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Last revised: February 2005
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OPSEU
Pension Plan members who leave their jobs before retirement often have an
important decision to make. Once they receive their Termination Statement
from
OPTrust, many members will have to choose between one of two options:
- leaving their pension credit in the Plan and receiving a deferred
pension from OPTrust, or
- transferring the “commuted value” (CV) of their deferred pension into
a registered, “locked-in” investment, such as a registered retirement
savings plan (RRSP).
These options are available if you are terminating from the Plan and:
- have two or more years of pension credit or continuous membership in
the Plan (you are “vested”)
- are younger than age 55
- do not qualify for an early unreduced pension (under Factor 90 or
60/20), and
- are not leaving the Plan as part of a divestment.
The “commuted value decision” is not a simple one. There are a number
of important factors that you should consider if you are deciding whether to
withdraw the value of your pension or stay with the OPSEU Pension Plan. In
fact, we suggest that you talk to an independent financial advisor before
making your decision.
Your Options
If you leave your OPTrust employer, are vested and under age 55 and are not
eligible for an immediate pension, you will have two options:
Option #1:
A deferred OPTrust pension
If you decide to take a deferred OPTrust pension, you will receive a
lifetime retirement income. Your pension will be based on:
- your average annual salary (typically the average of your highest
consecutive five years of annual salary rates) and
- your years of credit in the Plan.
Your deferred OPTrust pension includes the following features:
Early retirement benefits: Your deferred pension is payable at the
Plan’s normal retirement age of 65. You also have the option to collect a
reduced lifetime pension as early as age 55 under the Plan’s early
retirement provision. At age 65, your OPTrust pension is reduced for
integration with the Canada Pension Plan (CPP).
Inflation Protection: Your deferred pension is protected against
inflation. Before you start to receive your pension, it will be adjusted for
inflation over the deferred period. The annual pension escalation for
inflation is based on increases in the Consumer Price Index (CPI), to a
maximum of 8% per year. Any increase of more than 8% in the CPI will be
rolled over to future years when inflation is below 8%. Once you start to
receive your pension, your payments will continue to increase annually with
the cost of living (subject to the 8% annual maximum) for the rest of your
lifetime.
Survivor Benefits: Your deferred pension includes survivor benefits.
Once you start your pension, should you die before your eligible spouse, he
or she will receive a survivor pension equal to 60% of your pension, indexed
to inflation, for the rest of his or her life. The pension amount will be
integrated for CPP the month following your 65th birthday, even if you die at
a younger age.
Death benefits are also payable if you die before you start your pension, so
the value of your pension entitlement under the Plan is not forgone if you
die before retirement.
Depending on your years of credit in the Plan, your OPTrust pension may
qualify you for post-retirement health, dental and life insurance benefits
provided by your former employer (see below).
Option #2:
Transferring the commuted value of your pension
Alternatively, you have the option of transferring the commuted value (CV)
of your pension entitlement to a locked-in RRSP or similar registered
investment. The amount you can transfer out of the Plan will be listed on
your Termination Statement. The commuted value of your pension is the
lump sum present value of the stream of payments you and your surviving
spouse, if applicable, are expected to receive following retirement, based
on expected interest, inflation and mortality rates. The CV reflects the
value of your early retirement and inflation benefits at the time you
terminate from the Plan.
This option of a CV transfer may be attractive to members who want greater
control over their retirement savings, and who believe that they can realize
a higher retirement income by managing their investments themselves. If you
choose to move the commuted value of your pension to your own RRSP, your
retirement income will be based on the market performance of the investments
you choose.
Sometime between the ages of 55 and 69, you will have to choose one of
several options for converting your locked-in RRSP into retirement income.
These include:
- purchasing an annuity
- transferring your money to a Life Income Fund (LIF) and drawing
regular income from that fund until you reach 80 years of age. At
that time you will be required to purchase an annuity with the
remaining funds or transfer them to a Locked-in Retirement Income
Fund (LRIF).
