When leaving an employer, many people are faced with the decision to leave their pension entitlements on a paid-up basis with their former employer or to move it to a personal locked-in retirement savings plan (LRSP) or locked-in retirement account (LIRA)
If you belong to a defined contribution or money purchase plan, the decision is relatively easy. The full market value of your entitlement can be transferred to a personal LIRA. The advantage of this is that it will provide you with full and direct access to a more diverse range of investment options, which are typically more limited in the company pension plan.
However, if you belong to a defined benefit pension plan, the transfer to a LIRA isn’t as straightforward. This article summarizes some of the things that will need to be considered to make the most of the benefits you’re entitled to.
Maximum Transfer Value
In many cases, the maximum transfer value imposed by the Income Tax Act will prohibit the full value of your entitlement from being transferred to a LIRA.
let’s review whether to commute a defined benefit pension plan or not.
Here are some considerations:
- Can an individual plan be created that will promise the same or better guaranteed income?
- Will you be giving up a retiree benefits package?
- Will your spouse be affected by the decision?
- Will the pension plan survive?
Most commuted values from a defined benefit/contribution plans are composed of two components: an amount that can be transferred to LIRA or LIF; and a non-registered component. A CRA table is used to determine the locked-in amount and the non-registered amount.
Let’s consider an example:
A client age 58 is contemplating commuting their pension. They tell you the pension income is $40,000 annually. Then using the factor from the table, we see for a 58 year old, the factor is 11. Therefore, 11 x $40,000 or $440,000 is the maximum amount that can be transferred to a LIRA. If the commuted value is $500,000, then $60,000 would be non-registered and added to the client’s income in the year the pension was commuted.
If the client had at least $60,000 of RRSP room available, then this additional income could be offset by an RRSP contribution. Or if a spouse had the room, the client could gift money to their spouse and let the spouse reduce their income.
Indexed benefits can add substantially to the amount of dollars needed at retirement to purchase the same pension. This is especially true if there’s indexing of your benefits prior to retirement as well as after retirement.
Benefits such as health and dental are sometimes offered to employees who are considered to be retired. In some cases, the criteria depend on whether the pension money is transferred. If you’ll lose retiree benefits because you take the commuted value and are, therefore, considered a terminated employee rather than a retired employee, then the additional cost of private coverage will also need to be factored in. That may not be a very popular opinion for an advisor who could make more commission on your transfer, so get good advice.
Financial stability of your former employer
Your former employer’s financial stability can also be a consideration. If you’re not sure that your employer will still exist or be financially able to meet its pension promises over the long term, you may decide that you’d be better off taking the lump sum now to avoid any uncertainty with respect to your retirement income in the future
If you’re earning benefits governed by Ontario pension laws, there’s some protection provided to employees of insolvent employers through the Pension Benefits Guarantee Fund. However, the maximum benefit is capped at $1,000 of income per month. There’s no protection in any other province.
As you can see, there are many factors to be considered when deciding whether to take a commuted value or to leave the pension on a paid-up basis with a former employer. This article discusses the mathematical factors, but not all factors in your decision will be financially based. Depending on the terms of your termination of employment, you may also have emotional reasons for severing all ties with a former employer. Talk to an advisor.
If you would like to talk about whether to commute your own pension, or someone you know, feel free to reach out to me for a free 15-minute call here: FREE 15 MINUTES.
As always, I look forward to your comments and feedback.
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THIS ARTICLE IS PROVIDED AS A GENERAL SOURCE OF INFORMATION ONLY AND SHOULD NOT BE CONSIDERED TO BE PERSONAL INVESTMENT OR LEGAL ADVICE. READERS SHOULD CONSULT WITH THEIR FINANCIAL OR LEGAL ADVISOR TO ENSURE IT IS SUITABLE FOR THEIR CIRCUMSTANCES.