Commute the Pension

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Published: August 29, 2023

Should you stay or should you go? Deciding whether to take your workplace pension’s commuted value or remain with the plan really depends on your situation, and is a choice best made with the help of independent financial advice.

The question of taking the commuted value of a workplace pension occasionally comes up with clients that are members of defined benefit plans.

Whether leaving employment that has a defined benefit (DB) workplace pension plan, or after several years of service and reaching a certain age (i.e., age 55), these clients are faced with the decision to take the pension’s commuted value and manage the money on their own, or to remain vested with the plan so upon retiring they can receive a guaranteed retirement income for life. The commuted value can be substantial–in some cases, exceeding $1 million, depending on years of service, pension performance, and long-term interest rates.

Certainly, having access to that capital to manage on your own—with the help of an advisor–for retirement has advantages. Yet so too does remaining with your pension plan. Either way, it’s a decision that should not be taken lightly or made quickly.

Rather, the choice should be backed by extensive financial analysis and planning to help make the right decision based on your specific needs. Still, there are reasons individuals may want to take the commuted value of their pension, and others why they may want to stay with their workplace plan.

 

Why taking the pension’s commuted value might make sense:

  • One reason is you gain control of a significant asset that, when invested and managed well with the help of an advisor, can ultimately serve as a source of wealth for the surviving spouse and the estate. In contrast, a DB pension provides income for the pensioner’s life, and potentially a reduced benefit to the surviving spouse. But once both are deceased, this income stream stops with no residual capital passing to the estate.
  • Individuals with life limiting health conditions may also want to take the commuted value given they may not live long enough to benefit much from the guaranteed income stream it provides. In contrast, by taking the commuted value, they could use the capital to increase spending early in retirement—perhaps to tick off some bucket list goals—while leaving the remaining capital for the estate and beneficiaries.
  • Taking the commuted value is also appealing to couples, who are both members of DB pension plans. In this case, one spouse may stay with their plan, receiving a guaranteed income upon retiring, while the other can take the commuted value. In turn, that capital can be invested to preserve wealth while providing income in retirement that is tax-efficiently layered with other sources, including CPP, OAS, the RRSP and their TFSAs. Again, the advantage is they may be able to preserve more capital for beneficiaries of their estate.
  • Other clients may have many other sources of retirement income—more than enough to meet their lifestyle needs for life. Instead, their challenge is managing their flow of retirement income to avoid paying taxes in higher brackets than necessary and clawbacks for government benefits like OAS. Income from DB pensions, OAS, CPP and RRIF minimums are all fully taxable, potentially leading to higher income than clients may need. In turn, they pay more taxes than they need to as well. By taking the commuted value of their pension, these clients have more flexibility in how much taxable income they draw from that source to potentially stay under certain tax thresholds, thereby preserving more wealth for needs later in life or for their estate.
  • In some instances, the financial health of the pension plan is a concern, particularly with respect to those still offered by private sector employers. Plenty of examples exist of private sector pensions getting into trouble, including Sears Canada’s plan where pensioners saw payments cut significantly, dramatically altering their retirement. Similarly, pensioners with Nortel faced reduced income from the plan. If that is a concern, it’s worth considering taking the commuted value to protect that capital and help secure your future ability to generate retirement income.

 

Why you may want to stay vested with your DB pension

  • Some clients don’t have an appetite for market risk, and market volatility keeps them up at night. For those individuals, a guaranteed income for life from a pension is likely their best choice because it largely eliminates those worries. They know they have that income stream and can base their retirement plan around it—which hopefully helps them rest easy at night.
  • Others may not have other sources of significant savings—i.e., TFSAs, RRSPs, etc.—and they risk running out of savings later in retirement. While taking the commuted value could help increase their savings, often a better choice is building a plan around their DB pension, CPP and OAS. Then they can use what little savings for supplemental income.
  • There are also clients with longevity in their family. While they may not risk running out of money from other retirement savings, they are likely to live long enough that the guaranteed payments from their pension could outweigh the benefits of taking the commuted value of their pension.

In summary, no two situations are alike. The decision to take the commuted value of your DB pension or to remain with the plan depends on each individual’s situation because both choices have pros and cons that must be evaluated in the context of a well-devised financial plan. Only with analysis of your individual circumstances and assets, can we really determine the best outcome for you.

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