How to decide if pension plan income or a lump sum commuted value is best for your retirement
For those of us with a work pension plan and a retirement date circled on the calendar, an important decision may be looming: leave the value of the pension in the plan to provide lifetime pension payments, or remove the value of your pension and invest the proceeds on your own to provide for your retirement income?
Pension plan vs. lump sum commuted value
Generally speaking, the commuted value represents the amount of money if invested today which would grow to match your plan's pension payments. There's more risk associated with choosing the commuted value—inflation, investment return, your retirement age, and how long you live influence how much money you have and how long it will last.
Pension income, on the other hand, is inflexible, but it provides a lifetime guaranteed income that, in some cases, may be protected against inflation.
Pension income vs. lump sum commuted value is an important decision that will have a lasting impact on your finances and tax situation after retirement.
So how do you know which choice is best for you?
Start by asking yourself these questions:
- Are you concerned about outliving your money?
If you are in good health, the lump sum may not provide enough income throughout your lifetime.
- Does risk make you nervous?
With pension income, you have a guaranteed income. Are you comfortable giving that up and assuming some investment risk in exchange for the flexibility of a lump sum payment?
- Are other assets or income available to you?
If you can access significant savings and investments when you need them, the pension option will help meet your lifetime income needs. On the other hand, if you have other sources of lifetime income (like a spouse's pension or annuity payments), the flexibility of the commuted value might be more important to you.
- Is the pension indexed?
As the cost of living increases, the purchasing power of your investments drops. An indexed pension protects a portion of your pension income from inflation.
- How much of the commuted value is immediately taxable?
If the lump sum commuted value is larger than the Canadian Revenue Agency's transfer limits, a portion would have to be taken as immediately-taxable cash.
- What interest rate would be required for the money to last your lifetime?
Think about the kind of returns you would need and how much risk is required to get those returns.
- Is income splitting a consideration?
Income received from a pension is eligible for the Pension Income Tax Credit, and up to 50% can be shared with your spouse for tax purposes, at any age.
It's important to note that as a result of COVID-19 there may be a temporary restriction placed on some or all of a commuted value transfer. This is something you should confirm with your pension administrator and take into consideration if you are considering the commuted value option.
Ultimately, you should consider a lot of factors before deciding on a pension payout plan. Once you've made a decision that fits your future goals, you can focus on enjoying your retirement.
For help planning your retirement income, contact an ATB Wealth financial advisor.
Editor’s note: This article was previously published and has since been refreshed to make sure the insights we bring you are timely.