Commuted Value of Pension Plan

[Retire Hopeful]

What would you do? Only 1 year until retirement with a monthly pension or take the commuted value? Have to add that the company may or not make it during the economic downturn.

[George]

I'd talk to a financial planner - or better yet, a few of them - and seek their advice. A lot of the decision comes down to the security of the pension itself versus the security of the funds if they're in your hands.

If the company fails, that doesn't necessarily mean that the pension plan will fail. That said, it's a possibility.

If you take the commuted value, there's the risk that those funds will drop in value or not grow enough to provide you with the lifetime income you would have received from the pension.

There are risks on both sides, so it'll be up to you to get some professional advice and make your own call as to what'll let you sleep at night.

[johnsazzr]

There may be another option...under the pension act , you can take your pension commuted value to an ins company and buy an annuity which 100% mirrors your actual pension plan...including bridging and spousal benefits,,this eliminates having to take a large lump sum in taxable cash as CRA limits the amount of your commuted value you can tfr directly into a locked-in plan based on age and years in the plan...the highest amount I have seen is just under 400k..the balance had to be taken in cash..which in some cases means 200k+ in taxable cash.

Its unfortunate that GM employees weren't made aware of this 6 months ago..I fear now it may be too late for them to exercise this unknown option.:(

[Retire Hopeful]

I've already talked to two financial advisors and one thinks I would do better with the commuted value. The other one said that the pension would be better. Of course it is ultimately my decision and I just want to make the best informed decision that I can. Buying an annuity is an option but with interest rates so low the timing is not good. I just wish I had a crystal ball!

[CanadianCapitalist]

There may be another option...under the pension act , you can take your pension commuted value to an ins company and buy an annuity which 100% mirrors your actual pension plan...including bridging and spousal benefits...

That's very interesting. Good to know.

[gwcanuck]

Don't forget that if you take the commuted lump sum, you may have to forfeit other retirement benefits ie. health care coverage.

[MoneyGal]

Depending on the financial advisor, he or she likely has a (hidden) interest in recommending you take the commuted value: he or she has no chance of managing the pension option, while, if they work on commission, would love to take a large lump sum under management (what's 5% of the lump sum?!)

Another way of looking at this is to determine the implicit rate of return in the pension option. You will need to assume a life expectancy to make this calculation, and you will need to either be able to run the math functions in Excel or use a financial calculator.

If the implicit rate of return is, for example, 3%, you could then determine whether you would be comfortable taking on additional risk in order to boost your return, if you managed the funds yourself.

Another factor in the decision is that if you manage the funds yourself, you will need to do so for the rest of your life. If you receive a pension, you will never need to do anything to manage that money (presuming the plan remains solvent).

Purchasing an annuity is another way to reduce the number of financial decisions you need to make, but this is generally a TERRIBLE time to purchase an annuity.

Another consideration is whether you have funds outside the pension plan or not. You could structure your overall holdings such that your pension income is treated like fixed income (which it essentially is!), and the remainder of your portfolio includes your pension income as a fixed income allocation.

There's a lot to think about.

[Retire Hopeful]

The company I work for no longer gives health/dental benefits when you retire. This is one of the reasons that I am contemplating leaving after almost 40 years. Someone suggested a LIF, but I don't know much about them. Are they like an annuity?

[MoneyGal]

When you have a locked-in retirement account, and you reach the age at which this account must be converted (or before), you must convert your LIRA to a LIF, an LRIF, or a life annuity.

A LIF (life income fund) is like an LRIF, except, in addition to minimum withdrawals that must be taken into income each year, LIFs have maximum withdrawals beyond which you cannot take out income.

In addition, in most provinces LIFs must be converted to life annuities when the annuitant (the LIF holder) turns 80.

A LIF is a less-flexible option than an LRIF. They aren't my favourite investment vehicles.

[Tommy_Act]

If your employer and the pension plan are both in bad shape when you retire taking the commuted value is still very likely to be a worse option than taking the lifetime pension. You should be able to obtain information directly from your plan sponsor and/or administrator. The basis for calculating commuted values has just been changed resulting in smaller values which are much less than the actual value of the lifetime benefit.

[Jon Chevreau]

This question comes up a lot. Is there not a 50/50 way to saw it off down the middle? When it comes time to turn an RRSP into a RRIF, you can choose to annuitize half of it instead, or any other percentage. Why is it "all or nothing" when it comes to the commuted value of a pension.

