Members of defined benefit (DB) pension plans may be able to commute their pensions when they retire or leave the plan. There are many considerations when deciding whether to take a lump sum or to draw the pension.

Clients may be asking about lump sums since the current low interest environment has driven up commuted values (CVs). For clients with generous plans and many years of service, CVs can top $2 million, making the CV their largest asset.

Advisors need to take considerable care in providing appropriate advice to their clients. Inappropriate advice can put the plan member’s retirement at risk and result in litigation for the advisor.

This article assumes that the advisor has determined that commuting is an appropriate choice, and lays out certain considerations.

Is the plan member entitled to commute the pension?

Plan members and their advisors must look at the pension plan’s provisions since a CV is not always available. For instance, the Pension Benefits Act (Ontario) provides that an employer can establish a plan with a normal retirement date (NRD) no later than one year after the plan member turns 65, and that in the 10 years leading to the NRD, a member can only commute the pension if the plan permits.

While many plans do not allow a pension to be commuted once the member is in that 10-year period, some do. The plan member will want to know what the NRD is, and whether commutations are permitted in that 10-year period. If the plan has a NRD of 60, for instance, the 10-year window would start at age 50. The plan member would also want to know whether a commutation is available at a later point (e.g., while he or she is a deferred member).

The maximum transfer value

The amount that may be transferred from a plan’s DB provision to an RRSP, DPSP or defined contribution provision of an RPP is subject to a cap called the maximum transfer value (MTV). This value imposed by the Income Tax Act (ITA) takes into account the plan member’s age. Anything above the MTV is taxable as regular income in the year it is received.

Case study: calculating the MTV

Let’s look at Alissa, who works and lives in Ontario. She turned 55 on Nov. 1, 2017, when her monthly pension was estimated as follows:

Lifetime retirement benefit (LRB) $4,600
Bridge benefit payable until age 65 $800
Total $5,400

Alissa’s plan allows her to commute her pension when she is within 10 years of the NRD. The pension administrator provided Alissa with the following estimates (rounded to the nearest thousand):

Maximum transfer value $574,000 (37%)
Excess $985,000 (63%)
Total commuted value $1,559,000 (100%)

To calculate the MTV, we need to know Alissa’s exact age on the date of transfer to determine the associated factor as per Section 8517 of the Income Tax Regulations. On Nov. 1, her age is exactly 55. The present value factor specified in Section 8517 is 10.4 (see Table 1).

We then annualize the LRB (12 x $4,600 = $55,200) and multiply it by 10.4. This gives us $574,080. The bridge benefit of $800 does not enter into the calculation.

Given the excess of $984,920, Alissa will have quite the tax bill. Since she has been receiving employment income for the first 10 months of the year and has other income, most of the excess will be taxed at the top rate. (In Ontario, the top marginal tax rate for 2017 is 53.53% once taxable income exceeds $220,000.) That means the taxes owing on the excess could be more than $500,000.

Table 1: Present value factors in Regulation 8517

Note: Between ages 49 and 64, the factors are interpolated. If, for example, a person is aged 55.5, the present value factor is 10.5.

Age Present value factor Age Present value factor
Under 50 9.0 73 9.8
50 9.4 74 9.4
51 9.6 75 9.1
52 9.8 76 8.7
53 10.0 77 8.4
54 10.2 78 8.0
55 10.4 79 7.7
56 10.6 80 7.3
57 10.8 81 7.0
58 11.0 82 6.7
59 11.3 83 6.4
60 11.5 84 6.1
61 11.7 85 5.8
62 12.0 86 5.5
63 12.2 87 5.2
64 12.4 88 4.9
65 12.4 89 4.7
66 12.0 90 4.4
67 11.7 91 4.2
68 11.3 92 3.9
69 11.0 93 3.7
70 10.6 94 3.5
71 10.3 95 3.2
72 10.1 96 or older 3.0

Why is Alissa’s excess so large?

Alissa belongs to a generous, indexed pension plan; the richer the plan, the larger the tax liability if she commutes the pension. We also know that using low interest rates in the CV calculation makes the resulting number larger.

There’s also a policy reason for the relatively small MTV: the outdated “factor of nine.”

