How to Factor a Pension Into Your Retirement Savings

If you're lucky enough to have a pension, you may wonder how it should affect your retirement savings goal. Should you count your pension as part of your retirement nest egg? Should you save less because you'll have guaranteed income? And how should your pension fit with CPP, OAS, RRSPs, TFSAs, and other investments?

The answer starts with an important distinction: a pension is generally an income stream, not simply another investment account.

Understanding how much income your pension is expected to provide—and when it will begin—can give you a much clearer picture of how much additional savings you may need.

Start by Identifying Your Type of Pension

The first step is understanding exactly what kind of retirement plan you have. The terminology can be confusing because pension arrangements differ between countries, employers, and industries.

Defined Benefit Pension

A defined benefit (DB) pension promises a retirement benefit determined according to the plan's formula. The formula may consider factors such as your years of service and earnings.

Instead of asking how much is in your pension account, you usually want to know:

• How much annual or monthly pension income is expected?
• At what age can you receive it?
• What happens if you start it early?
• Does it increase with inflation?
• What survivor benefit is available to your spouse or partner?
• What happens if you die shortly after retirement?

Your pension administrator or plan statement should provide information about these features.

Defined Contribution Pension

A defined contribution (DC) plan works differently. Contributions are made to an account, and the eventual retirement benefit depends on the contributions and investment performance.

A DC pension therefore behaves more like an investment portfolio during the accumulation phase. The account balance can be an important part of your retirement savings, but you still need to determine how that balance could be converted into retirement income.

A Canadian DC pension plan should not automatically be treated as equivalent to an RRSP. The rules governing workplace pension plans and RRSPs are different, even though both can play an important role in retirement planning.

Don't Simply Add Your Pension to Your Savings Balance

Suppose you have $500,000 in investments and expect a pension paying $30,000 per year.

It isn't particularly useful to think of this as having "$530,000" for retirement. The pension and investment portfolio behave differently.

A more useful way to think about the situation is:

• Pension: $30,000 of expected annual retirement income
• Investments: $500,000 of capital that can potentially generate additional income
• Other benefits: CPP, OAS, and any other income sources

The real question becomes: How much of my desired retirement spending is already covered by reliable income?

Calculate How Much of Your Expenses Your Pension Covers

Start by estimating your annual retirement spending.

For example, imagine you expect to spend $70,000 per year after tax and your pension provides the equivalent of $30,000 per year before considering taxes.

Your pension covers only part of the picture. You still need to account for taxes and determine how the remaining spending will be funded.

Your other sources might include:

• CPP
• OAS
• RRSP or RRIF withdrawals
• TFSA withdrawals
• Non-registered investments
• Rental income
• Part-time employment
• Other pension income

This is why a retirement-income projection can be much more useful than focusing on one savings number.

Understand When Your Pension Starts

The timing of your pension can be just as important as the amount.

Some plans provide an unreduced pension at a particular age or after reaching certain service requirements. Starting earlier may reduce the pension, while delaying it may increase the payment depending on the plan's rules.

Don't assume that the date you stop working has to be the date you start your pension.

There may be several possible combinations:

• Retire and start the pension immediately.
• Retire and delay the pension.
• Continue working while delaying the pension.
• Retire from one employer while receiving income from another source.

Your pension administrator can explain the options available under your specific plan.

Check Whether Your Pension Is Indexed

Inflation can have a major effect on retirement income.

A pension that pays $30,000 per year today may not provide the same purchasing power decades from now.

Some pensions include inflation protection or cost-of-living adjustments. Others may provide limited or no indexing.

Find out exactly how your pension handles inflation.

This is particularly important if you expect a long retirement. Even relatively modest inflation can significantly reduce purchasing power over several decades.

Consider Your Survivor Pension

If you're married or have a partner, find out what happens to the pension after your death.

Many pension plans offer different survivor options, and the choice can affect the amount of income paid while both spouses are alive and the income available to the surviving spouse.