- transferring your money to a LRIF, which is similar to a LIF,
but with no annuity purchase requirement.
If you purchase an annuity, it will provide you with a monthly
retirement income. The amount of each payment will depend on your age, the
value of your investments and interest rates at the time of purchase. An
annuity that provides inflation protection or survivor benefits will cost
more than one that does not include these features.
If you choose a deferred pension (Option #1 above) when you first terminate,
you will still have the option of taking a CV transfer at any point in the
future, provided you are under age 55. Your CV will be recalculated
according to your age and interest rates in effect at the time of your
election.
Considering the risks and benefits
In making their decisions, some members will opt for the security of a
deferred OPTrust pension, with its guaranteed lifetime retirement income
based on their salaries and pension credit. The Plan’s survivor benefits and
access to employer-sponsored, post-retirement health and dental coverage for
those who qualify may also be factors in their decisions.
Other members may choose to transfer the commuted value of their pensions in
anticipation of earning a higher retirement income by investing their money
themselves. In making this choice, these members assume individual
responsibility for their investment decisions. While they may achieve a
higher retirement income, this is not guaranteed.
Managing your retirement investments yourself involves financial risks
associated with the particular investments you choose.
If you are leaving the Plan and are wondering whether to take a deferred
pension or a CV transfer, you should consider carefully which option best
suits your individual needs and circumstances.
How is your commuted value calculated?
The commuted value of your pension is the lump sum present value of your
expected future pension plus related benefits. In calculating the CV,
OPTrust uses a number of assumptions concerning mortality, interest and
inflation rates. These assumptions are based on the Canadian Institute of
Actuaries Standard of Practice for Determining Pension Commuted Values
(CIA Commuted Value Basis).
If you take a CV transfer, you would have to realize a “real rate of
return”1 on your funds (including the “real rate of return” inherent in the
annuity purchase rates)2 as high as those used in calculating your commuted
value. If you achieve this “real rate of return,” you should be able to
purchase the same pension at retirement as if you had stayed in the Plan. If
your investment returns are higher, then you should be able to purchase a
higher pension. If you have lower returns, you will receive a smaller
pension.
For example, let’s assume you take a CV transfer that has been calculated in
accordance with the CIA Commuted Value Basis for February 2005 and you
retire in 10 years at age 60.
If:
1. you earn an annual “real rate of return” of 2.25% on your funds, and
2. annuity purchase rates are based on a 2.75% “real rate of return” at the
time of your retirement,then you should be able to purchase the same
income at retirement, as you would have received through your
OPTrust pension. However, you also need to consider the fee to
purchase an annuity.
If you take a CV transfer you should discuss your investment options
with an independent financial advisor. It may be possible to achieve
a “real rate of return”1 on your CV that will give you a retirement
income greater than what you would have received had you left your
money in the Plan. However, investments that have a potential for
higher returns usually also carry a higher risk. And, while market
indexes such as the S&P Composite Index reflect overall
trends, each individual investment is subject to its own risks.
Also, you will incur certain investment costs2 on your RRSP
investments. For mutual funds, these costs can average $2 to $3 for
every $100 you invest. That means your investments may need to earn
an extra 2% to 3% to cover these costs.
For example, if you plan to start receiving a pension in 10 years,
you will need to earn a net rate of return of 2.25% per year after
inflation to match the value of a deferred OPTrust pension. If you
buy mutual funds that carry a 2% management expense ratio (MER), you
would need to earn about 4.25% per year, after inflation, to cover
the MER and still break even.
If you are thinking about withdrawing the commuted value of your
pension and investing it, you may want to get a quotation from the
individual annuity market to help you decide. If you do so, you
should ensure that the insurance company preparing the quotation has
all the facts about your OPTrust pension, including:
- the inflation protection on your OPTrust pension, both before
and after retirement
- your pre- and post-retirement survivor benefits
- the Plan’s early retirement provisions
- your personal pension data, including your age, the age and
sex of your spouse if applicable, and your accrued pension.
