Which is the better option? Drawing the guaranteed lifetime pension from the plan, or taking the commuted value and investing separately?
An increasingly common question which GBL receives is this: “I am enrolled in my company’s Defined Benefit plan and am nearing retirement age. Should I remain in the plan and draw a lifetime pension, or take the commuted value and invest it with my Advisor?”
Registered Defined Benefit pension plans (DB Plans) are required to provide portability to their members in the event of a member’s termination of employment before attainment of early retirement age, often age 55. Many DB Plans will also permit portability after the member attains their early retirement age if they haven’t yet started to receive their pension. Portability is provided by permitting the member to choose the lump sum value of their pension entitlement (called a Commuted Value or CV) instead of receiving a future lifetime pension from the DB Plan. In deciding between lifetime pension or commuted value, it is important to understand the financial implications of each option.
There is no obligation for a DB Plan to provide members with an estimate of what their CV would be before the member actually terminates employment. The lack of a CV estimate leaves many members in a difficult situation when attempting to perform retirement/financial planning; they need to know the amount of their CV to appropriately review all their future options. They don’t want to terminate employment just to obtain information on the CV amount.
GBL Can Help Provide Clarity to the Lifetime Pension or Commuted Value Dilemma
GBL can assist in these situations. We have worked with many individuals, participating in various DB Plans across the country, to estimate DB pension CVs. This service provides the individual with the ability to perform their financial planning without terminating employment and without letting their employer know that they might even be considering terminating employment. In addition, we provide such clients with additional insight from our actuarial team about their specific circumstances. For example, we would typically provide:
The estimate of the CV
Details on how much of the CV would be tax-sheltered in their locked-in retirement account and how much would have to be paid as a taxable lump sum payment
Insight on how to receive the CV to reduce tax consequences on the taxable portion
Insight on the value the employee might be “leaving on the table” if they terminate employment immediately just to obtain the CV option and not participating in the DB Plan for the next year or two
A better understanding of any other issues we see in the determination of their CV related to their specific circumstances
The decision for a DB Plan member to choose a lifetime pension or the CV should be based on an assessment of their overall retirement/financial plan because there are financial risks between the choices that need to be considered and reflected. We encourage members to share our determination of the CV, and our insights on their pension entitlements, with their financial advisors as part of their overall financial review.
Case Study # 1
Background
Bob turns age 55 in May 2025 and his wife, Jane, is 3.5 years younger. Bob participates in the Alberta Local Authorities Pension Plan (LAPP) where he will lose the ability to take a CV if he continues to participate until attaining age 55. His most recent annual statement as at December 31, 2023, shows credited service of 21.25 years and an accrued annual pension of $34,615. His 2024 earnings were $115,000 due to a promotion, and his current 2025 rate of earnings is $118,000. He indicates that he would like to work until about age 58 but wants to possibly terminate employment now to get the CV option. If he does terminate, he plans to work elsewhere until about age 58. He has requested a CV estimate now to help him decide. If he chooses not to take the CV, he would continue to work in his current role until age 58.
CV Estimate at March 31, 2025
Age:
54.9167
Credited Service:
22.5 years
Accrued Annual Pension:
$38,415
CV:
$514,800
Portion to be transferred to LIRA:
$398,900
Portion to be received at taxable payment:
$115,900
Insights About Lifetime Pension and Commuted Value Calculation:
LAPP is expected to change CV assumptions effective April 1, 2025. Based on most recent actuarial valuation, it is expected that his CV would be reduced by $5,400 on April 1. This reduction would come out of the taxable payment portion.
In taking the CV, there would be no effect on unused RRSP contribution room with the transfer to the LIRA. The taxable portion can be tax-sheltered to an unlocked RRSP the extent that Bob has unused RRSP contribution room, with such transfer reducing his ability for future RRSP contributions.
The taxable portion is added to taxable income in the tax year of payment.
