Should I take the commuted value of my pension?
Breaking up is hard to do.
Or is it – when it comes to your employer?
Whether that is voluntary leave or involuntary leave, at some point, some people are faced with a very important financial decision: should I take the commuted value of my pension?
This post will hopefully provide some insights, based on a reader question, including my own situation with my pension to share any considerations as food for thought!
Pensions 101
I already have a very detailed post on pensions including the introductory basics on my site so I won’t repeat all details here, but I think it’s very important to understand there are two main types of pensions that we’ll talk about today:
- Defined Contribution (or DC for short), and
- Defined Benefit (DB).
The difference?
Think of your DC plan just as the words sound – your contribution is defined but ultimate pension value is not. Meaning, there are no promises. You’ll get what you’ll get based on what you invest in and the returns of what you invest in over time.
Think of your DB plan this way – your (pension) benefit is defined – meaning your pension value at the end of the line is known, usually based on a formula with your company that goes something like this:
Best Average Five Years’ Salary x Benefit Percentage x Years of Plan Membership = Annual Pension Income
So, using real numbers it could be this for some:
$60,000 x 1.5% x 25 = $22,500
Here is a quick pension comparison summary worth noting:
| Defined Contribution (DC) Plan | Defined Benefit (DB) Plan | |
| Philosophy | Assisting employees accumulate retirement savings during their career. | Rewarding long-service employees with a lifetime retirement income. |
| Investment Decision | Employees decide how contributions are invested in (usually) a limited number of funds. | Professional money managers look after investment decisions based on strict guidelines. |
| Investment Risk | Employee bears the investment risk (since they selected the investments). | Employer bears the investment risk. |
| Income at retirement | Based on employer and employee contributions and investment performance. | Based on a formula that includes your annual earnings and years of service. |
| Valuing Your Pension | Simple, as employees have their account balance readily available. | Difficult, the commuted value is not readily available for most pension plans (except at termination). Actuaries help calculate. |
| Other notes | My wife has this plan. | I have this plan 🙂 |
What happens when you leave the organization and you have a pension?
When leaving your employer, if you have a DC plan, things are rather straightforward.
If you own a DC plan, the full market value of that plan at the time of your leave can be transferred to a personal Locked-In Retirement Account (LIRA).
I won’t go into too many details on LIRAs since as you guessed it, I also have other blogposts about that subject including how I manage my LIRA. (I used to have a DC plan when I worked and lived in Toronto. I moved my DC plan money into a LIRA when I left my former employer. I’ve had this LIRA ever since.)
With a DB plan, it’s a bit more complex to say the least. Which brings us to our reader case study for today and my thoughts and comments on that.
Reader Case Study (questions and information adapted slightly for the site):
Hi Mark!
I really enjoy your blog!
I also really like your concept of hourly passive income wage – it’s something I’m now tracking myself!
Thoughts on this for us although I know you can’t offer specific advice but your perspectives would be good given I have read you have a pension as well.
- I have been managing my investments for a few years now and have recently been more focused on financial independence topics as my wife and I have a goal of her stopping full time work this year to focus on family (3 young kids at home) and our health.
- We are in Ontario. We are very fortunate as we are both in the healthcare field with HOOPP defined benefit pension plans. If we both were to continue to work until 55 and take our DB pensions we’d be essentially ‘set for life’. We are lucky and grateful.
- That said, we are seriously contemplating having my wife retire from her full time job (now) to focus on our young family and her health (both are more important). We are electing to take the commuted value of her pension. She is 45.
- If we were to go this route, we would then plan to take my pension as a monthly amount regardless of when I retire or leave employment with my healthcare role. I enjoy my role and have no plans of retiring. Maybe in another 14 years, so a pension around age 55.
My thinking is – if our investments earn at least 5% on average going forward we could be well ahead of what the future monthly pension amount would be.
So, your thoughts?
I feel we could have the best of both worlds this way (I could keep working; contribute to my pension; my job is very stable) AND we could have the lump sum commuted value for us to invest as my wife stays home and supports our family.
Yes, we would take a VERY large tax hit in the year the lump sum is paid out (ouch!) but for the first year of my wife’s retirement she is planning to focus on health and family.
We plan to live off my salary alone and while our savings rate would be very close to 0%, we could do it. We have been consistently living off my income alone for around 18 months now and saving the rest so we know this is very feasible (on one salary).
Worse case, if things do not work out, my wife can easily go back to a part time or full time job to supplement our lifestyle and long-term savings.
Thanks so much for any thoughts!
Should I take the commuted value of my pension?
Lots to unpack, so let’s get into it.