The market for a deferred annuity with all these features is very
limited. You may find that either you will be unable to purchase the same
amount of retirement income with an annuity, or you will not be able to
purchase an annuity with comparable features to the OPSEU Pension Plan, such
as inflation protection.
Insured benefits
Currently, many members who retire with an OPTrust pension have access to
continuing health and dental benefits provided by their former employer. If
you qualify, these benefits may cover some or most of the costs related to
vision care and hearing aids, hospital stays, dental care, certain
medications and other paramedical services for you and your dependants.
Post-retirement benefits may also include basic life insurance coverage. Once
you become eligible, these benefits will continue and will be available for
your surviving spouse and dependants, if applicable. These benefits are
provided by the Government of Ontario. To check whether you are eligible,
contact your employer.
If you choose to leave the OPSEU Pension Plan, you will have to pay for
these services directly or purchase insurance coverage on your own (unless
you have access to these benefits under your spouse’s plan). This can be
very expensive and, in some cases, coverage may not be available if you have
a pre-existing health condition or once you reach a certain age.
Furthermore, the cost of health coverage in Canada is increasing at a much
faster rate than the general rate of inflation. (This is sometimes called
“health inflation.”)
When to retire
In calculating the commuted value of your pension when you terminate from
the Plan, OPTrust assumes that your pension payments will start at the age
that gives you the maximum value of the Plan’s early retirement benefits.
For most members this would mean starting to collect a pension at
approximately age 60.
If you keep your pension in the Plan but do not start collecting it until
after age 60 (or if you start your pension before age 60), you will lose
some of the value of the Plan’s early retirement benefits. On the other
hand, if you take a CV transfer and do not retire at age 60, the early
retirement value will not be lost and can be converted to additional pension
when you actually retire (all else being equal). If you have no intention of
starting to receive your pension at age 60, in some cases taking a CV
transfer (whether at your date of termination or before age 55) could be a
desirable option. Once again, this is something that should be discussed
with an independent financial advisor. The key is whether you can achieve
the investment returns from your CV payment.
Plan improvements
Every three years, OPTrust’s actuaries prepare an “actuarial funding
valuation” of the OPSEU Pension Plan, which is filed with Ontario’s pension
regulators. This independent study compares the growth in the Plan’s assets
to the anticipated cost of members’ and pensioners’ benefits. Gains result
when the Plan’s investments grow more quickly than its liabilities. If
assets grow more slowly than needed to fund the Plan, the result is an
actuarial loss.
Future gains in the Plan are not guaranteed, and gains may not always be
used to improve benefits. However, future gains may result in pension
improvements that apply to members who leave their deferred pension in the
Plan or who go on to become pensioners. For example, deferred members and
pensioners benefited from several improvements in the OPSEU Pension Plan
that came into effect in1999 and 2002 as a result of Plan gains.
Members who choose to withdraw their commuted value when they leave the Plan
will not benefit from any future Plan improvements.
The Plan’s next funding valuation must be completed and made available no
later than mid-2007. OPTrust also has the option of valuing the Plan at any
earlier date. At this time, gains at the next funding valuation are not
expected, but could occur in future years.
Examples
The following examples show the kind of investment return two members would
need to earn on their CV transfer amounts to generate a retirement income
comparable to that provided by the OPSEU Pension Plan today. We have also
provided information on the cost of post-retirement health and dental
benefits.
Both examples use the following assumptions:
- rate of inflation is assumed to be 2.25% per year, for the
first 10 years and 3.25% thereafter.
- the commuted value of the member’s pension is based on a
“real rate of return” of 2.25% per year, for the first 10 years
and 2.75% thereafter.
When the above inflation rate is added, this is equivalent to a nominal
rate of return of 4.5% per year for the first 10 years and 6% per year
thereafter. (These are the CIA rates that would apply for terminations
occurring in February 2005.)
