So you’re leaving your employer?
If you’re leaving a job with a defined-benefit pension, you may have a number of different options for the funds that have accumulated in the pension plan — including leaving them in place to pay out a monthly pension in retirement, or “commuting” the built-up value from the plan to be invested by you. This decision is often irreversible so it’s important for you to obtain all the information necessary to make an informed decision.
When you leave your job you will be provided with information about when your income from the pension plan would start paying out, how much the monthly income would be, and the assumptions that have been used to determine how much you’d receive. If you have the option of taking a commuted value you will also be provided with information about how much of the commuted value can be transferred to a Locked-In Retirement Account, how much you can roll into an RRSP via your Retirement Allowance, how much you can roll into your RRSP based on your personal RRSP room, and lastly how much will be paid out in cash (fully taxable in the year received).
If you’re receiving a retirement severance it’s important to calculate out the total tax bill of receiving not only your Salary for the calendar year but the additional payment of the severance and the cash portion of your commuted value pension. All of these will factor into your decisions to take a commuted value or not.
- Leaving the Pension in Place
- Taking the Commuted Value
- Transferring the Pension to another Pension – if you continue to work you may be eligible to transfer your pension to a different pension, allowing you to accumulate more pension contributions and deferring your decision to take a commuted value or not.
Leaving the Pension in Place
- The pension will pay for as long as you live (which could be a very long time), assuming the pension remains funded.
- If your pension benefit is indexed for inflation, it will go up over time as the cost of living increases.
- If you have a spouse or common-law partner, the pension can continue to pay them (potentially at a reduced rate, such as 60 per cent of your pension payment) after you pass away.
- You don’t have to take any investment risk or make any investment decisions – those risks and decisions are all in the hands of the pension plan, not you.
- Your pension will start as promised, and pay out as promised, even if investment markets dip before or during your retirement.
- The monthly income from your pension is eligible for “pension income splitting,” which can reduce your household tax bill if you have a spouse or common-law partner.
- The money in the plan is not liquid, but is paid out from month to month.
- If the pension plan “runs into trouble,” your pension benefit may be at risk.
- The pension income dies with you, or your spouse, if you have one – there is usually no estate value left after the second spouse passes away. If you don’t have a spouse or common-law partner, the income from your pension plan ends when you pass away.
Taking the Commuted Value
- If you commute your pension to cash, the money in your plan is accessible to you and, subject to tax rules that govern how the funds in a locked-in retirement account can be used, can then be spent to meet goals for providing income.
- You can manage the funds invested based on your individual situation rather than a pension managing funds based on the needs of thousands of members.
- If you pass away earlier in retirement, the remaining value in your account can be left to your beneficiaries or to your estate.
- Commuted Values offer significantly more flexibility in using more funds earlier in retirement while you are healthy and able to travel.
- If you’re not comfortable making investment decisions, you may have concerns about making all of the investment decisions for your locked-in retirement account yourself.
- The amount of your commuted value that is above the Maximum Transfer Value can be high – as much as 50 per cent of the plan value, or more — meaning that you might face a significant tax bill if you commute to cash.
- Without a financial plan in place, you may be tempted to deplete the funds that have been set aside for retirement on other, shorter-term goals — meaning you might fall short once you hit or when you’re in retirement.
- Market downturns just before or early in retirement, when withdrawals start, can limit the amount of retirement income your commuted value can produce.
- If you commute your pension plan to cash, the income you receive from the commuted amounts will require you to setup a Spousal loan in order to income split for tax purposes.
First, any decision you make – whether staying in the plan, commuting to cash or a copycat annuity, or transferring your pension benefit to a new pension plan – should be made in the context of your overall goals. If you don’t have a clear picture of what you want your financial future to look like, this could be an opportunity to create one.
Of course, you’ll also want to review the details of your specific options carefully, to make sure you’ve thought through all of the choices available to you. You’ll also want to assess the overall health of your employer pension plan, to evaluate whether you expect it will be able to pay out the promised benefit when the time comes.
Questions to ask before making a decision:
- Confirm when your pension income will start, the amount, and if it is indexed – if so, what is it indexed to.
- If you were to commute your pension, how much of it would go to a Locked-In Retirement Account (LIRA) and how much will be taxable to you? If you have the RRSP contribution room, you will be able to move the taxable portion to your RRSP, so you need to confirm how much RRSP contribution room you have.
- If you take on a new position are you able to combine the pension from your previous employment with a new pension?
- What is your life expectancy? If you have a health issues, it likely makes sense to commute your pension.
- Are you a conservative investor?
- Do you want to leave an estate? A pension stops when you stop, and if you take the commuted value there may be money available to leave to loved ones.
- What other sources do you have for generating retirement income to cover your basic lifestyle expenses in retirement?
If you would like assistance in determining whether or not you should take your commuted value you can book a call or meeting with Elijah Kirchmaier. He specializes in managing Liquidity Events including commuted value pensions and can help you make an informed decision based on your individual needs.