Bob is in a key period for his LAPP service accrual where he would be forfeiting substantial additional pension value of accruing benefits by terminating currently. Specifically, if he worked 3-more years as planned:
He would have 3 more years of recognizing his higher salary reflected in his highest average earnings, which affects he entire accrued pension
Bob is in the part of his career (between 20 and 30 years of credited service) where each additional year of work will reduce the early retirement reduction on his entire accrued pension by 2 years, or 6% per year. Currently, his pension commencing at age 55 would be reduced by 22.5% for early commencement. If he terminated employment but chose not to commence it until age 58, it would be reduced by 13.25%. If he works until age 58, and then commences his pension, his entire LAPP pension would only be reduced by 4.25%.
Bob would be required to make employee contributions during the period of continued service until age 58, but even after deducting these employee contributions, and deducting the interest that he might have otherwise earned by investing his current CV, the extra value of the increase in pension during the period to age 58 has the equivalent value of getting about 40% of salary per year contributed to a retirement program. To take the CV, Bob would be walking away from the most valuable portion of pension accrual in his career.
All of the above are substantial issues regarding the pension that Bob and his spouse should discuss with their financial planner/advisor as part of their overall financial plan.
Case Study # 2
Background
Sue turns age 55 in April 2025 and her husband, Sam, is 4 years older. Sue participates in the Alberta Public Service Pension Plan (PSPP) where she will lose the ability to take a CV if she continues to participate until attaining age 55. Her most recent annual statement as at December 31, 2023 credited service of 31.25 years and an accrued annual pension of $63,400. Her 2024 earnings rate was $122,000. She indicates that she would like to work until age 60 but is considering terminating employment now to have the CV option. If she does terminate, she plans to work elsewhere until age 60. She thinks she can get a comparable job with comparable pay. She has requested a CV estimate now to help her decide. If she chooses not to take the CV, she intends to continue working in her current role until age 60.
Commuted Value Estimate at November 30, 2024
Age:
54.9167
Credited Service:
32.17 years
Accrued Annual Pension:
$65,271
CV:
$1,221,400
Portion to be transferred to LIRA:
$678,800
Portion to be received at taxable payment:
$542,600
Insights About Lifetime Pension and Commuted Value Calculation:
In taking the CV, there would be no effect on unused RRSP contribution room with the transfer to the LIRA. The taxable portion can be tax-sheltered to an unlocked RRSP the extent that Sue has unused RRSP contribution room, with such transfer reducing her ability for future RRSP contributions.
The taxable portion is added to taxable income in the tax year of payment. Given the timing of the termination, it would likely be paid, thus taxable, during 2025.
If Sue continued to work in her role until age 60, she would only continue to accrue pensionable service until age 57.75, when she reaches the 35-year maximum accrual under PSPP.
Because Sue is eligible to commence her accrued pension at age 55 without reduction for early commencement, continuing to participate reduces her net pension value.
What this means is that the expected value of her accrued pension in the future, after deducting the value of the contributions she would be required to make to the pension in the interim, and deducting the interest that she otherwise would have been able to earn on the current CV, would be less than the current CV.
If Sue ultimately decides that she prefers the financial security of the lifetime pension income, she still might be financially better off to terminate employment currently, take the accrued lifetime pension of $65,271 per annum, and seek the comparable job. Other options include:
If Sue terminates, takes the CV, and is subsequently re-hired into her role, she would rejoin PSPP as a new member and earn pension credits all the way until her subsequent retirement at age 60, instead of only until age 57.75.
If Sue terminates, takes the lifetime pension, and is subsequently re-hired into her role, she would have the option to re-join PSPP, but have her pension payments suspended in the interim, or continue to receive the pension in addition to her salary, and have RRSP contribution room from such employment.
All of the above are substantial issues regarding the pension that she and her husband should discuss with their financial planner/advisor as part of their overall financial plan.
If you or your client have questions about what to do with a DB pension plan, GBL would be happy to assist.
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, RCA, 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
