Clients with defined benefit pension plans may reach a point where they must decide whether to take the pension or commuted value.

While there are numbers involved, the decision usually incorporates factors that can differ for each person. It’s our job to walk clients through all those factors so they can make an informed, appropriate decision.

Meet Robert

Robert is a 50-year-old former teacher now working in sales and making $90,000 a year. His investment assets are as follows:

  • RRSP $80,000
  • TFSA $17,000
  • Non-registered $177,000

He has two choices for his teacher’s pension:

  1. Take an annual pension of $40,000 starting at age 55, indexed at 70% of the Consumer Price Index annually. He can’t defer his pension, so it must commence at age 55.
  2. Take a total commuted value of $606,998.22, which consists of two parts:
  3. a maximum transfer value of $376,000 that can be transferred to a Locked-In Retirement Account (LIRA) and
  4. an excess amount of $230,998.22 that must be paid in cash, less applicable income taxes.

Robert has no RRSP room available. He’d like to keep working until he’s at least 60 years old and would consider deferring retirement to age 65, if necessary. He’s a moderate-risk investor and is meeting with you to review his situation and decide which option is best.

Step one: Run the numbers

The first thing you and Robert want to understand is the financial impact to his retirement income if he takes the pension versus the commuted value. To make this an apples-to-apples comparison, compare retirement income starting at 55 (the age the pension must start). The analysis should show three things:

  1. How taxes impact the excess amount of the commuted value. For Robert, this presents an upfront income tax cost of about $100,000, with the remainder available for investment.
  2. How long the commuted value would last based on Robert’s investor profile, while trying to replicate the pension income stream. Robert can’t fully replace the pension income beyond age 72 if he takes the commuted value and starts drawing it at age 55 (see Chart 1).
  3. The value of the cost-of-living adjustment associated with the pension income. While the pension income increases over time, Robert’s ability to match the increasing income with the commuted value declines throughout his retirement.

Robert has stressed that he wants to retire comfortably. This should be quantified by projecting after-tax retirement expenses. By putting a dollar figure on a comfortable retirement, we can see if Robert meets this income need under the pension or the commuted value. We can also see how significant the pension income is in relation to his overall retirement income.

Step two: Customize the plan

Now it’s time to provide Robert with retirement income projections based on retirement ages of 60 and 65. For the pension scenario, the first calculation should provide the projected pension income throughout Robert’s retirement, regardless of when he decides to retire. We could look at investing the pension income between 55 and 60, or 65, to try to minimize taxes for the years he’ll be working and receiving the pension. With earned income during those years, he’ll accumulate new RRSP contribution room, which he could maximize to reduce taxes. His TFSA contribution limit can also be maximized to reduce income taxes on future income and on investments held within it.

If he waits until 60 to begin payments, he can replace the pension income until age 82 (see Chart 2). If he waits until 65 to begin payments, he can replace his pension income for the entire time horizon (age 90; see Chart 3). While this may seem positive, it’s based on a number of assumptions, including a fixed annual rate of return.

And our projection cannot accurately predict income for every year of his retirement (about 25 to 35 years). What if the markets experience negative returns (which is likely over a 30-year-plus time horizon)? Is Robert prepared to bear this risk if he takes the commuted value?

Step three: Other considerations

While the commuted value provides Robert with the ability to determine when he will start drawing an income, this flexibility has limits. When payments are initiated in a locked-in plan (typically after conversion to a Life Income Fund), there is both a minimum and maximum payment. The maximum payment caps how much can be withdrawn annually. The federal, and some provincial, pension legislation allow the unlocking of funds beyond the maximum payment. The options vary by legislation, and criteria must be met before funds can be unlocked. As Robert’s advisor, you must review these options with him.

Next, consider longevity. If outliving money is a concern, that bodes well for the pension option, since longevity risk rests with the pension plan. If longevity doesn’t run in the family, the commuted value may be preferred. Robert tells you that his mother died at 68 from an unknown illness and that his father, currently 77, has had a heart attack and cancer. However, we don’t know ultimately when our time will come, so, if the commuted value is taken, Robert will assume the longevity risk.

Hand-in-hand with longevity are estate considerations. Robert currently doesn’t have a spouse and has indicated that his children from his first marriage will receive an inheritance funded by insurance. If he doesn’t have a spouse when the pension payments begin, he’ll have to choose a single-life pension option or a joint-and-survivor option with a dependant named as nominee.

Robert will also have the option of selecting a guarantee period. Guarantee periods (commonly five, 10 or 15 years) allow the pension to continue to be paid to Robert’s chosen beneficiaries or estate if he dies during that period. For example, if Robert chooses a 10-year guarantee period and dies in year four, his pension payments will continue to be paid to his beneficiaries or estate for the remaining six years. The single-life monthly pension may be reduced when a guarantee period is chosen to reflect the value of that additional estate feature. Alternatively, if Robert chooses no guarantee period, the pension stops at his death.

If Robert has a spouse when his pension payments begin, he must choose a spousal pension option, unless his spouse waives the right to a survivor pension in writing. The survivor option allows for a pension to continue to the surviving spouse when Robert dies (or his pension continues to him if his spouse predeceases him). For Robert, he’s found there are three choices:

  1. 100% pension. When either he or his spouse dies, the survivor continues to receive 100% of Robert’s pension income.
  2. 67% pension. When either he or his spouse dies, the survivor continues to receive 67% of Robert’s pension income.
  3. 60% pension. If Robert dies first, his surviving spouse receives 60% of his pension. If Robert’s spouse predeceases him, Robert continues to receive 100% of his pension.

Robert’s future pension amount can be adjusted to reflect the chosen pension option. So, it’s important to review all pension options, and understand the costs and benefits associated with each.

With the commuted value, Robert can bequeath any remaining assets to his chosen beneficiaries. If he has a spouse, the spouse is the beneficiary of the locked-in funds, unless the spouse declines in writing. The question then becomes: How much money will be available for beneficiaries at Robert’s death? This depends on a number of factors, including investment returns, income drawdown and Robert’s age at death. In other words, there could be no assets at death.

Finally, the financial stability of the employer and pension plan should be reviewed. Is the pension plan well-funded? Are there concerns about the employer’s future financial stability or the plan’s ability to remain funded? If so, the commuted value option could mitigate this risk. Do research by reviewing the documentation provided to Robert with his pension options or by obtaining financial information directly from the plan. In this case, Robert expresses confidence in both the employer and the financial state of the plan, so they may carry little weight in his decision.

Finally, as an advisor, you stand to gain new assets and revenue if Robert takes the commuted value and invests with you. The pension plan could also benefit financially from a decision that Robert makes. Explain these potential conflicts to Robert clearly.


Despite the volume of information Robert has already provided you, it’s clear that you must obtain more information from him and the pension plan to help Robert make an educated decision.

Our role as advisors involves helping clients like Robert understand the financial implications of taking either the pension or commuted value in the context of considerations such as income flexibility, longevity, estate planning and the financial condition of the pension plan. If we take time with clients, we can help them make informed decisions for long-term financial well-being. In this way, we become the advisors that clients need now and throughout retirement.

Chart 1: Start drawing at 55, income replaced until age 72, Chart 2: Start drawing at 60, income replaced until age 82 and Chart 3: Start drawing at 65, income replaced until age 90

Curtis Davis, FMA, CIM, RRC, CFP, is senior consultant, Tax, Retirement & Estate Planning Services, Retail Markets at Manulife. Reach him at