This is an important part of retirement planning because the financial needs of a household don't necessarily end when one spouse dies.

Review the survivor provisions carefully before making a pension election. Once certain pension decisions are made, changing them may not be possible.

Factor in CPP and OAS

For Canadian retirees, an employer pension is only one potential source of retirement income.

CPP and OAS may provide additional income, depending on your circumstances and eligibility.

Don't automatically assume you'll start every source of income at the same time. The timing of government benefits can be part of your overall retirement-income strategy.

Consider how your pension, CPP, OAS, personal savings, and spending needs interact over the entire retirement period rather than evaluating each source separately.

Factor in Taxes

One of the easiest retirement-planning mistakes is comparing gross income with after-tax spending.

If you need $60,000 of spending money, that doesn't necessarily mean you need exactly $60,000 of taxable retirement income.

Your actual tax situation depends on your income sources, deductions, province or territory, account types, and other circumstances.

Pension income, RRIF withdrawals, investment income, CPP, and OAS can all affect your taxable income in different ways.

This makes tax planning an important part of determining how much additional savings you need beyond your pension.

Don't Forget OAS Recovery Tax

Higher-income Canadian retirees should also be aware that OAS can be subject to a recovery tax once income exceeds the applicable threshold.

This means that the interaction between pension income, registered-account withdrawals, investment income, and government benefits can become important when planning retirement withdrawals.

A retirement plan should therefore look at the after-tax income available to you, not simply the gross amount generated by each account.

How Much Should You Save If You Have a Pension?

Having a pension can reduce the amount you need to accumulate in personal savings—but it doesn't eliminate the need for savings.

Think about your retirement in terms of a gap:

Retirement spending need − reliable after-tax income = amount that must come from other sources.

The smaller the gap, the less dependent you may be on your investment portfolio.

For example, if your household needs $80,000 of after-tax spending and reliable income covers $55,000 after accounting for taxes and other relevant factors, the remaining $25,000 needs to come from savings, investment income, employment, or another source.

This is much more informative than simply asking whether you have reached an arbitrary savings target.

Think About Your Pension as Part of Your Retirement "Floor"

Some retirees think of dependable income sources as the foundation of their retirement plan.

Your pension, together with government benefits and other relatively dependable income, can help cover essential expenses such as:

• Housing
• Utilities
• Groceries
• Insurance
• Basic transportation
• Healthcare and prescriptions

Your investment portfolio can then provide additional flexibility for discretionary spending, travel, major purchases, gifts, or unexpected expenses.

This approach can also help you think differently about investment risk. If a substantial portion of essential spending is covered by reliable income, you may have a different capacity to tolerate investment volatility than someone whose entire retirement income depends on their portfolio.

Be Careful With the 4% Rule

The 4% rule is often discussed as a way of estimating how much someone might withdraw from an investment portfolio during retirement.

But it is not a guarantee, and it isn't necessarily appropriate for every retiree.

A pension changes the calculation because part of your retirement income may already be coming from a relatively predictable source.

Rather than automatically withdrawing 4% of your investments, consider your actual spending needs and how much income is already provided by your pension and other sources.

Our Four Percent Rule article provides more information about the strengths and limitations of this commonly discussed retirement guideline.

Don't Assume a Pension Eliminates Investment Risk

A pension can reduce your reliance on investments, but you may still have significant exposure to market risk through your personal savings.

Your portfolio may need to fund retirement expenses for decades. It may also need to cover expenses that your pension doesn't address.

Consider maintaining enough flexibility to deal with:

• Market downturns
• Inflation
• Major home repairs
• Vehicle replacement
• Healthcare expenses
• Long-term care
• Travel and lifestyle spending
• Financial support for family

Should You Take a Pension Lump Sum?

Some pension arrangements may provide a choice between receiving a pension income and transferring or taking a commuted value, depending on the plan and your circumstances.

This is a significant decision and shouldn't be reduced to a simple comparison of "monthly pension versus lump sum."

