Pension buybacks are especially beneficial when the client’s income is lower and is expected to increase over time.Dragon Claws/iStockPhoto / Getty Images
This article is part of a new Globe Advisor series, Pensions Unpacked, exploring how workplace pensions fit into retirement strategies, and the technical details and decisions that come with the plans.
Clients who took short breaks from their careers – such as parental leave or sabbatical – or who neglected to join their company’s defined-benefit pension plan when eligible may opt to “buy back” into their pensions to boost the amount of guaranteed income in retirement.
Andrea Thompson, certified financial planner (CFP) at Modern Cents in Toronto, says many clients with pensions are enthusiastic about the opportunity for buybacks.
“They’re aware of the value of a DB plan in this day and age and they’re more than willing to make it work,” she says. “This can be a great thing, especially in the economic environment we’re in. If they have a pension plan that’s indexed to inflation, getting that guaranteed income is key for them.”
Usually, the employer presents buyback opportunities over a specific time period. Defined-benefit (DB) pension plans will have the employer match the employee’s contributions or, in certain cases, exceed them.
Travis Koivula, senior wealth advisor with Island Savings Wealth Management at FW Wealth Management Ltd. in Victoria, notes that pension buybacks are especially beneficial when the client’s income is lower and is expected to increase over time. That means the buyback will cost less. Many pension plans base the final payout on an employee’s five highest-earning years, which tend to come later in their careers.
“You’ve won financially in that case,” he says.
Compare that to someone doing a buyback at the end of their career. As they’re already earning the highest possible income, a buyback may not be a slam-dunk solution compared with other alternatives such as a more self-directed investing approach.
Clients may find money for the buyback by taking on a short-term home equity line of credit, receiving an inheritance, or saving up the money in anticipation of a buyback. Another option is to transfer some money from an RRSP. While there aren’t tax consequences for the transfer, Mr. Koivula notes buying back pensionable years can reduce a client’s RRSP contribution room.
Ms. Thompson helped a client on maternity leave with a buyback. The client ultimately decided on a 12-month leave instead of 18 months, so “there was enough of a buffer at the end of maternity leave to be able to fund that buyback,” she says.
But situations do arise in which buybacks may not make sense. Mr. Koivula may caution someone, for example, with terminal health challenges to consider other options, or at the very least run some projections for different alternatives.
“They could move their money into a pension and then die, and their estate would lose out on that money,” he says. But if the funds were contributed to an RRSP or TFSA, that wouldn’t be the case.
The pension’s actuarial stability and how it’s structured also need to be considered before investing more money into a buyback. Ms. Thompson points to her grandfather’s pension plan from Nortel Networks Corp., which was supposed to be a stable company with a coveted pension plan.
That pension was cut back several times after Nortel’s bankruptcy because of its inability to fund its pension plan liabilities after insolvency, which ultimately wasn’t the guarantee he had hoped for, she says.
If a prospect or client has significant liabilities, such as credit card debt they’re struggling to pay off, Ms. Thompson would advise against a buyback until that debt is cleared. She might also express caution for those who only have a pension and few other assets.
“It’s not wise to tie up more assets when you may need access to liquidity in the future,” she says.
Laura Whiteland, CFP at Inclusive Financial Planning in Truro, N.S., offers the cautionary example of the Nova Scotia Teachers Union Pension Plan. The pension is underfunded and hasn’t had a cost-of-living increase in more than two decades, she says. A buyback will likely not deliver the same value in retirement.
“You have to consider the cost versus the benefit,” she says.
If the employer isn’t matching the employee contributions, that means more upfront money is required from the employee, she adds.
We may add topics to this ongoing series. If you have pension story suggestions or feedback on the series, please leave a comment in the stories or e-mail us at: PensionsUnpacked@gmail.com.