A pension’s commuted value is calculated by multiplying the pension’s projected pensionable earnings at retirement by a set factor, which is inversely proportional to the number of years before you reach age 65. The Pension will be paid in monthly instalments over a term that corresponds to your individual life expectancy as determined by the Canada Pension Plan Actuarial Table for that year.
The reason you would want to take the commuted value of your pension rather than the pension itself is that there are a few things you can do with that lump sum of cash to use it to your advantage. We’ve compiled a list of our 5 top reasons to take your pension’s commuted value as a lump sum:
1. Pay Off Your Mortgage Early.
If you have an outstanding mortgage, you may be able to use some or all of the commuted value to pay off this debt. This will allow you to clear it more quickly and save on interest charges. The mortgage lender should give you a statement of what proportion of the loan can be paid off using your commuted value. If this amount is less than the amount they originally lent you, they may still agree to release part of the value in order to get some of their money back. Alternatively, they may agree to accept payment from your pension plan in instalments over several years. If they refuse, you can write to them asking them to reconsider. You have nothing to lose by asking, but do not delay too long because most mortgage lenders are fairly inflexible when it comes to repayment terms.
2. Transfer the value of your pension to a Registered Retirement Income Fund (RRIF).
Popular with Canadians, a RRIF is a federally registered account that you can invest in while receiving your pension. You transfer money from your RRSP to a RRIF, and you can earn tax-deferred returns on those investments. You don’t pay taxes on the investment income until you start making withdrawals from the account. Withdrawals are taxable as regular income.
If you do not need the income from your pension right away, you should transfer it to a RRIF as soon as possible because this will reduce the amount of tax payable on each annual payment when you take it later.
3. Invest In Your Own Portfolio.
If you need money right away and do not want to transfer it to a RRIF, you can take it in a lump sum payment as cash and invest it in your own investment portfolio such as mutual funds, bonds, stocks, etc.
4. Use Up Your RRSP Contribution Room.
You can rollover the value of your pension into a Registered Retirement Savings Plan (RRSP) and take advantage of the tax deduction that comes with an RRSP contribution.
5. Acquire A Copycat Annuity
You can use the commuted value of your pension to acquire an annuity that will pay you monthly income for the rest of your life. The annuity payments are taxable income, so be aware of the tax implications by speaking with a Certified Financial Planner.
If you’re not sure about which option is best for you, speak to a financial planner. At Pension Solutions Canada, we can help you determine which option is best for your circumstances. We’ll also help you with estate planning, address tax minimization, and answer all of your retirement questions.