Important considerations can include:

• Your expected longevity
• Investment risk
• Inflation protection
• Survivor benefits
• Tax consequences
• Your other sources of guaranteed income
• Your ability and willingness to manage investments
• Your estate objectives

Because the rules can be complex and the decision may be irreversible, consider obtaining professional advice before making a pension election.

Use Your Pension to Reassess Your Savings Goal

A pension can change how aggressively you need to save before retirement.

Someone without a pension may need a larger investment portfolio to generate retirement income. Someone with a substantial indexed pension may have less dependence on personal investments for essential spending.

That doesn't mean you should stop saving.

Personal savings can provide flexibility and help cover expenses that your pension doesn't cover. They can also give you more choices if your retirement plans change.

Instead of asking, "How much money should I have saved?" ask:

"How much of my desired retirement spending will my pension and other reliable income cover, and how much will I need my savings to provide?"

Run Different Retirement Scenarios

Retirement planning becomes much more useful when you test different possibilities.

For example, compare:

• Retiring at 60 versus 65
• Starting your pension immediately versus delaying it
• Higher versus lower retirement spending
• Different investment-return assumptions
• Higher versus lower inflation
• Different withdrawal strategies
• Living to age 85 versus age 95 or beyond
• Working part-time for several years after leaving your primary career

No calculator can predict the future, but scenario analysis can show you which assumptions have the biggest effect on your retirement plan.

The Retirementize online income calculator can help you bring pensions, savings, expenses, and other income sources together in one retirement projection.

A Simple Pension-and-Savings Example

Imagine a couple expects to spend $75,000 per year after tax in retirement.

Their combined pension and government benefits may provide a substantial portion of that income, but they still need to determine how much additional income their investments must generate.

Rather than treating their pension as part of their investment balance, they can model it as an income stream and then determine how much their portfolio needs to contribute.

If their spending changes over time, the amount required from their investments can also change.

This approach produces a more realistic retirement plan because it reflects how retirees actually fund their spending: through a combination of income sources and withdrawals.

Review Your Plan Regularly

Your pension estimate may change as you continue working. Your investment balance will change. Government benefits can change. Your spending priorities can change.

Retirement planning therefore shouldn't be a one-time exercise.

Revisit your plan when you:

• Change your expected retirement date
• Receive an updated pension estimate
• Change jobs
• Experience a major change in income or expenses
• Buy or sell a home
• Receive a large inheritance
• Experience a major family change
• Change your retirement lifestyle plans

Common Mistakes When Planning Around a Pension

Mistake 1: Treating the Pension Like a Savings Account

A DB pension is generally better understood as an income stream rather than a balance you can spend down.

Mistake 2: Ignoring Inflation

Find out whether your pension is indexed and understand what that indexing actually provides.

Mistake 3: Forgetting Taxes

A pension amount quoted before tax isn't the same as the amount available for spending.

Mistake 4: Ignoring Other Income

CPP, OAS, RRSPs, RRIFs, TFSAs, investments, rental income, and employment income can all affect the amount your personal savings need to provide.

Mistake 5: Assuming a Pension Makes You Invulnerable

Even with a strong pension, you may still need savings for unexpected expenses and discretionary spending.

Fun Facts About Pensions and Retirement

Conclusion: Your Pension Is One Piece of the Retirement Puzzle

If you have a pension, don't simply add its supposed "value" to your retirement savings and assume the resulting number tells you whether you're ready to retire.

Instead, look at your pension as one component of your retirement-income system.

Determine how much income it provides, when it begins, whether it is indexed, what happens to it after your death, and how it interacts with CPP, OAS, taxes, personal savings, and your spending needs.

Then determine how much of your desired retirement lifestyle needs to be funded by your investment portfolio.

This approach can give you a much clearer answer to the question that really matters: Do I have enough reliable income and savings to support the retirement I want?

The Retirementize online income calculator can help you combine your pension, savings, other income sources, expenses, and retirement assumptions into one projection so you can explore how the pieces fit together.

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