- To determine annuity purchase rates at retirement we have
assumed a “real rate of
return” of 2.25% per year. This is a more conservative basis
than that used to determine the member’s commuted value, and
reflects current realities of the annuity market for fully
indexed pensions.
- The examples do not reflect the investment costs that may
be payable. Each individual’s investments would have to
generate additional income to cover these costs.
 Sanjay’s OPTrust pension
If Sanjay keeps his money in the OPSEU Pension Plan and starts receiving
pension payments at age 65, he will receive an annual pension of
$14,220, including adjustments for inflation and integration with CPP. If he
starts collecting his pension at age
60, he will receive a reduced annual pension of $12,790. At age 65, after 5
years of increases for inflation and the reduction in his pension for CPP
integration, he will receive $10,660 per year.
If he withdraws from the fund
What happens if Sanjay decides to withdraw the commuted value of his pension
and invest it in a locked-in RRSP? In this case, assuming he retires at age
60, he would need to earn 5.8% per year (plus the extra returns required to
cover the investment costs on his RRSP) to be able to purchase an annuity
that would provide the same income as his OPTrust pension.
Let’s suppose that Sanjay decides not to retire until age 65. If he
continues to earn 5.8% per year on his funds (net of the MER), he can
purchase an annual pension at age 65 in the amount of $14,900.
This is $680 per year higher than the pension he would receive from OPTrust.
By taking a transfer value, instead of losing the value of the early
retirement benefits under the Plan, he was able to invest the value of that
additional benefit for five more years. This provides him with a greater
retirement income than he would have received had he left his money in the
Plan.
Sanjay’s investments
Suppose Sanjay invests his money in a diversified mix of stocks and bonds
(including some foreign content) and manages to earn 6.5% per year after
paying the MER fees. At age 60, Sanjay could purchase an annual pension of
$14,840, reducing to $13,070 at age 65. If he deferred his retirement to age
65, he could receive a pension of $18,770 per year.
Post-retirement health, dental and life insurance
Since Sanjay has only eight years of service in the OPSEU Pension Plan, he
is not eligible for post-retirement health, dental and life insurance
benefits provided by his employer.
After consulting an independent financial advisor, Sanjay is tempted to take
the commuted value transfer option. Before he makes his decision however, he
needs to think carefully about the downside risk and whether he could bear
the financial consequences of disappointing investment returns on his
commuted value.
 Isabelle has a number of things to consider. She will be without an income
for the four years during her program; she will not be contributing to a
pension plan and her initial salary at her new job may be lower than her
current income. She is married and has one child, age 7. Her husband works
for a company that does not provide post-retirement health, dental and life
insurance benefits comparable to those available to qualifying retirees from
the Ontario Public Service (OPS). Isabelle hopes to retire at age 60, as her
husband will be 65.
Isabelle’s OPTrust pension
If Isabelle keeps her money in the OPSEU Pension Plan and starts receiving
pension payments at age 65, she will receive an annual pension of
$19,360, including adjustments for inflation and integration with CPP.
If she starts collecting her pension at age 60, she will receive a reduced
annual pension of $17,420. At age 65, after 5 years worth of increases for
inflation and the reduction in her pension for CPP integration, she will
receive $14,520 per year.
If she withdraws from the fund
What happens if Isabelle decides to withdraw the commuted value of her
pension and invest it in a locked-in RRSP? In this case, she would need to
earn 5.7% per year (plus investment costs) to be able to purchase an annuity
that would provide the same income as her OPTrust pension.
Let’s suppose that Isabelle decides not to retire until age 65. If she
continues to earn the above rate of return on her funds, she can purchase an
annual pension at age 65 in the amount of $20,360. This is $1,000 per year
higher than the pension she would receive from OPTrust. By taking a transfer
value, instead of losing the value of the early retirement benefits under
the Plan, she is able to invest the value of that additional benefit for
five more years. This provides her with greater retirement income than she
would have received had she left her money in the Plan. However, to do this
she would have to postpone her retirement by 5 years.