Here are the main options that might be available to you, if you leave your employer.
Option 1: Leave the pension in place as-is
Although you won’t be working at your job any more, one option that’s usually offered is leaving the funds that have accumulated in your pension plan in place. For example, you might be eligible to start receiving income at age 55, 60, or 65. If this option is available, 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.
Option 2: Commuting the pension
A second option is to “commute” your pension entitlement by taking the funds out of the pension plan. This option is typically called commuting your pension. We’ll get to more pros and cons in a bit. With this option, the funds in the pension plan would be transferred to a Locked-In Retirement Account (LIRA), up to something called the Maximum Transfer Value, a limit set by the Income Tax Act. Any amount that’s greater than the Maximum Transfer Value would be paid out to you as taxable cash. You could then contribute some or all of these funds to a Registered Retirement Savings Account, if you have contribution room. (If you don’t have RRSP room, the full value of the cash portion of your pension benefit will be added to your taxable income for that year.)
Option 3: Transfer your entitlement to a different defined-benefit pension plan
Finally, if you’re moving from a job with a defined-benefit pension to a different job with a defined-benefit pension, you may be able to transfer the funds you’ve built up in the pension plan from the first job to the plan at the new job. This option will depend on the details of each pension plan.
OK, back to the reader question.
Similar to what I wrote back to this reader, I believe there are a number of considerations. Let’s go through those one by one but before that, let’s show some math.
1. Consider the maximum transfer value for your tax hit. For any commuted value (i.e., the lump sum amount to be paid out), the maximum transfer value (MTV) is something to be mindful of. There is legislation (a regulation in the Income Tax Act) that regulates that. My understanding is (since I haven’t been in this situation yet myself!), there is a maximum transfer value/present value factor (the amount you can move into a Locked-In Retirement Account (LIRA)) that will prohibit you from transferring the full value of your pension into any LIRA unlike any DC plan.
Here is the current MTV table as I understand it based on the current Act up to age *71:
*We could go beyond age 71 but for the purposes of this post it’s not relevant, the present value factor continues on a downward trend.
| Under age 50 = 9 | 57 = 10.8 | 65 = 12.4 |
| 50 = 9.4 | 58 = 11 | 66 = 12 |
| 51 = 9.6 | 59 = 11.3 | 67 = 11.7 |
| 52 = 9.8 | 60 = 11.5 | 68 = 11.3 |
| 53 = 10 | 61 = 11.7 | 69 = 11 |
| 54 = 10.2 | 62 = 12 | 70 = 10.6 |
| 55 = 10.4 | 63 = 12.2 | 71 = 10.3 |
| 56 = 10.6 | 64 = 12.4 | *And on and on… |
Table source – Advisor.ca
To use the table for MTV, select your age at retirement.
For example, for our reader, age 45, they would have a factor of 9.
**In our simplified example, take your factor and multiply that by your annual pension income expected at age 65. (I’m making this annual pension number up but let’s assume the annual benefit at age 65 is $30,000 for our case study. With HOOPP it could be higher.) **Calculations for months between years are a bit tricky.
So, at age 45, the formula is:
MTV = present value factor X annual benefit.
MTV = 9 (under age 50) X $30,000 = $270,000.
As long as our reader’s commuted value is less than $270,000, they can put that entire amount into a LIRA.
Otherwise, this comes into play:
2. Given the maximum direct transfer value into the LIRA, if the commuted value is higher, then you may be able to put some of your commuted pension into your RRSP – if your wife in this example has available RRSP contribution room.
That may or may not be available.
This is because many folks such as your wife who own a healthy/generous DB pension don’t often have any pension room because the pension contributions themselves limit RRSP contribution room – thanks to a pension adjustment. They may also contribute to their RRSP. No RRSP contribution room is a good problem to have overall but a downside when you commute. That brings me to my final point on MTV below.
Should I take the commuted value of my pension?
3. Given only so much money can go into a LIRA, to be tax-sheltered, and then only so much can go into your RRSP based on any available RRSP room (that may not exist) then you might get taxed (heavily) since the rest is a lump sum taxable amount.
Example for our reader assuming she has no RRSP contribution room:
- Commuted value statement of DB pension at age 45 is actually worth $400,000. Nice! But wait!
- Only $270,000 can be put into LIRA.
- No RRSP contribution room.
__________
$130,000 is paid out as a lump sum and is taxable.
Assuming a 40% tax rate (example only), then $52,000 lost to taxation for an after-tax balance of $78,000.
So what Mark? We still want the money!!
I get it.