When the tax rules relating to retirement savings were overhauled in 1990, the Department of Finance theorized that saving 9% of annual earnings would let a person acquire a life annuity providing 1% of pre-retirement income. But that assumption no longer holds up. In a November report, “Rethinking Limits on Tax-Deferred Retirement Savings in Canada,” the C.D. Howe Institute pointed out the factor of nine was derived assuming real returns at 3% and using a 1971 mortality table. Moreover, the benchmark DB plan used to arrive at the factor was not as generous as, say, Alissa’s current plan.

C.D. Howe’s report suggests that, in today’s environment, a factor of 20 should be used for the benchmark DB plan, a factor of 25 for a generous plan like Alissa’s and a factor of 15 for a basic DB plan.

Indeed, if the factors were updated, Alissa’s tax issue should be mitigated.

What should Alissa do?

Alissa and her advisor must carefully consider next steps. Let’s assume they decide commutation is the preferred approach.

Alissa’s pension adjustment has eliminated most of her RRSP room, and let’s say she also maxed out her RRSP contributions over the years. Thus she cannot contribute any excess to her RRSP. The $500,000 in taxes owing on the excess will erode the capital she can use to generate retirement income.

Fortunately for Alissa, there are two potential solutions that may allow her to transfer her CV out of the plan while mitigating the $500,000 in tax. A high-level discussion of these two potential solutions follows, and will be examined further in a subsequent article.

Excess room: the Section 147.4 copycat annuity solution

According to Ontario’s pension legislation, if a member is entitled to commute their pension, the plan may allow the member to acquire a life annuity with the CV. (Pension standards legislation in many other jurisdictions includes similar language.)

Advisors are not necessarily familiar with these annuities. Until a few years back, conflicts between the pension and tax legislation resulted in a situation where few plan members acquired life annuities with their CVs. Termination statements provided to plan members often state that there may be adverse tax consequences to acquiring an annuity. This is because Section 147.4 of the ITA provides that the entire CV is taxable if the rights under the annuity contract are “materially different” from the rights under the pension plan. Thus, the advisor will want to ensure that the life annuity that is acquired is not considered by CRA to be materially different. We’ll review these issues in a future article.

Excess room: the Individual Pension Plan (IPP) solution

Termination statements typically allow the plan member to transfer the CV to a DB pension plan with another employer, as long as the other DB plan accepts the transfer. An IPP is a DB pension plan that could accept the CV transfer. However, CRA (and in Alissa’s case, FSCO) have specific requirements for this to be allowed.

One specific requirement is the “primary purpose” test. In Regulation 8502(d), the ITA requires that the “primary purpose of the plan is to provide periodic payments to individuals after retirement in respect of their service as employees.”

In other words, if CRA determines the IPP was set up so that Alissa could avoid tax on the excess rather than accrue a pension at her new employer, CRA will revoke the registered status of the IPP. Thus, anyone contemplating the IPP solution must be sure to meet the “primary purposes” test and also adhere to all of CRA’s and the applicable pension regulator’s other requirements. Moreover, other considerations relating to the implementation of the IPP will have to be assessed. Again, we’ll review these issues in a future article.

Special rules


If the member dies, the MTV rules do not apply for transfers made to a surviving spouse’s RRSP (or DC RPP).

Breakdown of marriage or partnership

If there is a breakdown of a marriage or common-law relationship, and an amount is transferred to an RPP, RRSP or RRIF of the other spouse or common-law partner, the MTV rules do not apply. The transfer must be pursuant to the terms of a decree, order or judgement of a competent tribunal, or under a written agreement. (Ontario requires that the transfer be to a locked-in retirement account or a life income fund.)

Transfer from a plan that isn’t fully solvent

Some jurisdictions do not allow a member to transfer out the entire CV if the plan is not fully solvent. In such a situation, the MTV calculation is based on the proportion of the benefit paid at that time. Similar calculations are done when subsequent payments are made.

Non-commutation of the bridge benefit

A plan may allow a member to commute only the LRB and not the bridge benefit. If this is the case, the bridge benefit would be paid by the plan and the LRB would be commuted. (If Alissa were able to do this, the $984,920 excess would have been reduced by the CV of the bridge benefit.)


Several issues come into play when deciding whether a pension should be commuted. In many instances, the appropriate decision may be for the member to remain in the plan. Make sure to obtain specialist advice when clients are considering the associated factors.

Lea Koiv, CPA, CMA, CA, CFP, TEP, is a tax, pension and retirement expert who has held senior roles at a national insurer and international accounting firms. Reach her at

Originally published in Advisor's Edge Report

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