Isabelle’s investments
Let’s say that Isabelle, like Sanjay, invests her money in a diversified mix
of stocks and bonds (including some foreign content) and manages to earn a
total return of approximately 6.5% per year after investment costs. At age
60, Isabelle could purchase an annual pension of $19,590, reducing to
$17,070 at age 65. If she deferred her retirement to age 65, she could receive
a pension of $24,580 per year.
Post-retirement health, dental and life insurance
While Isabelle initially thought a CV transfer might be worth considering,
the picture changed considerably when she looked at the value of the
post-retirement benefit she would be giving up by taking a transfer value.
Currently, for a 60-year-old, premiums range from $3,200 to $3,800 per year
for health and dental coverage comparable to that available to qualifying
OPS pensioners. Let’s assume that health inflation will increase the cost of
these benefits at 7.5% per year for the first six years and 5% per year
thereafter. By the time Isabelle reaches age 60, premiums for this coverage
could range from $9,780 to $11,610 per year for a couple. At a marginal tax
rate of 31%, this is equivalent to pre-tax income of $14,170 to $16,830 per
year.
To make the transfer option worthwhile in these circumstances, Isabelle
would have to earn at least 9.9% to 10.4% (after investment costs) on her
transfer value. This would enable her to retire at age60 and purchase enough
pension to replace both her
OPTrust pension and the post-retirement health and dental benefits she had
given up.
Given her situation and the cost of the health and dental benefits, Isabelle
believes that taking a deferred OPTrust pension makes more sense for her
than the CV transfer option. She thinks it would be hard to achieve the
rates of return necessary to earn a higher pension than she would receive
under the Plan, especially since she would like to retire at age 60.
Although she knows that there is no guarantee, employer-paid,
post-retirement health benefits could still be available when she retires.
A Checklist for Your Commuted Value Decision Conditions
Leaving your job is a big step that involves a number of
important decisions. Whether you stay in the OPSEU Pension
Plan or transfer your pension value to a locked-in RRSP, your
choice will affect you for many years to come. Make sure
you’ve looked at all the facts before you make your decision.
If you are deciding whether or not to withdraw the commuted
value of your pension consider the following steps:
 Get independent advice from a financial services
professional. Be cautious about accepting financial advice
from someone who hopes to sell you a product or ongoing
service.
Consider comparing a deferred pension with an annuity
purchased with the investment income from the commuted value
of your pension. Be sure that you take into account the OPSEU
Pension Plan’s:
- early retirement provisions
- inflation protection features
- pre- and post-retirement survivor benefits
- post-retirement health, dental and life insurance benefits
that may be provided by your employer.
Consider the potential value of these benefits and what you
might be foregoing if you choose a CV transfer option instead
of a deferred pension option.
Remember, your investments will need to generate a higher
income at retirement to cover the cost of these insured
benefits.
Make sure that the annuity income generated from a CV transfer
option will be enough to offset health inflation, which is
running higher than general inflation, and is expected to
continue at a higher rate.
Make sure that you can get adequate postretirement insurance
coverage in the individual insurance market. Remember that you
or your spouse may be required to undergo a medical exam
before coverage is granted.
Remember that if you take a CV transfer, your rate of return
will be subject to market conditions. You should be
comfortable that the level of risk you are assuming does not
outweigh the potential benefits.
Take the time to consider your options carefully and perhaps
discuss them with your family. This is an important decision -
and one that will have long-term consequences for you and your
family.
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1 The annual percentage
return realized on an investment adjusted for changes in the price level due
to inflation or deflation. For example, if you earn 10% on an investment,
but inflation is 2%, then your real rate of return is actually 8%.
2 In the mutual
fund industry, these costs are referred to as Management
Expense
Ratios (MERs). Direct investment in stocks and bonds incur
trading costs.
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Deferred Pension or Commuted Value Transfer? Your options if you leave the OPSEU Pension Plan