In this hypothetical example, a $400,000 lump sum payout is absolutely a pile of money and I can appreciate that. Yet, before your wife rushes into signing any paperwork and taking the cash, consider these other items beyond MTV even though the money seems great.
Can you invest wisely?
Beyond the tax considerations for any lump sum payment, I would make sure your wife will reasonably invest as well as the pension plan itself. This often means earning about, as you point out, 5-6% long-term annualized rate of returns that most balanced portfolios, like pensions are.
To earn more than 5-6%, my personal experience has been you should have a bias to owning more equities than bonds in your portfolio. You should also strive to invest in a way that delivers market-like returns with time.
Can you stomach equity risk? Can you stay the course when the market sky is falling? Easy to say, very hard to do. I will leave that decision to your wife and yourself to discuss!
Bottom line on this point: what you must consider is taking any lump sum/early retirement package from the company, and your ability to duplicate the same eventual income by commuting it. Depending on your age, time vested in the plan, a deferred pension payable from the plan could be worth it for the dependable payments it will provide. This is very much a risk-based and risk-tolerance decision. One you cannot change your mind on.
My take: The short/shorter timeframe you’re vested in a DB plan, I think it makes far more sense to commute. The longer timeframe you’re in a DB plan, or certainly if you’re near retirement age after decades of years of service, I would at least consider leaving your money in the plan. Talk to a licensed professional. More on that in a bit.
Is your DB plan indexed?
Some pensions have some inflation protection built-in, in line with Consumer Price Index (CPI) increases. Building in inflation protection into your personal portfolio might not be as easy. I would enquire about that before your wife makes a decision. HOOPP may or may not be indexed.
My take: If indexing is part of your plan, you might want to keep money in the plan. Why? Inflation should be expected over time, how much, we don’t really know. My plan has something like this: indexing is effective January 1st following retirement and payments will be indexed based on 75% of the Consumer Price Index to a maximum of 5.5%.
Gosh forbid, but what about shortened life expectancy?
If either of you have a health issue, it may make sense to commute the pension and leave a lump sum to your partner. I would however check your wife’s survivor benefits package in this case study since survivor benefits with HOOPP could be 66.6%, 80% or higher.
My take: My DB plan offers 66.6% survivor benefits. That’s pretty good. Should something happen to me, my wife gets my pension at that benefit rate PLUS my benefits are guaranteed for a period of time. Read on:
“Under the normal form of pension payment, your retirement income is payable for your lifetime with a guaranteed minimum of 120 payments. In the event of your death before you have received 120 monthly pension payments, the balance of these 120 monthly payments will be paid to your beneficiary. However, if you have a spouse when you retire, your monthly pension will be automatically reduced so that your spouse will receive 66 2/3% of your monthly pension after your death, which is the 66 2/3% joint and survivor form of pension payment.”
Again, the longer you are in such DB plans, the more valuable these benefits become. Don’t rule out the benefits from the benefits!
Is your company stable?
When it comes to HOOPP, heck ya. A quick Google search and folks can read up on that but our reader already knows that. For others, any defined benefit pension is only as good the company supporting it. Think Sears Canada, Nortel and the list goes on!
My take: My DB plan is affiliated with many collective healthcare agreements across Canada, so I’m personally not concerned my pension will end up like Sears Canada or Nortel.
Want to pension split?
With a pension, again, not there yet myself, you can split pension income as soon as the pension starts. With a LIF (income drawn from LIRA) your wife will have to wait until age 65 before she can split pension income. (See provincial and federal regulations for details). Something to think about when you want to optimize your taxes! The pension income tax credit can be appealing.
My take: For our reader, if you intend to work until age 55 or so, maybe this doesn’t make as much sense. Typically, if you are the recipient of the pension and are 65 or older, you may split income from your RRSP, RRIF, life annuity, and other qualifying payments. If you are under 65, it depends, only certain payments are eligible for pension splitting. With many years vested in your DB plan, with a sizeable commuted LIRA from your wife’s plan, maybe you’ll have plenty of flexibility anyhow.
Unlock and unleash the LIRA!
Some provinces allow you to unlock some of your LIRA – say 50% (and put assets into RRSP for example), yet other provinces beyond that allow you to unlock it all before it becomes a LIF or annuity! (I recall Saskatchewan is like this). Pension legislation is messy across the country. Best to confirm with your plan provider in all cases what the unlocking rules are in advance.
My take: Since I live in Ontario and I’ve read up (a bit) on this stuff myself, for pensions in Ontario you should be able to transfer out 50% of the pension funds into a RRSP or RRIF at a certain age. That provides great financial flexibility and a positive side to commuting!
