What to do with your pension when leaving an employer | Manulife Investment Management (2023)

What to do with your pension when leaving an employer | Manulife Investment Management (1)

What to do with your pension when leaving an employer | Manulife Investment Management (2)

Investment insight

When leaving an employer, many people are faced with the decision to leave their pension entitlements on a paid-up basis with their former employer or to move it to a personal locked-in retirement savings plan (LRSP) or locked-­in retirement account (LIRA).

If you belong to a defined contribution or money purchase plan, the decision is relatively easy. The full market value of your entitlement can be transferred to a personal LIRA. The advantage of this is that it will provide you with full and direct access to a more diverse range of investment options, which are typically more limited in the company pension plan.

However, if you belong to a defined benefit pension plan, the transfer to a LIRA isn’t as straightforward. This article summarizes some of the things that will need to be considered to make the most of the benefits you’re entitled to.

Maximum transfer value

In many cases, the maximum transfer value imposed by the Income Tax Act will prohibit the full value of your entitlement from being transferred to a LIRA.

Regulation 8517 of the Act provides a factor, based on age, that’s multiplied by your annual benefit. Because this factor doesn’t consider the value of additional benefits, such as indexing or early retirement features, the maximum value is often less than the true cost of the benefit provided.

This creates a problem since a portion of the commuted value may not be transferable and must be taken into income as a lump-sum, taxable amount. You can reduce theimpact if you have available registered retirement savings plan (RRSP) contribution room and use some of the taxable amount to make a contribution. However, many people in this situation don’t have the necessary room since their RRSP contribution limits have been reduced each year by the value of the benefit received under the pension plan (known as a pension adjustment). A pension adjustment reversal (PAR) may be available under certain circumstances, which is discussed further in thePension adjustment reversalsection below.

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Maximum transfer values (factor times annual benefit)

What to do with your pension when leaving an employer | Manulife Investment Management (3)

Maximum transfer value example

Assume you’ve left your current employer at age 50, and your statement indicates that the commuted value of your benefit is $350,000 and your annual benefit is $27,000, payable at age 65, indexed at two per cent each year. If you choose to transfer the commuted value to a personal LIRA, under the Income Tax Act, the maximum allowed as a direct transfer will be $253,800 (27,000 x the factor of 9.4). The balance of $96,200 will be paid to you as a taxable lump sum. At a 45 per cent tax rate, you would have an after-tax balance of $52,910.

If you invest both these amounts, the $253,800 in a LIRA and the after-tax lump sum of $52,910 in a taxable account for 15 years, you’ll need a rate of return of 3.69 per cent compounded annually to have the $528,2011needed at age 65 to purchase the same $27,000 indexed pension income. Alternatively, if you decide to spend the $52,910 and invest the $253,800, you’d need a compound rate of return of 5.01 per cent. Even in a low-interest environment, this rate of return may be achievable.

In this example, a person may decide that the transfer is still a good decision despite the large tax bill. This won’t always be the case, however. Often when the comparison is between a pension payable immediately, such as taking early retirement from the company, and trying to duplicate the same income by commuting, the upfront tax hit on the non-transferrable portion will make the company retirement plan almost impossible to beat.

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It’ll be important for you to use numbers that reflect your own situation before determining the feasibility of transferring the commuted amount. Remember also, if you commute, your employer will no longer be assuming the investment risk; you will.

Indexed benefits

Indexed benefits can add substantially to the amount of dollars needed at retirement to purchase the same pension. This is especially true if there’s indexing of your benefits prior to retirement as well as after retirement. The previous example uses a two per cent indexing factor after retirement. If this income was indexed at 1.5 per cent during the 15 years prior to your income date, the amount of annual pension to be purchased at age 65 would increase by 25 per cent to $33,756 for a cost of approximately $659,037 — 125 per cent of the original amount. The new required rate of return would be 5.23 per cent if all available dollars are invested, and 6.57 per cent if only the locked-in portion is invested.

Benefits

Benefits such as health and dental are sometimes offered to employees who are considered to be retired. In some cases, the criteria depend on whether the pension money is transferred. If you’ll lose retiree benefits because you take the commuted value and are, therefore, considered a terminated employee rather than a retired employee, then the additional cost of private coverage will also need to be factored in.

