Take the Commuted Value of Your Pension, or Leave It in Place? (2023)

If you're leaving a job with a defined-benefit pension, you might have several different options for the funds that have accumulated in the pension plan — including leaving them in place to pay out a monthly pension in retirement, or “commuting" the built-up value from the plan.

The stakes for this decision can be high, as your choice is irreversible, the value of your pension can be significant, and you may not have much time to decide. How do you make a decision you feel confident about? Here’s an overview of the choices you might be facing, along with the pros and cons to consider for each option.

Option 1: Leaving the pension in place

Although you won’t be working at your job any more, one option that’s usually offered is leaving the funds that have accumulated in your pension plan in place. Then, when you are eligible – based on your age and the rules of that plan – you would receive a monthly income. For example, you might be eligible to start receiving income at age 55, 60, or 65.

If this option is available, when you leave your job you will be provided with information about when your income from the pension plan would start paying out, how much the monthly income would be, and the assumptions that have been used to determine how much you’d receive.

(Video) The Commuted Value Of Your Pension...Should You Take It? | Financial Tip 82

Option 2: Commuting the pension

A second option is to “commute” your pension entitlement by taking the funds out of the pension plan. This option is typically called commuting your pension to cash, or “cashing out” your pension benefit.

With this option, the funds in the pension plan would be transferred to a Locked-In Retirement Account (LIRA), up to something called the Maximum Transfer Value, a limit set by the Income Tax Act. Any amount that’s greater than the Maximum Transfer Value would be paid out to you as taxable cash. You could then contribute some or all of these funds to a Registered Retirement Savings Account, if you have contribution room. (If you don’t have RRSP room, the full value of the cash portion of your pension benefit will be added to your taxable income for that year.)

A second option for commuting your pension, depending on your pension plan, might be to use the funds set aside for you to purchase a life annuity from a life insurance company. The annuity would need to match the benefits you’d have under the plan.

The Canada Revenue Agency will allow all of the funds in your pension entitlement to be transferred over to a life insurance company to purchase an annuity without any tax consequences, so long as the annuity is identical or very close to the pension benefit you would have received, if you stayed in the plan. That’s why this kind of annuity is called a “copycat annuity.”

(Video) Commuted Values Explained | Pension Plan Termination Selection Statement

Option 3: Transfer your entitlement to a different defined-benefit pension plan

Finally, if you’re moving from a job with a defined-benefit pension to a different job with a defined-benefit pension, you may be able to transfer the funds you’ve built up in the pension plan from the first job to the plan at the new job. This option will depend on the details of each pension plan.

Which of these options might be right for you? There are pros and cons for each.

The stakes for this decision can be high, as your choice is irreversible, the value of your pension can be significant, and you may not have much time to decide. How do you make a decision you are confident about?

(Video) How do i calculate my pension's commuted value?

Option 1: Leaving your pension in place – Pros and cons

Pros:
  • The pension will pay for as long as you live, even if that’s a very long time.
  • If your pension benefit is indexed for inflation, it will go up over time as the cost of living increases.
  • If you have a spouse or common-law partner, the pension can continue to pay them (usually at a reduced rate, such as 60 per cent of your pension payment) after you pass away.
  • You don’t have to take any investment risk or make any investment decisions – those risks and decisions are all in the hands of the pension plan, not you.
  • Your pension will start as promised, and pay out as promised, even if investment markets dip before or during your retirement.
  • The monthly income from your pension is eligible for “pension income splitting,” which can reduce your household tax bill if you have a spouse or common-law partner.
Cons:
  • The money in the plan is not liquid, but is paid out from month to month.
  • If the pension plan “runs into trouble,” your pension benefit might be at risk.
  • The pension income dies with you, or your spouse, if you have one – there is usually no estate value left after the second spouse passes away. If you don’t have a spouse or common-law partner, the income from your pension plan ends when you pass away.