Always double-check the unlocking rules with your provincial or federal regulator.
In Ontario, I visit this site.
If you do commute, do it January 1st when you haven’t earned any income.
One “trick” I’ve heard of (and I certainly haven’t done this myself…) is if you’re going to “retire” or leave your employer voluntarily, then do it early in the calendar year when you’ve earned next to nothing for taxation purposes – and commute your pension at this time.
My take: I’ve talked to a few early retirees and they’ve done this. They have retired in the months of January, February and into early March for that very purpose and tactic – since any monies paid out in a lump sum that cannot be moved into a LIRA, or as part of your RRSP contribution room, are paid out in a taxable sum.
So, should you take the commuted value of your pension?
Hard for me to say for you at age 45!
Kidding aside, I see the real benefit of commuting your pension before your 50s as one that offers flexibility – assuming you haven’t been in the DB plan very long AND you can invest wisely AND you can keep your ongoing your money management costs low. With this decision, just be mindful you’re now taking on all the investment risk.
I see the real benefit of staying in your DB plan, say after age 50, for the fixed income security it will provide – assuming you’ve been in the plan for maybe 20 or closer to 30 years. With this decision, the employer keeps the investment risk. You might also have an indexing component – even better too! Maybe you have enough investment risk with your own assets. You can sprinkle that steady DB pension payment in with income derived from your personal portfolio. Those are good reasons among others to keep your DB gold-plated pension if you are lucky to have one!
Should you take the commuted value of your pension?
One of the challenges in calculating net worth relates to pension values. Unfortunately, it’s complicated.
Yet a good rule of thumb I’ve read is the following:
For every $1,000 earned per month in payments, that CV (Commuted Value) pension is likely worth ~ $180,000 in present value dollars.
So,
- If your DB pension pays $2,000 per month, that CV pension value is worth about $360,000.
- If your DB pension pays $3,000 per month, the CV pension value could be close to $540,000.
- What about $4,000 per month? The CV pension value could be worth as much as $720,000.
You get the idea.
In fact, I’ve heard that to receive anything north of $500 or $600 per month from Old Age Security (OAS), that pension value is likely over $100,000.
Here is a link to my dedicated Retirement page where you can learn about when to take CPP, OAS and more.
Should you take the commuted value of your pension?
If you do, don’t forget the TFSA even with a pension!
Even with a company pension plan (DC or DB), I think it’s very wise for Canadians to contribute to at least their Tax-Free Savings Account (TFSA) – and max that account out every year. That’s because the income and returns earned inside the TFSA are not income tested. There will be no reduction in the means-tested government benefits like Guarantee Income Supplement (GIS) and/or Old Age Security (OAS) regardless of how much you have sheltered or will withdraw from the TFSA in the future (based on current TFSA rules of course)! This makes the TFSA an outstanding account to own – for any pension backup.
Also, while a portion of the pension lump sum payment may be taxable, the money leftover can go to your mortgage payment or building your emergency fund (if not already done). Both GREAT things!
Lastly, and I can’t stress this enough, these are my perspectives only. Whenever in doubt speak to a fee-only planner or tax accountant professional that can help you make this major (and irrevocable) financial decision. I can only speak to my insights, what I’ve learned and how I intend to keep my DB pension with my current employer for the future fixed-income payments they will provide. I might commute my pension eventually as well.
Disclosure – My Own Advisor is not a tax expert, this is not tax advice nor any form of financial advice. I strongly advocate any reader consider working with a fee-only planner or tax professional to ensure they are getting the best advice for the best personal reasons for their own unique situations. Misinformed commuted pensions decisions could cost you your retirement. Ensure any planner or professional you work with has a designation and no conflicts of interest. Thanks for reading.
Mark
My name is Mark Seed - the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, I'm looking to start semi-retirement soon, sooner than most. Find out how, what I did, and what you can learn to tailor your own financial independence path. Join the newsletter read by thousands each day, always FREE.
Thanks for the great article and comments! So many great suggestions. I really like thi# website, thank you.
This is my first time posting.
I’ve been on the fence about leaving my job before I turn 55 yrs. old. I’ll be 54 @ then end of Jan 2022.
So I only have 1 year to go till early retirement age. I had planned to go a few years ago but With Covid that stopped many things.
Thank you so much for the info because I forgot about the big hit I would take regarding taxes. Considering I’ve been with my company for 17-18 years so far.
My predicament is the following;
my DB is not indexed
Im single, so unless I chose a guaranteed pension option (with reduced monthly $) I can’t leave my funds to anyone.
