Employment Termination Series: How Do You Handle Your Company’s Pension Plan?
Many companies may offer pension plan as part of the employees benefits, where these plans are considered as one of the most important source of retirement funding beside government pensions and personal savings.
However, when employees leave the company before they retire, what are the options available? Last time, we’ve talked about the treatment to deal with severance pay upon employment termination. Now, let’s discuss about company’s pension.
The pension plan consists of the following:
- Employee’s contribution
- Employer’s contribution
- Investment return
When employees leave the company prior to retirement, they may take the employee’s contribution and any investment return generated from this portion. On the other hand, the right to take away the employer’s contribution would depend on the vesting period. Vesting means that the employee has been enrolled to the plan more than a pre-specified amount of time. This vesting period is intended to encourage employees to stay within the same company for a longer duration. Although it is varied among different places, from my own personal experience in dealing with my clients, the vesting period are mostly around two years. Once the plan is vested, the leaving staff may receive the employee’s contribution, the employer’s contribution and any investment returns being earned.
When employees leave the company, usually they would be provided with a letter that state the options available for their existing vested pensions. Below are some common options I’ve seen.
- Let the funds stay in the existing pension plan and receive the benefits upon retirement.
- Suppose the new employment also offers a pension plan, you may transfer the funds to that plan. (However, make sure to confirm if the new pension plan permits it.)
- Some plans may allow you to receive in cash, but this would be taxable. You’ll have to include them as income for the year you receive them.
- Transfer out the pension into a RRSP. Some plans allow you to transfer into a regular RRSP, while some restrict the transfer into Locked-in RRSP only. Locked-in RRSP can held the same type of investments as regular RRSP, but it has strict rule such that withdrawals are not allowed until the employee reach the age of retirement. Although, there are exemptions on the withdrawal rules such as extreme financial hardship and shorten life expectancy, I advice do not expect to receive the funding until retirement age.
Since there are not much to comment on the first three options, I’ll discuss on transferring out the pension into a RRSP, while the goal is to minimize and defer the taxation impacts. For now, I’ll focus on the two types of pension plans, they are the “Defined Contribution (DC)” plan and the “Defined Benefit (DB)” plan. Just like its names, DC plan means that the employer will guarantee the company’s contribution amount, but not the results. While DB will guarantee the amount of retirement benefits being received by the employees.
For DC plan, the transfer is straightforward. One may transfer the full vested amount into a RRSP or Locked-in RRSP if required.
For DB plan, the “Lump Sum Value” of the pension would consist the “Maxmium Transfer Value” and the “Taxable Cash Payment”. (Lump Sum Value =Maximum Transfer Value + Taxable Cash Payment). In short, the “Maximum Transfer Value” may be transferred directly into a Locked-in RRSP , where that portion will be tax-sheltered and there will not be any immediate tax consequence. The remaining portion, “Taxable Cash Payment” will be taxed as income. One strategy to offset the taxation effect is to contribute the same amount as the “Taxable Cash Payment” into a RRSP/spousal RRSP, but this strategy is only applicable when one has enough RRSP contribution room to absorb the transfer.
[note] As everyone’s situation is different, there could be other consideration when handling with the company’s pension. To discuss your situation in more details, feel free to contact me [/note]