Option 2: Commuting your pension – Pros and cons

Pros:
  • If you commute your pension to cash, the money in your plan is accessible to you and, subject to tax rules that govern how the funds in a locked-in retirement account can be “unlocked,” can be spent to meet goals other than providing retirement income.
  • You can manage the funds in your locked-in account directly, taking more or less investment risk as you choose.
  • If you pass away earlier in retirement, the remaining value in your account can be left to your beneficiaries.
  • If you commute your pension to a “copycat annuity,” you can avoid any risk of the pension plan becoming insolvent, and failing to make the promised payments. The income from a copycat annuity is also eligible for pension income splitting, and is protected from default through Assuris, the not-for-profit organization that protects Canadian policyholders if their life insurance company fails.
Cons:
  • If you’re not comfortable making investment decisions, you may have concerns about making all of the investment decisions for your locked-in retirement account yourself.
  • The amount of your commuted value that is above the Maximum Transfer Value can be high – as much as 50 per cent of the plan value, or more — meaning that you might face a significant tax bill if you commute to cash.
  • Without a financial plan in place, you may be tempted to deplete the funds that had been set aside for retirement on other, shorter-term goals — meaning you might fall short once you hit or when you’re in retirement.
  • Market downturns just before or early in retirement, when withdrawals start, can limit the amount of retirement income your commuted value can produce.
  • Usually, the amounts you invest on your own don’t have the same guarantees as the payments from a pension plan. For example, funds you invest on your own aren’t guaranteed to provide income for as long as you’re alive, usually don’t offer any guaranteed inflation protection, and aren’t guaranteed to pay out the same amount even if markets drop.
  • If you commute your pension plan to cash, the income you receive from the commuted amounts is not eligible for pension income splitting.
  • If you commute your pension plan to a copycat annuity, the income is not liquid and, like payments from your pension plan, the annuity income dies with you, or your spouse, if you have one – there is usually no estate value left after the second spouse passes away. If you don’t have a spouse or common-law partner, the income from your annuity ends when you pass away.

As you can see, there are pros and cons for each option you might be considering. If you’re facing this decision, how will you know which option is right for you? Here are a few points to consider.

First, any decision you make – whether staying in the plan, commuting to cash or a copycat annuity, or transferring your pension benefit to a new pension plan – should be made in the context of your overall goals. If you don’t have a clear picture of what you want your financial future to look like, this could be an opportunity to create one.

Of course, you’ll also want to review the details of your specific options carefully, to make sure you’ve thought through all of the choices available to you. You’ll also want to assess the overall health of your employer pension plan, to evaluate whether you expect it will be able to pay out the promised benefit when the time comes.

All in all, if you’re facing a decision about remaining in or leaving your defined-benefit pension plan, it might make sense to get some personalized financial advice from a pro who is suited to provide the advice you need.

(Video) Commuted Value Series: The Pension Decision (PART 1)

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FAQs

Is it better to cash out a pension? ›

The Bottom Line. The risk of outliving a one-time lump-sum payment means there are very few good reasons to cash out your pension besides a below-average life expectancy. Withdrawing your pension before retirement can also result in unplanned taxes and penalties.

Is it better to take lump sum or pension? ›

Taking a lump sum could help you pay off debts. On the other hand, if you're concerned about covering your essential monthly expenses and like the idea of having a source of guaranteed monthly income, that could favor the annuity over a lump sum.

How much is a $30000 pension worth? ›

As an example, examine how much an earned pension income of $30,000 would add to a person's net worth. A defined benefit plan income of $30,000 annually is $2,500 per month, which is 25 times $100.

What affects a commuted value of a pension? ›

Commuted values are calculated using the assumptions prescribed under the Pension Benefits Act (Ontario). The interest rate used to calculate a commuted value is based on yields on long-term Government of Canada bonds and hence can change from month to month.

How can I avoid paying tax on my pension? ›

Ways to reduce tax on your pension however include:
  1. Not withdrawing more than you need from your pension each year.
  2. Utilising a drawdown scheme so that you can vary your yearly pension income.
  3. Taking out small pension pots in one lump sum to benefit from 25% being tax free.
  4. Avoid drawing large pensions in one go.
Apr 26, 2022

What is a good pension amount? ›

A good pension income will be dependent on your own circumstances and finances but, as a guide, a good starting point would be around 2/3 of your working salary.

What is the best thing to do with a pension lump sum? ›

When you take a lump sum pension payout, one investment option is to roll the funds into an IRA. Once in the IRA, you can use some of the funds to purchase an immediate annuity, which is an investment vehicle that offers regular payments to investors for a specified period of time.