The options of guarantee is for 5, 10, or 15 years then I can leave it to a beneficiary in that time period. After that it’s gone. ( personally I think that is seriously flawed and unfair). The pension advisor at work basically said it’s your pension and should be used for your own retirement and should never be considered an expectation after you die. Which I found stupid to say as many people work at certain places for the bonus incentive in part of having a DB (especially for what I do and where I live). I work as a Nurse in private sector). Many more jobs in less brutal weather conditions but I’m rambling..lol
The bonus with our retirement plan is we do get some funds toward medical.
Plus we do get a bonus SRP (supplemental retirement plan) that adds onto the BRP (basic retirement plan).
I was going to see a financial advisor regarding this thought of leaving my job early and investing the accumulated value but I think it would be smarter to just stick it out for 1 last year.
Plus I have other investments and have maxed out my TFSA and RRSP room.
Any thoughts?
Hi Missy,
Thanks for reading and I hope you continue to subscribe. Even though your DB plan might not be indexed, it might be worth quite a bit.
Some pension advisors might be a bit narrow minded. Like a mechanic or any other profession, they are not created equally 🙂
“I was going to see a financial advisor regarding this thought of leaving my job early and investing the accumulated value but I think it would be smarter to just stick it out for 1 last year.”
Maybe check out this post for some help?
https://www.myownadvisor.ca/should-i-take-the-commuted-value-of-my-pension/
https://www.myownadvisor.ca/got-a-defined-benefit-pension-plan-consider-yourself-lucky-then-consider-it-a-big-bond/
Maxed out TFSA and RRSP, is GREAT and will be very valuable with your pension.
So, are you thinking of leaving early? If so, are you concerned what your commuted value may or may not be?
Cheers.
Mark
Hi Mark,
I was re-reading your articles you mentioned above and am still as of today on the fence about leaving before 55. Luckily enough my birthday falls at the end of January so if I quit earlier in January the tax hit would be in the new year. 😊
Regarding if I’m concerned about my commuted value. The Only part that concerns me is the tax hit. I crunched the numbers into the formula you provided and the outcome depends on 2 factors.
Like I mentioned about there are 2 components to my pension which is, the basic retirement plan and supplemental retirement plan. Both together would be a substantial tax it.
I have to do more to research to do regarding the options when you chose retirement over quitting etc. I’ll keep you posted on what I find out.
I don’t think much is written on “what happens to your pension when you die for single folks”. I do get about leaving money to your spouse but some single folks do help take care of their family members etc. Why can they not be called a pension partner… I’m sure you get my gist. 😊
You and me both 🙂
Ha.
Correct, if you’re going to leave work, and take your DB pension, based on any potential tax hit then I think it makes sense to do it in early January 🙂
Please do keep me posted on what you find out – I would be happy to post an article about that, your case study.
Can your pension administrator help you with any math? re: this is what it means to keep the money in the plan vs. commute?? I would be curious. I’ve been asking my pension administrator and they won’t do anything for me until I leave!
I would agree: “I don’t think much is written on “what happens to your pension when you die for single folks”.”
Our pension regulations are certainly not flexible and don’t get with the times per se, in that single folks are penalized in some instances when it comes to splitting pensions (can’t), estate planning (limited options), other. Not always helpful.
So, I get you!
Keep me posted Missy.
Mark
I am ready to retire in the next 3 months from my teaching position and have been in the CAAT pension plan for about 6 years. In a meeting with my advisor at my bank he mentioned taking the commuted value from my pension and investing that money with them so that in the event of my death the money would not stop and would become part of my estate to be given to my wife, is this a good strategy as I am 69 years old and what about the option to continue paying for medical, glasses, dental if I stay with my monthly pension from the union after I retire?
Love the name Rosco!
Congrats on the upcoming retirement. 🙂
Nothing wrong with taking the commuted value assuming:
a) you can invest it wisely, like a pension plan (e.g., simple balanced fund like HBAL, VBAL, XBAL, etc.) and/or
b) you don’t need the fixed income security that some inflation-protected pensions can provide.
I know my parents who are retired nurses are very fortunate to have pensions that have some healthcare coverage attached. Incredible when I think about that…
Have you considered running the numbers with an insurance broker just to see how much healthcare coverage might be for you, at your age, and then commute? Might be worse a comparison…
I know a guy and would likely do it free since he is compensated by any plans he sells vs. fee-for-service.
Cheers,
Mark
Great article !
Commuted value could be different from DB a pension to another. In mine, it is 175% of your contributions + interests. A few years ago in Quebec, the goverment have allowed employers to reduce commuted value of DB pensions according the solvabilty ratio which could it hit a lot the commuted value.