P.S. Welcome aboard, Tom. Nice to have an experienced actuary here.

[Retire Hopeful]

I have had the numbers run at work on what the commuted value would be. They ran them at the end of November and again at the end of March. There is a certain amount that goes to a locked in vehicle and the remainder is paid in cash. The cash amount went up 20K because of the bond rate. I have asked for the numbers to be run again at the end of April as the new way of calculating the commuted value changed April 1 I believe. From what I have been reading because of my age and length of service it will probably be reduced 5%. I will be curious as to what the figures will be.

[Tommy_Act]

Based on your latest post I am speculating that the cash amount you will receive is likely the portion of the CV that is over and above the maximum amount that can be transferred on a tax free basis under the tax act. If so this means that you will be taxed immediately on that part of the CV. Please note also that the 5% difference previously referred to is relative to the previous basis that was used to calculate CVs and is not a comparison to the actual value of your pension. The previous CV basis also understated the value. If we consider the actual value of your pension to be the amount that you would have to pay an insurance company for an annuity which duplicates your pension benefit the pension value is likely to be much greater than the CV. Further, based on your last post, it seems that you are well aware of the fact that your CV a year from now could be much lower if government bond rates go up from their current level. There doesn't seem to be much room left for bond rates to go down which would increase your Cv amount.

[Retire Hopeful]

The cash amount is the amount over and above what goes into a locked in vehicle. I understand the amount will be taxed and am hoping to offset some of it by being able to put some into my rrsp because of the pension adjustment reversal. If I decide to take the cv it will be within the next 7 months while bond rates are still low. May be better with the pension as long as the company survives although taking the commuted value will be able to leave the money to family upon death instead of it going back to company (depending on guarantee payout choosen) Somedays I think the guarantee is much better as there are too many what if's, but's and could be's!

[Tommy_Act]

Did someone tell you that you will receive a PAR? If your pension commuted value (CV) is high enough that you exceed the CRA limits for a tax free transfer you will not be receiving a PAR. To test it yourself divide the commuted value by your accrued annual pension. If the result is greater than 9 (which it should be if you are close to normal retirement age) there will not be a PAR. You should confirm this with your pension administrator. Also note that PARs are not calculated until the actual CV payout is made.

[Mike H.]

When transferring money from a pension plan, a portion will need to be locked into a LIRA or LIF; a portion can be transferred tax free to an RRSP and usually only a small percentage needs to be taken in cash and taxed; if any. Be sure to find out exactly what your options are for tax sheltering a commutation.

Half of the locked-in portion can become unlocked upon conversion to a LIF. This removes the upper limit on withdrawals for this portion of funds.

The commuted value of the DB pension plan entitlement is calculated using the formula prescribed by the CIA. (http://www.actuaries.ca)

An important factor in the calculation is the bond rate - which is also an important factor in determining annuity payouts. It ain't exact; but the commuted value payout should be about the correct amount to purchase an annuity paying the promised pension benefit. Low bond rate = high commuted value = low annuity rate. A person MAY wish to do this if they feel that the insurance company selling the annuity (or the Assuris coverage) is more secure than the company pension plan.

When I counsel clients on whether to take the commuted value or not, I advise them to look at various factors:

Confidence - Are you confident you can manage your money yourself (or with an advisor) to generate a return greater than the pension or annuity? Are you confident that the pension plan will be able to deliver the benefits promised?

Discipline - Can you discipline yourself to not spend or lose ALL your money before your meter runs out?

Control - Would you prefer to have control over the cash flow - amount, timing or deferral? Do you want to continue working for a few more years and let the money grow? Do you prefer the "certainty" of the pension plan?

Longevity - Do you expect to live longer or shorter than the average pensioner?

Residual - Do you want the ability to leave money to your estate? A pension plan will offer several retirement guarantee options - including a percentage to a surviving spouse or a number of years of guaranteed income; such as 5 or 10 year guarantee. After the guarantee runs out and you croak, or on the death of the second spouse, there's nothing for the estate. With a combination of RRIF / LRIF &/or LIF, a surviving spouse can receive all the funds to their own account tax deferred; and the estate receives the after-tax residual (if any) on the second death instead of it staying with the pension fund or insurance company.

