for automatic tax relief, but check the specifics of your available pension plans and taxes to see how this affects you. In most cases, you may also be able take a portion of your pension savings as a lump sum tax-free.[iv]
When evaluating what income you can expect in retirement, you will need to find out how much you can expect to receive from each of your pensions. If you are selecting investments in a pension, you will also need to decide what asset allocation is appropriate for your goals and circumstances.
When reviewing your asset allocation it is important that you understand your investment time horizon—how long you need your money to last. Investment time horizon is not necessarily the same as estimating how long you will live. It may include the life expectancy of your spouse, children or other dependents. Your asset allocation decision should also take into account your cash flow and investment growth needs. You will also have to consider how inflation might affect your purchasing power over time. If you make the mistake of underestimating the effects of inflation or your potential investment time horizon, your income could potentially fall short of your retirement needs.
And, of course, don’t neglect to account for your attitude towards risk. If you aren’t comfortable with market volatility, you may prefer to invest in less-volatile asset classes. However, understand the risk-return trade off when making this decision. In limiting exposure to market volatility, you will likely be limiting your potential long-term returns, which may mean making some sacrifices to your cash flow needs and long-term goals. You may benefit from having a conversation with a financial professional to help you weigh these important decisions and find the right approach for you.
If you have control over your pension investments, you may want guidance or assistance on selecting the right asset mix for your needs. Fisher Investments Canada may be able to help you review and evaluate your current pensions and investments.
[i] Organisation for Economic Co-operation and Development (OECD), as of 11/30/2018. Pensions at a Glance 2017: Country Profiles – Canada. https://www.oecd.org/els/public-pensions/PAG2017-country-profile-Canada.pdf
[ii] Canada Revenue Agency (CRA), as of 12/11/2018. Savings and Pension Plans. https://www.canada.ca/en/services/taxes/savings-and-pension-plans.html
[iii] Canada Revenue Agency (CRA), as of 12/11/2018. RRSPs and Other Plans for Retirement. https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/t4040/rrsps-other-registered-plans-retirement.html
[iv] The contents of this document should not be construed as tax advice. Please contact your tax professional.