In October 2016, I was quoted in an article about whether to commute a defined-benefit pension.

A reader asked if my answer about whether to commute Georgi’s pension would be different if the following variables were changed:

  • His pension is indexed.
  • It is an Ontario Teachers’ pension.
  • He has decided to work until age 65 and makes approximately $150,000 per year.

In the original article, Georgi is 50 years old and no longer working. The health of his company was questionable and the pension was not indexed to inflation. After weighing his options, Georgi took the commuted value, transferring the eligible amount to a Locked-In Retirement Account (LIRA) and taking the balance as taxable income.

Georgi had 26 years of service and would receive a lump sum of $800,000 if he took the commuted value. At a 53% tax rate in Ontario, Georgi would be left with $394,800 in his LIRA and $202,600 in an after-tax non-registered account.

Read: Commute this pension or not?

Georgi’s changed circumstances

  • Pension is indexed. An indexed pension will provide Georgi with an income stream that will increase in value every year. There are not many indexed pensions, so staying in the plan can provide Georgi with an income that can continue to cover his expenses when his cost of living increases due to inflation.
  • Pension is administered by Ontario Teachers’ Pension Plan. This pension plan is large, healthy and well-run. Georgi can be comforted knowing that his pension benefits are more stable than they would be in the company used in the first example.*
  • Georgi decides to keep working to age 65, with an income of $150,000 per year. This fact would result in income tax consequences should Georgi commute his pension. There would be increased income tax for Georgi to pay, with the same amount of pension monies flowing into his LIRA.

Read: 5,000 people retire each week. Are we ready?

The solution

With Georgi working until age 65, he has an income coming in, so he doesn’t need the cash flow from commuting his pension. With the indexation of his pension, Georgi decides to leave his pension intact and wait to draw on his full pension at age 65.

As you can see, no two situations are the same. Encourage clients to speak to you before deciding to commute or stay in a defined-benefit pension.

Would you do the same thing? Email us or comment below.

*Note: an earlier version of the column suggested that Georgi and Liesel would receive health benefits under the pension. Mike Foulds, president of the Ontario Teachers’ Federation, tells us that the pension plan does not offer such benefits (the Ontario Teachers Insurance Plan and the Retired Teachers of Ontario do). We regret the error. Return to the corrected sentence.

Carol Bezaire, PFPC, TEP, CLU, is the vice-president of tax and estate planning at Mackenzie Investments. Carol can be contacted at:
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Duncan Badger

When making the decision you need to know the discount rate the pension administrator used to calculate the lump sum amount. The last one I saw used 1.9% for the first 10 years and 3.2% after that. I think companies are required to provide this information now. So with this information on a person knows as long as their future returns on their invested commuted value exceeds the discount rate the pension plan used they would be further ahead. If the pension plan has built in inflation assumptions that should also be indicated in the pension administrators report to the terminated employee. In the case above it was 2%. So, In my mind as long as the individual expected to make a return on their investments better than the discount rate plus inflation they would be better off.

In your example you cannot change the assumption to add inflation to the pension amount without also increasing the commuted value to also reflect future inflation.

Friday, Jul 21, 2017 at 12:15 am Reply

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