I have several old widows (or never-marrieds) as clients; and they want to maximize their retirement income while maintaining certainty and have no desire to leave an estate. Life annuities are perfect for them; but then again; they're in their 80's. Rate of return is almost irrelevant to them.

My personal preference is to take the commutation, for three reasons:

1. I DO have confidence that I can achieve a rate of return greater than the current bond rate, over the next 40 years I hope to live; and:

2. Retirement expenses tend to be lumpy. I plan to travel and be active during the first years of retirement while health and energy permit; and this is expensive. Later, sitting around and playing cribbage is quite cheap. At some point in the future, I'll need to replace my hip; re-shingle my roof, and rescue my children (or grandchildren) all at the same time. Or maybe I'll want to blow all my money in a futile attempt to get my cancer cured in China. I want that flexibility.

3. I really don't expect to live that long in retirement. I have bad longevity genes. If I croak at age 60 like my father, do I really want my spouse to have a 40% reduction in income? or have nothing for the estate?

Every person's decision will be different; based on their situation, values, abilities and predictions of the future. The is no one-size-fits-all answer.

[Mike H.]

Just another thought about longevity - a defined benefit pension plan makes no allowance for health, gender, age... but annuities can. Think about it as the reverse of life insurance. If you are male, overweight, diabetic and smoke like a chimney while washing down your 12 beer a day; an insurance company may give you a HIGHER payout on an annuity due to your increased risk of early death.

If you are a fit female non-smoking triathlete; you'll probably live to 100 or more and the pension could be better for you than buying an annuity.


I personally don't put a lot of faith in any defined benefit pension plan unless it has a government sponsor. If investment markets do well, companies get to take contribution holidays. If they do REAALLY well, they may get to remove surpluses. If markets do poorly, apparently companies can get relief from mark-to-market rules and don't have to make up deficiencies. If markets do super-crappy, companies go bankrupt, and there's no guarantee that pensioners will be taken care of. It seems that in any circumstance, the pension plan member is screwed. Plan sponsors are getting the upside, and members carry the risk. This ain't how DB is supposed to be!

[sherwooddavid]

I am in the same boat as Retire Hopefull. I can retire in OCt. 09 with a full DB pension and am considering taking the commuted value of my pension. Someone mentioned that bond yields are low, can someone explain how bond yields effect the commuted value amount ?? Are commuted values higher now because the bond yields are low ? Does the inflation rate effect the cv amount ? I can leave my company anytime and take the cv and am trying to figure out if I should do it now or wait until October. Will it make any difference ?

[Mike H.]

I am in the same boat as Retire Hopefull. I can retire in OCt. 09 with a full DB pension and am considering taking the commuted value of my pension. Someone mentioned that bond yields are low, can someone explain how bond yields effect the commuted value amount ?? Are commuted values higher now because the bond yields are low ? Does the inflation rate effect the cv amount ? I can leave my company anytime and take the cv and am trying to figure out if I should do it now or wait until October. Will it make any difference ?

The commuted value is an estimation of how much money a person would need to have in a lump sum now to provide the DB pension income in the future. The calculation takes into account factors such as age; and an assumed rate of return. The rate of return is based on bond rates. If the assumed rate of return is low, a higher lump sum amount is needed.

Inflation affects the commuted value inasmuch as bond yields have assumptions about inflation baked into them. Actual future inflation may be quite different than bond yields assume, which would impact your purchasing power.

Whether it's better to take the commuted value now or in October depends on what you THINK may be different between now and October. Will bond yields be different? Will expected returns from other investments be higher or lower? Will your pension entitlement be higher due to a few more months of service? Will you get hit by a meteorite before October?

My OPINION is that, at some point, all the money governments are printing and borrowing will cause inflation and interest rates to rise. I don't know exactly when that will happen. As markets continue to recover, the perception of risk in equities will decrease along with expected returns. I don't have a crystal ball, and you shouldn't make major life decisions based on my opinions.

Taking the commuted value may make financial sense if a person is able to invest the lump sum and earn a higher rate of return than that used in the calculation. Historically, equities have provided higher returns than bonds to compensate for the higher risk. Risk is still risk; and would include the possibility that a portfolio of equities performs significantly worse than bonds. As I indicated in my earlier post, there are many other factors involved as well. These include personal preferences and abilities; as well as a whole raft of assumptions about the future. It is impossible to know in advance if any choice you make now will turn out to be the best one.

