Should you commute your pension?

In many pension plans, you have the option to “commute your pension.” This means taking some or all of your built up funds in a lump sum. There are a variety of things to consider with this option.

Consider the case of Anil, 61, a married and recently laid-off senior bank employee who, with his portfolio manager, Kathy Clough of PWL Capital Ltd., must choose whether or not to commute an indexed, defined-benefit pension plan. He worked for the bank for 25 years.

If he commutes the pension, Anil would get a large lump sum that would go into a locked-in retirement account (LIRA) if he holds off on withdrawing the money until later, or a life income fund (LIF) if he starts withdrawing now.

Anil is happy to start retirement now. His wife, Meena, is a teacher and also has an attractive pension. She’s still working, but the couple is supporting two daughters through master’s degrees, so Anil needs to draw income right away.

Anil has a minor heart murmur, and his wife’s benefits cover 70% of his medical expenses. He’d like to claim the rest under the plan that would come with his pension. Plus, one daughter has a thyroid condition that requires daily medication. As a student under age 26, she’s covered under both parents’ plans.

Anil wants income right away, so his choice is between a LIF and the pension. The LIF would let him direct his own investments and roll some funds to a regular RRSP. He could also modify withdrawal amounts to manage around government benefits that have clawbacks, such as OAS.

In Anil’s case, choosing a LIF would mean relying on investments with slightly higher levels of risk than he’s comfortable with, making the decision easy: take the pension, and the medical benefits and certainty that come with it.

What if?

If Anil were only a few years into his career, in a non-indexed DB pension plan, Clough would have been more likely to recommend he commute the pension.

“The younger [you are], with fewer years of service, the less impact it’s going to have on the overall financial plan,” she says. “Chances are better that [you] will end up with a bigger [amount with which] to generate pension income.”

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.