Financial stability of your former employer

Your former employer’s financial stability can also be a consideration. If you’re not sure that your employer will still exist or be financially able to meet its pension promises over the long term, you may decide that you’d be better off taking the lump sum now to avoid any uncertainty with respect to your retirement income in the future.

If you’re earning benefits governed by Ontario pension laws, there’s some protection provided to employees of insolvent employers through the Pension Benefits Guarantee Fund. However, the maximum benefit is capped at $1,000 of income per month. There’s no protection in any other province.

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Early retirement and pension income splitting

If your spouse is in a lower tax bracket and you plan to start receiving retirement income before age 65, the pension income received directly from a company pension plan can be split at any age (except in the province of Quebec, where you must be 65 to split pension income). If you commute the pension and draw income from a life income fund (LIF) you’ll have to wait until age 65 to take advantage of the tax savings available with pension income splitting.

Pension adjustment reversal

A PAR is calculated if you decide to transfer the commuted value of your pension to a LIRA. It’s not calculated if you leave the benefits with your former employer.

A PAR results when the pension adjustments reported while earning benefits after 1989 are greater than the commuted value actually paid out for those benefits. A PAR restores RRSP room equal to that difference. This restored RRSP room allows you to avoid taxes on some or all of the lump-sum amount not normally transferable under the maximum transfer rules. If you’re eligible to receive a PAR, your former employer will advise you of the amount.

Partial unlocking

Some provinces and federally regulated plans allow a portion of your benefit to be unlocked (New Brunswick, up to 25 per cent; Ontario, Manitoba, Alberta, and federal, up to 50 per cent; and Saskatchewan, up to 100 per cent). However, this isn’t available if you don’t commute. For more information, seeRegistered Retirement Income — The facts.

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As you can see, there are many factors to be considered when deciding whether to take a commuted value or to leave the pension on a paid-up basis with a former employer. This article discusses the mathematical factors, but not all factors in your decision will be financially based. Depending on the terms of your termination of employment, you may also have emotional reasons for severing all ties with a former employer.

1Based on annuity rates in effect October 2021

The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. Manulife, Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.

MK1982E 11/21

What to do with your pension when leaving an employer | Manulife Investment Management (4)

Tax, Retirement & Estate Planning Services Team,

Manulife Investment Management

(Video) What to do with your pension monies when you resign?

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FAQs

What happens to my fully vested pension if I quit? ›

However, if you are vested in the pension, then all the money in the account is yours to keep, even if you quit or are fired. Becoming vested depends on the rules of the pension plan.

Do you keep your pension if you leave a company? ›

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.

What happens to my pension if my employer goes out of business? ›

In some cases, plans continue to exist throughout the reorganization process. In a Chapter 7 bankruptcy, the company liquidates its assets to pay its creditors and ceases to exist. Therefore, it is likely your pension and health plans will be terminated.

How can I avoid paying tax on my pension? ›

Employers of most pension plans are required to withhold a mandatory 20% of your lump sum retirement distribution when you leave their company. However, you can avoid this tax hit if you make a direct rollover of those funds to an IRA rollover account or another similar qualified plan.

Do you forfeit a pension if you quit? ›

If you leave your job before you retire, you may forfeit your pension benefits. However, some pension plans allow you to take benefits when you leave. You should consult your documents to understand your options.

Can you lose your pension after retirement? ›

A number of situations could put your pension at risk, including underfunding, mismanagement, bankruptcy, and legal exemptions. Laws exist to protect you in such circumstances, but some laws provide better protection than others.

Can I withdraw my pension amount after resignation? ›

No, you cannot withdraw your pension contribution without leaving a job. You can only withdraw your pension amount if you are unemployed for a period of 2 or more months (provided you have completed less than 10 years but more than 6 months of service).

How do I cash out my pension? ›

Cashing in a pension usually only becomes possible at age 55. At this point some or all of your pension funds can be used to buy an annuity, set up a drawdown arrangement, accessed as cash, or you can opt for a combination of these options. Ruth Jackson-Kirby, Tim Leonard Last updated on 14 March 2022.

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.

Can I take my company pension as a lump sum? ›

In most schemes you can take 25 per cent of your pension pot as a tax-free lump sum. You'll then have 6 months to start taking the remaining 75 per cent - you can usually: get regular payments (an 'annuity') invest the money in a fund that lets you make withdrawals ('draw down')

Can I take all my company pension as a lump sum? ›

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.