I didn’t know that in Quebec Cedrick, thanks for sharing!
Mark
Hi Mark – wondering how the current interest rates factor into the decision. Because the discount rate used is the 5 year average for the gov of Canada bond – which is something like .5 – wouldn’t that make taking the commuted value more attractive
I am currently considering this option in order to distribute wealth to my young children now
Certainly when interest rates are low GC, commuted values are higher. This is because generally speaking, it takes more pension value to deliver the requisite fixed income pensioners are entitled to. So, to your point, your commuted value could be very attractive now.
I hope that helps from my DIY point of view. Good luck, nice problem to have 🙂
Mark
Mark thank you for your great insight. I will now find out more details about my bank DB plan. I am also looking to retire in about 5 years. I am preparing financial plan.
Thanks for reading 🙂 I hope to share more details about my actual plan, in the coming weeks. Stay tuned. It’s a big decision to commute and should not be taken lightly!
I’m 50 and recently lost my job after 25 years in a DB pension. Commuting was right for me, not only because the pension would not be indexed to inflation once I started to receive it at aged 65, but also because if I chose to keep the pension and defer the payouts, there would be zero salary growth to factor into the DB earnings formula. That $30K annual payout I’ve earned so far to age 50 will be worth a lot less at age 65, and probably will almost be pocket change by age 85 or 90. Fortunately, I’ve been saving some RRSP contribution room for an event such as this, which will help reduce the tax bite a bit. But in this low interest rate environment that maximizes the commuted value payouts and lots of great one-ticket ETFs to choose from, it seems to me that unless your pension has super-generous indexing provisions, commuting is the only way to go for anyone not already at retirement age. Otherwise inflation will just kill the value.
Sorry to hear Eire but I suspect many other folks are going to be in the same position soon – re: involuntary leave.
Certainly if your pension is not indexed, that’s a strike. Meaning, a potential reason to commute. There could certainly be a great loss in purchasing power between now and age 65 to take your pension without penalties. I know mine is structured that way (I take a HUGE hit taking any pension income at age 55 due to early withdrawal penalties.)
Your $30K annual payout is actually fairly close to what mine might be at age 65.
You’ve been very smart to maintain some RRSP contribution room. (I have not. I have none left.) So, you’re right, tax bite will be less for you and that’s always a consideration in this decision based on any case studies I’ve read about.
Indexing, survivor benefits, healthcare benefits with the pension, etc. are very important factors. If none of those apply AND your tax hit is not high then I would largely agree that commuting could be a leading choice.
I’ve always believed unless you are very close to retirement age (> age 55) AND assuming you have multiple years in the plan (>20 or even >25), the far better it is to commute.
Hey Mark,
I have a DC plan that I am currently investing in alongside my employer. The employer contribution is there regardless of whether or not i match it. I currently have been putting in the remaining portion to get to 18%. My question is am I better off putting my portion into a personal RRSP instead? This DC money will need to be put into a RIF when I retire (or a LIRA if I leave before I’m 55). Because of the min/max withdraw rules it seems like under the RIF my payouts will decrease over time as even if I pull the max allowed out the remaining balance will drop over time as I pull that money. Where as if I have the money in RRSP I don’t have to convert it to a RIF until I’m 71. I am currently 34 years old. Also thanks for the content.
Hard for me to answer for you Shawn but here are some insights from me…my situation. I have been fortunate to have a pension at work as well for about 19 years. It’s DB. I contribute to that of course and I also contribute to my personal RRSP on top of that.
If your company is offering a match, I would absolutely take that provided you can invest in some decent low-cost funds.
If your company is not offering any match, I know of some investors who have decided to do just that and invest on their own. This way, they are diversified away from the company should anything happen to it and they have more personal control over the low-cost options.
FWIW, my wife has a DC pension and she also contributes to her personal RRSP – and there is employer contributions automatically for her as part of that DC pension.
Again, we like options and it has gotten us to where we are today 🙂
Thanks for the kind words!
Mark
I commuted my pension at age 47 because I couldn’t and wouldn’t be taking it for awhile, it was not indexed to inflation and I wanted the flexibility that future unlocking a LIRA would allow. 8 years later and it has grown substantially thanks to simple index investing, and will continue to grow even when I do start drawing it. If I hadn’t commuted, it would still be worth the same as when I was terminated.
Smart stuff Carl. I think the benefit (kudos to you) and pun intended, is you stuck with a boring but successful plan in your LIRA and likely avoiding trading in and out of products to get market-like returns. You can certainly build your own pension-like plan but it takes discipline. The last 8 years has been overall very kind to investors.