What do you want to be doing for the next 6 months, five years, ten years? Do you love or hate your job? Do you want to continue working at something, or are you itching for fishing? In the past, many folks were able to "retire", take the commuted value of their pensions and start CPP payments, then return to work for the same employer on a contract basis for even higher wages. They could allow their commuted value to continue compounding tax deferred, and add the CPP payments to their savings as well. But the job market right now kinda sucks.

Another poster pointed out that it's not necessary to do an all or nothing choice. A person could use any portion of the commuted value to purchase an annuity; which is functionally the same as the pension for that portion of funds. An actuary calculating annuity costs and payouts will analyze the same factors that are used in the commutation calculation; though not the same formulae. It's a good idea to get an estimate of the commuted value and some annuity quotes before making any decisions.

[Retire Hopeful]

Did someone tell you that you will receive a PAR? If your pension commuted value (CV) is high enough that you exceed the CRA limits for a tax free transfer you will not be receiving a PAR. To test it yourself divide the commuted value by your accrued annual pension. If the result is greater than 9 (which it should be if you are close to normal retirement age) there will not be a PAR. You should confirm this with your pension administrator. Also note that PARs are not calculated until the actual CV payout is made.


I've checked and I will not receive a PAR. (I was so hoping). Because of the sum of money I will probably lose half to taxes so I have to consider this in my decision making. I think it might be best to wait until the end of November to leave and take CV because it may not be paid out until 2010 and that will be my income for that year. November is the last month I can take CV as I will be 55 in December and locked into a pension. Long range forecast for bond rates look like they will continue to stay low through until the first quarter of 2010 so this may also have an impact.

[Tommy_Act]

Sorry for the delay in responding to your last posting but I have been offline (enjoying my Findependence Days).
Based on your earlier posts ("almost 40 years") I didn't realize that you were just approaching early retirement age of 55 rather than normal retirement age (usually 65). Most pension plans do not allow you to take a lump sum rather than a pension once you qualify for early retirement.
If your pension plan provides for an early retirement pension on ANY BASIS other than what is known as "actuarial equivalence" there is a strong possibility that the commuted value that you can receive in November will be much lower than the commuted value of the actual monthly early retirement pension that you could receive beginning in December. Without knowing the early retirement provisions of your plan I cannot be certain that there is any increase in commuted value upon qualification for early retirement.
Based on the tax issues that you have already identified, early retirement rather than normal retirement necessitates that you must be extra careful and make sure that you have good information from your employer about whether or not there is any early retirement subsidy included in your plan. If there is this could significantly increase the downside risk of opting to take commuted value rather than pension. If you are married there may be other tax issues re pension splitting etc.

[Retire Hopeful]

Most pension plans do not allow you to take a lump sum rather than a pension once you qualify for early retirement.
If your pension plan provides for an early retirement pension on ANY BASIS other than what is known as "actuarial equivalence" there is a strong possibility that the commuted value that you can receive in November will be much lower than the commuted value of the actual monthly early retirement pension that you could receive beginning in December.
Based on the tax issues that you have already identified, early retirement rather than normal retirement necessitates that you must be extra careful and make sure that you have good information from your employer about whether or not there is any early retirement subsidy included in your plan. If there is this could significantly increase the downside risk of opting to take commuted value rather than pension. If you are married there may be other tax issues re pension splitting etc.

I am calling it retirement but the fact is I am only 54 so I can take the commuted value if I leave before my 55th birthday. Is that what you would call the actuarial equivlence? I could also choose to lock into my pension if I so desire but as I earlier posted I have concerns about the company. With current interest rates I would be better to take the pension but am hoping that with an economic upturn that rates would increase and if that was to happen I would be able to do equal or better than my monthly pension. I do plan on returning to work part-time as I am too young to completely retire. I will be able to enjoy my Findependence Days as well!

[Tommy_Act]

"actuarial equivalence" means that the annual pension amount that you receive if you elect to retire early retirement is calculated in a manner that makes the "commuted value" of your early retirement pension equal to the "commuted value" of your normal retirement age pension if you stop work but do not begin to receive your pension until age 65. This means that your annual early retirement pension at age 55 would be significantly less since you will be collecting your pension over a remaining lifetime that could be as much as 10 years longer. The ultimate subsidized early retirement pension would permit you to receive exactly the same pension beginning at age 55 as if you waited (without accruing additional pensionable service) until age 65. The commuted value of such a subsidized pension can be close to double the commuted value of the normal retirement age pension. Many plans have smaller subsidies (e.g. a 3% reduction for each year prior to age 65) which are still very valuable. You must check with your employer, or review any plan documentation that you have, to determine your plan's early retirement provisions.