How much will my Social Security be reduced if I have a pension? ›

We'll reduce your Social Security benefits by two-thirds of your government pension. In other words, if you get a monthly civil service pension of $600, two-thirds of that, or $400, must be deducted from your Social Security benefits.

How do I avoid taxes on lump sum pension payout? ›

You may be able to defer tax on all or part of a lump-sum distribution by requesting the payer to directly roll over the taxable portion into an individual retirement arrangement (IRA) or to an eligible retirement plan.

How much is the average pension per month? ›

According to the Social Security Administration (SSA), a retired couple should expect to receive $2,753 on average in monthly benefits for 2022.

Is Social Security part of net worth? ›

The reason Social Security often is excluded from standard measures of net worth is that it is an annuitized form of wealth—people receive their Social Security benefits as a stream of income. As such, they rarely consider how much wealth that stream of income represents, and are not asked about it by economic surveys.

Do pensions pay for life? ›

Because pension plans are intended to provide periodic payments for life, certain forms of payment are required by law. For single employees, the required form of payment is a straight-life annuity, which typically provides a monthly payment based on the plan formula.

What is the benefit of commuted pension? ›

Commutation of Pension

A Central Government servant has an option to commute a portion of pension, not exceeding 40% of it, into a lump sum payment. No medical examination is required if the option is exercised within one year of retirement.

Should I commute pension? ›

Commuting is a good option for many people, but there are some points you need to keep in mind. To begin with, if you go this route you should be aware that the maximum withdrawals may be lower than the pension benefit would be if you stayed in the plan.

How much tax do I pay on my commuted pension? ›

If this pension is commuted or is a lump sum payment, it is not taxable. Uncommuted pension received by a family member is exempt to a certain extent. Rs. 15,000 or 1/3rd of the uncommuted pension received – whichever is less is exempt from tax.

Do I need to do a tax return if I am on a pension? ›

You do need to lodge a tax return if: Centrelink is withholding any tax from your aged pension payment. If Centrelink does withhold tax from your aged pension payment; this will be noted on your PAYG summary. If there is any amount of tax withheld listed on your PAYG summary, then you should lodge a tax return.

Can the IRS take all of my pension? ›

The IRS has wide discretion to exercise its levy authority. IRC § 6331(a) provides that the IRS generally may “levy upon all property and rights to property,” which includes retirement savings.

Do I have to file a tax return if I receive a pension? ›

If you receive retirement benefits in the form of pension or annuity payments from a qualified employer retirement plan, all or some portion of the amounts you receive may be taxable unless the payment is a qualified distribution from a designated Roth account.

How much pension should you have at 60? ›

As a general rule of thumb, you need 20 – 25 times your retirement expenses.

How long will a 300k pension last? ›

You will still be drawing down from your pension each year (taking money out). But at a sustainable rate. So if you take 4% per year from 300k you could still have money in your pension pot at the end of a 25-30 year retirement.

How much does the average person have when they retire? ›

Federal Reserve SCF Data
Age rangeAverage Retirement Savings
Ages 18-24$4,745.25
Ages 25-29$9,408.51
Ages 30-34$21,731.92
Ages 35-39$48,710.27
6 more rows

Can you collect Social Security and a pension at the same time? ›

Yes. There is nothing that precludes you from getting both a pension and Social Security benefits. But there are some types of pensions that can reduce Social Security payments. Get instant access to members-only products and hundreds of discounts, a free second membership, and a subscription to AARP the Magazine.

How much is the average pension in the US? ›

Average Retirement Income In 2021

According to U.S. Census Bureau data, the average retirement income for retirees 65 and older in the United States decreased from $48,866 in 2020 to $47,620 in 2021.

How much tax will I pay if I take my pension as a lump sum? ›

When you take your entire pension pot as a lump sum – usually, the first 25% will be tax-free. The remaining 75% will be taxed as earnings. If you're thinking of doing this, it's important to contact Pension Wise first.

Do they take Social Security out of pension checks? ›

Pension payments, annuities, and the interest or dividends from your savings and investments are not earnings for Social Security purposes. You may need to pay income tax, but you do not pay Social Security taxes.