I suspect the last 8-years or so has delivered a solid 5-6% for you and if so, you likely exceeded any DB pension returns.
Are you going to unlock your LIRA (50%?) based on your provincial rules?
Mark, bit of a different question from this blog. For a 30-34 year old couple, what is a good net worth ($$)? What is a great net worth ($$$)?
Assuming these people live in Toronto or Greater Toronto Area.
Interesting question. “It depends”.
I would say if you have a young family, working your way out of debt (i.e., mortgage) and you have some emergency fund in place – that’s a good start 🙂
Maybe you’ve contributed to your TFSAs too. Even better!
Curious about your question – why the comparison? Do reply and let me know. I can offer this in the meantime:
https://www.myownadvisor.ca/stop-obsessing-net-worth/
Thoughts on that post?
Mark
Hard decision…looking at this in the new year.
With Interest rates so low Commuted value is high now (that is my understanding). Mine comes to about 4.25% return per year based on after tax Commuted value.
My DB pension is 60% COLA to Inflation. My gut feeling is that Inflation will be higher than 2% in the next decade. The 60% to inflation is spooking me, over 30 years that will add up to a significant deterioration.
Add in the option of VBAL\HBAL\XBAL type all in one funds.
The Couch Potato guy shows these all in one fund returns extended to 25 years ( if they had existed)
https://cdn.canadiancouchpotato.com/wp-content/uploads/2020/01/CCP-Model-Portfolios-iShares-ETFs-2019.pdf
Hmmm.
I think inflation will absolutely be higher with time. I bank on that. To combat inflation I will be/will remain invested in utilities, consumer discretionary stocks and REITs. Those tend to do “OK” since they can raise prices, rents, etc. in an inflationary environment.
Natural resources and commodities can also do well in an inflationary environment.
Certainly long-term maturity bonds would be a bad investment and I don’t invest in those. You might want to check how much long-term maturity bonds those balanced all-in-one funds own. A consideration of course, not advice!
When in doubt, personal perspective only, I think any sort of VBAL/XBAL/HBAL etc. will be very pension-like in terms of long-term returns by design.
I wish I could predict the future 🙂
There is one thing that is not accounted for when you decide to commute your DB pension and that is the RRSP pension adjustment reversal. In many cases, the pension adjustment that was calculated every year is much greater than what was put into the DB pension because it is backend loaded. Therefore when you commute your DB pension, then CRA should provide a pension adjustment reversal and therefore give you more RRSP headroom. I was one of the lucky ones to have taken my DB pension out of Nortel as a commuted value.
Another excellent detail Ling. Yes, you were lucky for the Nortel commuted value. I don’t recall everyone being so lucky!
Lots of great insight here Mark. I recently listened to an ExploreFI Canada podcast episode with Ed Rempel and he went into great detail about pensions. I would highly recommend a listen.
As a teacher who will leave teaching well before hitting my magic number this is something I’ve been thinking a lot about lately. When it comes time to pull the trigger I will be talking to a professional as this is a big decision and I want to make the right one for my family.
Yes, I listened to a bit of that and I’m sure he mentioned a few of the things I had in this post. Definitely a LOT to think about.
I think you’re very wise to talk to a CFP about your decision to commute or not if/when the time comes. 🙂
This is good problem to have. With a DB pension I would not commute unless there are some health problems that would shorten life expectancy. As the DB pension will last for the rest of your life and it should have a Cost of Living increase. This means once she turns 55 you can start to withdraw the pension and continue to do so. Not only that as Mark said depending on the survivor benefits it may continue to support the partner.
The best part I think if you don’t commute is the the risk remains with the company, whereas, if you do commute you take on the risk. Then if something happens within the 10 years from 45 to 55 then you may be out many future payments. As how many people would have predicted a pandemic? Unfortunately, we don’t know what will happen in the next 10 years never mind longer.
With big decisions like this it is always good to get multiple opinions. While doing so always remember who your asking’s incentive is, for example, financial advisors have an incentive for you to commute as then if you get them to manage it they will receive fees. Best of luck!
I think pensions that are not indexed to inflation make the decision easier – i.e., commute.
There are many other factors of course. “Unfortunately, we don’t know what will happen in the next 10 years never mind longer.”
This is why I feel it’s important to have many financial options in life, where possible, to reduce risks.
And yes, smart stuff when it comes to looking any financial advisor behaviour. A fee-only planner will avoid that bias.
