Hello;
Individuals in career transition who are vested members of a pension plan will be faced with the decision whether to leave the vested pension entitlements on a paid up basis with the company and eventually receive pension income, or transfer out the pension entitlements.
Irrespective of which path you choose, when a pension plan member leaves his or her employment, the employer is required to provide details of the employee’s pension value and options. The employee then has a specified time period within which to respond. The options are typically set out in a pension option statement. Generally, there are 4 options:
1. Leave the pension benefits with the former employer and receive a pension payment in the future. This is usually called the deferred pension option.
1.1 It’s important to point out that if this career transition is taking place within 10 years of your normal retirement age, you may also be offered the option to start receiving your pension right away but at a reduced rate.
2. Transfer your pension to your new employer’s pension plan.
2.1 This option requires that your new employer is willing to accept the transfer and take up the liability of managing your pension. Generally, public sector employees can utilize this option as there are existing transfer agreements between pension plans. This option is less likely if you are in a private sector defined benefit plan.
3. Transfer the pension value to an insurance company to purchase a deferred annuity.
3.1 The trade-off with this option is you will receive guaranteed lifetime income, but you relinquish control over your money.
4. Transfer the commuted value to a Locked-In account (LIRA)
4.1 The commuted value represents the amount that must be invested today to fund the pension benefits when you retire. The value is derived based on actuarial calculations.
4.2 The commuted value is transferred to a Locked-In Retirement Account (LIRA). The money is locked in, meaning that in most cases you cannot access the funds until a specific age. Also, to receive income from those funds, you will gave to set up a life income fund (LIF).
4.3 Exceptions to the locked in feature exist for pensions with small value, or where there is medical evidence of a shortened life expectancy, or if the individual claims financial hardship.
4.4 If you decide to take the commuted value of your pension, you might be eligible for a pension adjustment reversal (PAR). The PAR represents pension adjustments previously reported that are greater than the commuted value actually paid out. The outcome is an increase in your RRSP room equal to that difference in the year the commuted value is transferred out.
Which Option is Best?
The answer is usually influenced by which option provides you with the best cash flow throughout your retirement. In order to answer this question, some additional information is needed about the features of your pension.
- Is the pension benefit inflation adjusted?
- What is the survivor benefit?
- Is the pension benefit integrated with the Canada Pension Plan (CPP)?
- What portion of the commuted value has to be paid out as cash because it exceeds the amount that the government will allow to be transferred on a tax sheltered basis into a locked-in registered plan? This cash portion will be taxed in the year it’s received and future investment income will not be tax sheltered.
Other factors to consider when determining the best option for you include:
- If you covet income security, then the best option is keeping the pension with the employer or purchasing a deferred life annuity through an insurance company.
- If you like having control and flexibility over your money, then taking the commuted value is the best option. This option means that you assume responsibility for the performance of your investments, so having a trusted financial advisor to share this responsibility with you is recommended.
- Sometimes, the best option involves considering your spouse’s situation. Does he or she have her own pension which affords you greater flexibility to decide what to do with yours?
- The pension option normally provides that, in the event of your passing, your spouse is entitled to a reduced survivor benefit for his or her lifetime. However, if you do not have a spouse, then commuting your pension may be more attractive because on your passing, the full balance of your portfolio will form part of your estate and can be transferred to your heirs.
Sincerely, Mani Fenili