What is the most tax efficient way to take pension? ›

Don't draw your pension in one go

As is evident from the points above, staggering your pension so that you receive less on an annual basis ultimately means you will pay less tax. While you might be tempted to empty your pension pots in one go, it will mean paying income tax on that amount in one year.

At what age are pensions not taxable? ›

If you receive pension or annuity payments before age 59½, you may be subject to an additional 10% tax on early distributions, unless the distribution qualifies for an exception.

What are the 3 states that don't tax retirement income? ›

States That Won't Tax Your Pension Income

Alaska. Florida. Nevada. South Dakota.

How much cash before you lose pension? ›

It comes down to the amount of savings you already have, plus all sorts of asset types combined. For example, if you are a single homeowner you can get a full pension with an asset limit of $270,500. As a couple with a home and combined assets your limit is reached at $405,000 to receive a full pension.

How much money can I have before losing the pension? ›

A single homeowner can have up to $622,250 of assessable assets and receive a part pension – for a single non-homeowner the higher threshold is $846,750. For a couple, the higher threshold to $935,500 for a homeowner and $1,159,500 for a non-homeowner.

What assets can you have before losing your pension? ›

The asset value limit is the amount of assets a person can own before their pension or payment will reduce from the maximum rate under the assets test. Example: Currently the asset value limit for a single service pension homeowner is $280,000 and for a single service pension non-homeowner is $504,500.

What happens to unused pension money? ›

Your beneficiaries can take the remaining money left as a lump sum, set up a guaranteed income (an annuity) with the proceeds or, they may also be able to continue with flexible retirement income (pension drawdown).

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 on my pension lump sum? ›

Tax you'll pay

When taking a lump sum, 25% is usually tax-free. The other 75% is taxed as earnings. Depending on how much your pension pot is, when it's added to your other income it might push you into a higher tax band.

Is it better to take lump sum pension or monthly payments? ›

A Lump Sum Gives You More Control of Your Assets

By accepting a lump sum from the pension, you gain the control over your income assets. Even if the income generated from the lump sum is less than the promised annuity payment from the pension, you gain control over the assets.

Should I transfer my pension to new employer? ›

There may be benefits to transferring a pension. It's easier to manage one fund, the new scheme may seem to offer better returns and there are worries about companies being declared insolvent and the implications for the pension fund. However there are also many potential risks in a transfer.

How much tax will I pay if I cash in my pension? ›

Tax you'll pay

When taking a lump sum, 25% is usually tax-free. The other 75% is taxed as earnings. Depending on how much your pension pot is, when it's added to your other income it might push you into a higher tax band. Your pension provider will deduct the tax.

Can I take my pension early if I leave my job? ›

Yes – any money you've built up in an employer pension is yours, even if you've since left that employer. Once you reach your normal minimum pension age, you should be able to take your money out of your pension.

Should I keep my pension or take a lump sum? ›

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.

Do I have to use a financial advisor to transfer my pension? ›

In most cases, you'll be able to move your pension to another pension scheme without needing to get advice. But some of the decisions you may have to make can be complex and we would recommend that you consider getting regulated advice.

Is it best to take a lump sum from your pension? ›

Taking lump sums will affect your future contributions

If you think you might want to top up your pension pot in the future, for instance because you want to keep working part time, then you need to be aware that taking money out in lump sums could affect the amount you can pay in and receive tax relief on.

Does cashing in a pension count as income? ›

money you take out of your pension will be considered as income or capital when working out your eligibility for benefits - the more you take the more it will affect your entitlement. if you already get means tested benefits they could be reduced or stopped if you take a lump sum from your pension pot.

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.

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.

How much should I have in my pension at 40? ›

So, therefore, It is suggested that at the age of 40, you should really be putting 20% of your wages into your pension pot. This is a 5% increase up from the suggested amount in your thirties. Of course, this percentage is just a recommendation and every circumstance is different.

Can I lose my pension? ›

A number of situations could put your pension at risk, including underfunding, mismanagement, bankruptcy, and legal exemptions. Laws exist to protect you in such circumstances, but some laws provide better protection than others.

How long does it take for pension to pay out after resignation? ›

It typically takes between 4 and 12 weeks to process a retirement fund pay-out (21 business days at 10X Investments), from the time your last contribution is invested or the required instruction forms are received by the administrator (whichever is the later).

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