My advice would be, whatever they finally decide on, to not look back and second guess the decision. No one should leave a DB plan without much consideration and informed advice, however, health cannot be bought – I would rather look back on my life and mourn the loss of a few bucks instead of mourning the affects of a shortened lifespan. Great real life case study – thanks for highlighting it Mark! I too would be interested in knowing what they finally decide to do.
Thanks for this Karen, good comments. No point in constantly second-guessing anything in life. Good decisions can happen at a point in time, we have no idea what the future holds!
This is very much a personal decision but one that I made about 5-6 years ago and I would do it again. The most important factors are age, years to retirement and return (tricky part). Also needs considering – if your DB is indexed to inflation).
I ran the math, many, many times and had others confirm – i took the commuted value and deposited into a LIRA. According to the calculations i needed to only make 4% annually to have a pension that was equal to that of the DB.
Furthermore, the excess payout provided additional benefit. Sure, I was taxed on it but I had enough to clear out my debts and had $$ left over to re-invest. I have been debt-free ever since and because of this, I had more money to invest.
All things to consider. It is however, a very personal decision and based on your own situation. What works for one, may not be the best course of action for the other.
Fully agree about the “it depends” and it’s “personal” decision.
I think it generally makes sense to commute when you do not have many years into the DB plan, AND, you can invest wisely on your own, AND, you have other longer-term income sources to rely on in the future (CPP, OAS, personal portfolio income stream, other). You absolutely need to consider the MTV I wrote about I believe and how you’re going to manage any taxable lump sum. That can be a huge difference maker.
I’m happy to hear it worked for you Mat and thanks for sharing this to help other readers.
Did you have to make a decision about converting your pension to a LIRA as soon as you left your Toronto employer? I would like to retire in early summer and then convert my small DC pension to a LIRA in January of the next year.
I want to take a lump sum early in the year and attempt to move some of the LIRA to an RRSP for flexibility and to try and take a higher amount from the RRSP earlier in my retirement before I start CPP. I want to use part of my RRSP to fund my TFSA every year. I am a dividend focused investor and my goal is to keep loading my TFSA, from my RRSP and LIRA, to draw those down and to not have to touch my TFSA principal for as long as possible. This is all so complicated.
I did, I recall I had a few days to consider it. I went with a LIRA for me, because, I didn’t have many years in the plan (~5), I knew I had a long-time horizon to invest on my own and likely achieve market-like returns (I have), I knew I was moving to a DB plan with my future employer, and other factors.
I wouldn’t see this a simple decision by any stretch. A fee-only planner with a CFP designation might an excellent way to run some numbers and see what is of benefit to you; tax efficient, other. They have knowledge, experience and software to run models which can be invaluable to determining your risk-level with this decision. Just my take of course!
Mark
This is such a huge decision. You also have to consider other personal savings and the future value of CPP and OAS. I know that is a long way off but it counts. I come from the teaching world. My wife stopped working to raise our three fraggles and do volunteer work. She wasn’t vested in her DB pension yet so her contributions were transferred into RRSP. We will never regret that choice. Raised our family on a single teachers salary and still had lots of fun. I often suggest to two married teachers to consider commuting one pension and keeping one in place. Can leave a legacy fund for kids. When both teachers pass all payments stop once you get beyond the guaranteed payment period. That seems a shame.
Definitely seek some professional guidance on this one and don’t rush the decision. Good luck – nice problem to have.
Sounds like you have no regrets – very good of course – so hard to know what the future holds!
I think the reader was going to seek out a fee-only planner for that decision for sure. I would be interested to know what they finally chose and why.
I know for me, and I can only speak for my intentions vs. others, I have plans to keep my DB pension with my employer assuming I’m still there in a few years. Certainly knowing the exact commuted value will be important in that decision/my decision. Time will tell. So many factors at play and comfort and risk-levels of those involved.
Thanks for sharing your experience.
I’ve retired in my 40s and have decided to keep my teachers pension in the plan since our investments are 100% equity so this portion will be our fixed income part of our portfolio. It’s guaranteed money! Even though I’m confident we could manage our portfolio with the commuted value, this gives another layer of security and income stream.
One needs to look at what will work with their own personal situation.
I think that’s very smart Sabrina and it’s absolutely a personal decision. A teacher’s pension is very valuable and traditionally well invested.
Hard to go wrong with the long-term security a teacher’s pension can provide – fixed income for your future!
Thanks for your perspective.
Sabrina, that’s just how we thought about our to commute or not to commute question. We also, as you may have done too, considered our mental capacity at later ages to manage our own investments and the potential risks; you can’t easily, if at all, be scammed out of your entire DB fund.