[Retire Hopeful]

I really appreciate the input on this subject as I toss this important decision around. I found this article which is an interesting read and might help others.


www.pensions.ubc.ca/staff/publications/articles/commutedvalue.pdf

[Retireat50]

I too am approaching the same decision in the next 15months. Take the commuted value, or lifetime pension. I will more than likely take the pension as there are family benefits attached to the pension and fully indexed. Important decision though.

[Jon Chevreau]

My video interview with Tom Walker on this topic of taking commuted value went up today.

http://www.financialpost.com/personal-finance/wealthy-boomer/index.html

[Lumber Joe]

If you ask me, it depends where you live. If you live in a developing country with politically and economically stable environment and large GDP growth rates, then it does not make sense to invest in pension scheme that seems to me quite risky and can not provide you with appropriate return. Some solve this problem by investing in offshore banking centers that provide pension financing. If I am not mistaken Bahamas provide quite flexible pension scheme, but the problem is the same as in onshore pension schemes: your return on investment is not appropriate. In both cases you keep funds so that they earn you negative economic profit meaning that you can find better places to invest elsewhere.

Obviously you have a question: ok, I believe you, but where is a better place to invest. I would answer you to invest in real estate. First of all price of real estate increases with GDP and second you can rent out real estate and earn income on that.

Now you may have another question: but I was planning to put away tiny amounts every month and I can not afford buying land or a building. The answer is mortgage: get a mortgage and you can even cover month repayments by the rent.

[G J D Swain]

My video interview with Tom Walker on this topic of taking commuted value went up today.

http://www.financialpost.com/personal-finance/wealthy-boomer/index.html

Thanks , very informative . Lot's of great interviews on that page . Seems to be lot's of excellent insider information , from what I can see .

G J D Swain

[G J D Swain]

This is a very interesting discussion , since many of us are on the verge of retiring early and having the option of grabbing our cash value instead of leaving it in the plan .

MY CV was estimated at 168K just before the crash and a recent newsletter stated a 13% loss for our plan in 2008 . I'm guessing my estimate will also go down ?

Anyway , I see Bonds % are at an all time low right now , and I believe this will help my CV ?

My problem is this is all new to me but I am slowly learning thanks to great threads like these and awesome forum members , like Tommy & Mike H and moneygal etc .

So anyway , if I take out the CV in order to buy an annuity , does it have to go into a LIF or LRIF first , and then some funds are used to buy the annuity and some funds go toward and RRSP etc ? I'm just not sure about exactly how the money will flow and what the options along the way might best be .

Also , my pension plan will ding me 6% a year for 5 years if I retire early at 55 which seems like a lot of change to loose from my pension cheque (though I will collect many more cheques , I hope) . I can go at 58 , unreduced and with a $400 a month bridge until CPP kicks in , which sounds like a very good deal , but I'll have to leave the money in of course .

Can a move with the CV actually give me the unreduced amount plus a $400/month bridge too (at 58 years of age) ?

Should I start another thread for my specific situation ?

Thanks

G J D Swain

[Eric]

you can take your pension commuted value to an ins company and buy an annuity which 100% mirrors your actual pension plan

Would you have a reference to ins companies?

but this is generally a TERRIBLE time to purchase an annuity

Because of the low rates, I presume. This should also make the CV bigger. So the best might be to take the CV now and buy an annuity when the rates get higher.

However, if one can find an annuity that 100% mirror the pension, is it still that bad? I am inclined, to-day, to manage the CV myself, and, as I get older, buy an annuity.

The basis for calculating commuted values has just been changed resulting in smaller values which are much less than the actual value of the lifetime benefit.

Would you have a reference that explain the rationale? I wonder why they did that; it sounds quite unfair.

[craigwilson]

That's an interesting topic - taking out the commuted value or monthly retirement payments? It can be a very tough decision. My father is about to retire soon and he also does not know yet what he is going to do with pension plan. Since he worked in Germany for a few years, he also has a German private retirement plan (http://www.tc.umn.edu/~schw0888/Finance/401k-plans.html) running, so there are several things to consider. As already mentioned, you can not answer this question generally, you have to look at the individual situation.