Yesterday, I started a series about cashing your pension plan or taking the annuity. Some people have this choice upon retirement or when they leave their company, some others are stuck with the pension plan… Since I noticed that this option exist for several individual in Canada, I thought that it would be important to know what should influence your decision in regards to cashing your pension plan or taking the annuity. I started yesterday with the cash value of the pension plan and I continue describing it today.
We saw that the pension plan will be split into 2 amount: the first one will be sent into a locked-in registered plan where you will have the possibility to manage your fund as you wish (with ETF’s, mutual funds, stock picking, bonds, etc.) and the other part will be a non-registered check that you can do whatever you want. However, keep in mind that this amount is fully taxable to your marginal tax rate. Therefore, it wouldn’t be bright to put it all in a brand new BMW (but it will be a lot of fun!).
What to do with this money?
In order to decrease your tax bill, I suggest you look at your unused RRSP contribution. By contributing directly in your RRSP, you will decrease your declared income and help to reduce your tax bill.
The good news is that you will have more RRSP room by leaving your employer! In fact, your RRSP contribution limit is being reduced by an actuarial calculation of the value of your pension plan at retirement. However, if you leave 10 years before retiring, the Government will allow you more RRSP room so you can compensate for the annuity you should have received.
So even if you have maxed your RRSP contribution every year, you will be able to shove a part of the fund into your RRSP’s.
As for the rest of the amount, I suggest you estimate the amount of taxes that will be paid and invest this money into a money market fund.
The “cleared” amount can be used to contribute to your TFSA, pay off debts or invest into non-registered assets. This should not be used for going on vacation, buying a new car or renovating your property. Why? Because if you do so, you can be assured that it would not worth it to take cash your pension plan as you would have received more money through your pension plan. I know, it is tempting, but you won’t be a winner if you do so!
In fact, it is not always profitable to cash your pension plan. In most cases, you are better off keeping your pension plan than cashing its value. When you meet with your financial planner, keep in mind that it is in his interest that you cash in the pension plan as it will translate into a great amount of fund in his book. I personally declare this conflict of interest before I explain both the cash value and the pension plan. It is important to understand the impact of both choices.
Next week, we will look deeper into the pension plan option.
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