At what age is Social Security no longer taxed? ›

Social Security benefits may or may not be taxed after 62, depending in large part on other income earned. Those only receiving Social Security benefits do not have to pay federal income taxes. If receiving other income, you must compare your income to the IRS threshold to determine if your benefits are taxable.

What states do not tax your pension or Social Security? ›

Those eight – Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming – don't tax wages, salaries, dividends, interest or any sort of income. No state income tax means these states also don't tax Social Security retirement benefits, pension payments and distributions from retirement accounts.

Can I leave my tax free cash in my pension? ›

Just take the tax-free cash – you take out a tax-free lump sum (typically 25% of your pension) and leave the rest invested until you decide to make more withdrawals or set up a regular income. Take less than the tax-free allowance – if you don't need all your tax-free cash, you don't have to take it all at once.

Should I keep my pension or roll it over to an IRA? ›

The pros of rolling over a pension plan into an IRA include a wider variety of investment options, tax avoidance, greater control over your retirement savings, and withdrawal flexibility. The cons of rolling over into an IRA include lost creditor protection, no loan options, and penalties on early retirement.

Can I close my pension and take the money out? ›

You can take up to 25% of the money built up in your pension as a tax-free lump sum. You'll then have 6 months to start taking the remaining 75%, which you'll usually pay tax on. The options you have for taking the rest of your pension pot include: taking all or some of it as cash.

Can I take my whole pension as cash? ›

You can take your whole pension pot as cash straight away if you want to, no matter what size it is. You can also take smaller sums as cash whenever you need to. 25% of your total pension pot will be tax-free. You'll pay tax on the rest as if it were income.

Can I cash out my pension if I leave my job? ›

Question: Can I get my pension money if I am laid off? Answer: Generally, if you are enrolled in a 401(k), profit sharing or other type of defined contribution plan (a plan in which you have an individual account), your plan may provide for a lump sum distribution of your retirement money when you leave the company.

How much pension can I take tax free? ›

While the main aim of a pension is to give you an income throughout your retirement, you have the flexibility to take out lump sums whenever you want from the age of 55 – and, in most cases, up to 25% of the total value of your pension can be withdrawn tax free.

How much tax do I pay on a pension lump sum? ›

Generally, the first 25% of your pension lump sum is tax-free. The remaining 75% is taxable at the same rate as income tax. The tax-free lump sum does not affect your personal allowance. In this post, we will break down some of the details which will affect how much tax you pay on your lump sum.

Can I take 25% of my pension tax free every year? ›

You can take money from your pension pot as and when you need it until it runs out. It's up to you how much you take and when you take it. Each time you take a lump sum of money, 25% is tax-free. The rest is added to your other income and is taxable.

Is it worth cashing in a small pension? ›

Be aware that taking a cash lump sum from your pension, including using the trivial commutation or small pot rules, could push you up an income tax bracket and hit you with a larger tax bill than you were expecting.

Can I withdraw 100% of my pension? ›

You can leave your money in your pension pot and take lump sums from it as and when you need, until your money runs out or you choose another option. You can decide when you make withdrawals and how much to you take out.

Can I transfer my pension to my bank account? ›

A pension cannot be transferred to a bank account in the same way it can to a different pension scheme. To place your money into a bank account, you would need to withdraw the funds, and to do so you must be 55 or over and have an eligible scheme.

What should I do with my pension when I leave my job? ›

  • Leave your money in the plan. You may want to keep the balance in your old plan, especially if: ...
  • Rollover to a new employer's plan. Check if your new employer's retirement plan allows you to move the balance from your old plan into the new plan. ...
  • Withdraw the balance. ...
  • Rollover to an IRA.
Aug 30, 2022

What happens if I withdraw all my pension? ›

When you take your entire pension pot as a lump sum – usually, the first 25% will be tax-free. The remaining 75% will be taxed as earnings. If you're thinking of doing this, it's important to contact Pension Wise first.

What to do with your pension when you leave? ›

Take your pension money and invest it elsewhere: You can do this in two ways:
  1. Transfer your pension to a Locked-In Retirement Account (LIRA) offered by a financial institution, such as a bank. ...
  2. Transfer your pension to your pension plan's service provider, and convert it into a LIRA.

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