# How Do I Calculate My Pension’s Commuted Value?

Instead of your regular pension payments, you may be entitled to take the commuted value of your pension in the event that you terminate your employment.

The commuted value is basically the lump-sum amount that your pension represents (based on your future pension payments) if it were paid out now. It’s important to understand what the commuted value is and how it can benefit you when planning for retirement.

The commuted value calculation is used for defined benefit pensions plans but not for defined contribution plans, so make sure you know which type of pension plan you have. In a defined contribution pension plan, you know how much you will pay into the plan but not how much you will get when you retire.

The total amount of your pension’s commuted value (CV) is calculated using standards, as required under the Ontario Pension Benefits Act, and depends on many factors including future interest and mortality rates, and inflation.

Under most circumstances, any commuted values payable at termination are calculated by actuaries according to established formulas and procedures approved by government bodies like The Office of the Superintendent of Financial Institutions (OSFI).

What is an actuary? They are financial professionals who analyze the financial consequences of risk and uncertainty. In particular, Commuted Values (CVs) must be calculated in accordance with the Canadian Institute of Actuaries’ standards (the CV Standards).

## How Commuted Value Is Calculated

The commuted value of a defined-benefit pension in Canada is calculated using the actuarial present value of the future stream of payments from the pension. Actuarial present value is the amount that would be needed today to pay for a given stream of future payments.

The commuted value is sometimes called the “cash value” or “lump sum” value of a pension plan. This is because the commuted value represents the amount that could be paid to an employee today in exchange for all future payments from the pension plan. We’ve put together a list of the pros and cons of taking the lump-sum pension payment option here.

The commuted value is then divided by the life expectancy of the employee to calculate the annual pension benefit payable to the employee.

If you’re a mathematician, here’s the typical formula to calculate commuted value: PV = FV/ (1 + k)^n.

Looks complicated? That’s because it is.

Commuted Value isn’t easy to estimate because each company may have different ways of calculating it based on a number of factors. This is why it’s usually best to simply request an estimate from your employer. They will do the calculation for you and send you the estimate for your review.

When when your employer sends you your estimate papers, bring the estimate directly to a Certified Financial Planner to do an analysis on.

The team at Pension Solutions Canada can do this estimate analysis for you for no cost or obligation, simply call us at 1-888-554-6661.

Once you retire, or you are laid off by your employer, they will provide you with a pension statement that has the ‘commuted value’ of your defined-benefit pension plan on it.

Depending on the company you work for and how long you’ve worked there, the commuted value of your pension could be 500k, 800k, or even 1 million dollars or more, so choosing how to manage that money is a critically important decision.

The team at Pension Solutions Canada can do an analysis of your pension statement for you for no cost or obligation, simply call us at 1-888-554-6661.

## Is My Pension’s Commuted Value Enough For My Retirement?

The biggest challenge facing most retirees is determining how much money they need in order to retire comfortably in Canada while maintaining their current standard of living.

This is the question that most advisors are asked and one that is the subject of countless books and articles.

As mentioned previously, an individual’s financial needs will depend on his or her health, lifestyle, the location where he or she plans to live and the kind of housing that will be needed.

The good news is that you control your own spending.

When you retire, you can receive your commuted value money as follows:

• Transfer it to a Locked-In Retirement Account (LIRA), up to a limit set by the Income Tax Act called the Maximum Transfer Value. Any amount that’s greater than the Maximum Transfer Value would be paid out to you as taxable cash.
• If you have taxable cash, you can contribute some or all of that money to a Registered Retirement Savings Account, if you have contribution room. The entire value of the cash component of your pension benefit will be included in your taxable income if you don’t have RRSP room.
• Purchase a life annuity from a life insurance company (annual income of a fixed amount). The annuity would match the benefits under your pension plan. We call these ‘mirror annuities’ or you might have also heard it referred to as a ‘copycat annuity‘.

## Take The Company Pension or Commuted Value?

Clients with defined benefit pension plans may reach a point where they must decide whether to take the pension or commuted value. It’s important to know what your commuted value is, because you can then take that amount and shop it around to insurance companies to see if they’ll match it (or ‘copy’ it). This is typically referred to as a copycat annuity.

It is purchased from an insurance company, such as Canada Life or Sun Life, and is then the pension is paid to you from the insurance company.

An annuity contract allows you to take your commuted value pension and turn it into lifetime guaranteed income for yourself then for someone else, such as your spouse.

Annuity contracts are guaranteed by an insurance company. That means that they have very low risk of defaulting like other investments might have. If your employer has a risk of going bankrupt (such as retail companies or automotive brands), then a copycat annuity might be a great choice for you. If the insurance company fails, you have extra protections.

If you are unsure which option to take (company pension or commuted value), contact Pension Solutions Canada and speak with one of our Certified Financial Planners to assess your options free of charge. You can reach us at 1-888-554-6661.

## What Is A Defined-Benefit Pension?

A Defined-Benefit Pension is designed to provide a specified amount of monthly income after retirement. This monthly income is a percentage of your salary during working life.

You usually must start receiving pension payments when you reach age 65 or the normal retirement age set by your employer. You may be able to start receiving payments as early as age 50.

You generally can’t withdraw money from your pension plan until you retire. However, you may be able to withdraw money from a defined-contribution plan before retirement.

## Inflation, Interest Rates, & Bond Yields in Canada: How It Affects Your Commuted Value

Inflation protection means the amount of pension after retirement is adjusted according to inflation. Typically, a government pension is fully indexed to the Consumer Price Index (CPI) on your first day of retirement. The indexing of your pension ensures that it keeps pace with the cost of living, which will help protect you from inflation. There are two types of inflation protection methods: fixed rate and variable rate. Fixed rate is easy to understand, the amount of pension is adjusted by the rate specified in the plan. Variable rate is a little more complicated; this type of inflation protection uses a variable method (such as Consumer Price Index) to adjust the amount of your pension.

If you’re not sure about which option is best for you, speak to a Certified Financial Planner. At Pension Solutions Canada, we can help you determine which option is best for your circumstances and refer you to quality Life Insurance providers. We’ll also help you with estate planning, address tax minimization, and answer all of your retirement questions.

Private pensions normally do NOT offer inflation protection. So, your monthly income will effectively decrease over time as it’s eaten away by inflation.

## Chat With A Canadian Certified Financial Planner

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