Posted under: DB
Pat Johnston and Rob Easton
February 19th, 2025
Members who terminate from defined benefit pension plans (DB Plans) are generally provided the choice of either:
Such members often ask us at GBL “Which option is better: Lifetime Pension or Commuted Value?”
This article shows how this seemingly “simple” question has no simple answer. The classification of “better” is a matter of probability. Choosing one option results in financial risk to the member relative to selecting the other option.
Actuarial analysis is key in better understanding the pension-related risks and resulting financial trade-offs. Determining which pension option is “better” for the member is a risk management exercise regarding the member’s entire financial/retirement plan. To properly manage this risk, the member should consider working with a financial/retirement planner with the actuarial analysis of the pension option as one of the many tools.
In simple terms, a CV is the lump sum amount that would need to be invested today, which along with assumed investment income, would provide for the expected future pension payments that would have otherwise been paid to the member from the DB Plan.
A key element in the above description is “expected future pension payments”. The word “expected” implies probabilities. It is not known how long the member and/or spouse will live, therefore mortality probabilities are applied. The CV is a probability-weighted average of the amount that would need to be invested to provide for the future lifetime(s). The amount that is actually needed could be substantially more if the lifetimes are longer than average, or substantially less if the lifetimes are shorter than average.
Consider an analogy: An individual is playing a game where they would receive $1,000 x the roll of a pair of dice. In this game, they would receive anywhere from $2,000 to $12,000 with varying probabilities. Instead of playing this game, they are offered a CV of $7,000 (the average payout). Which is better, playing the game or taking the CV?
Taking the CV instead of playing the game:
A pension CV is often misinterpreted as being able to provide a drawdown of the pension income for the remainder of the member’s/spouse’s lifetimes. It isn’t! Even if the other assumptions used in determining the CV (such as investment returns and inflation rates) are exactly matched in future experience, the equivalent pension drawdown would only continue until the assets were depleted. In rough terms, there would be about a 50% chance of the assets being depleted prior to deaths of the member and spouse, and about a 50% chance of the member and spouse both dying prior to the depletion of assets leaving an asset for the estate.
The following table indicates the tradeoffs:
| Mortality Outcome | Taking Lifetime Pension | Taking CV |
| If member/spouse both die several years before average life expectancy | Risk is that there is no (or very little) estate value in this scenario | No risk – There would likely be substantial assets remaining from the drawdown of the CV for the estate |
| If either member or spouse live for several years longer than average life expectancy | No risk – pension and/or survivor pension would continue until death, regardless how long member or spouse lives | Risk is that investment from CV would have been depleted and provide no continuing pension |
| If death of the survivor of the member or spouse is within a few years of their life expectancy. | Not a material deviation – pension would continue for the lifetime of the member and likely no estate value. | Not a material deviation – there might be little estate value left over, or the assets might have been depleted for a short period.* |
* Although the value of the risk in this specific mortality scenario is limited, there is a very substantial stress-related risk at the time the assets are approaching depletion. Specifically, it is not usually known in advance that the mortality outcome will be in this category, rather than the scenario where survival of either the member or spouse continues substantially longer than average.
In performing the actuarial analysis we reflect:
Plan members are advised not to play a game of chance with this important decision. The decision to take the lifetime pension or CV has consequences; sometimes considerable. For those Defined Benefit plan members nearing retirement and wondering if they should take the lifetime pension or take their CV money and run, GBL can complete an actuarial analysis will outline the probabilities and expected outcomes of both options. This will help those plan members optimize their decision for themselves and their families.
Founded in 1995, GBL is a leading provider of retirement, health, and cross-border solutions for business owners, and corporate pension administration across Canada. With offices in Calgary and Toronto, we have served 7,000+ clients, have 3,000+ Financial/Investment Advisors in our network, actively manage 2,000+ IPPs, RCAs, and SERPs. We have created 1,000+ HBPs and 3,000+ FMVs. We’re known for our industry leading client service and administration, as well as our top-notch actuarial group. Contact us today at [email protected] or 403.249.1820 and follow us on LinkedIn to learn how we can help Build Your Future. www.gblinc.ca
