When Is the Best Time to Take Your Pension Settlement?

If you’re nearing retirement and considering your pension options, one of the biggest questions you’ll face is when to take your pension settlement. Timing is everything, and choosing the right time to cash out could save you a significant amount in taxes.

Many people don’t realize how much the timing of their pension withdrawal impacts their overall tax bill. In this article, we’ll explain why it often makes sense to wait until the start of the next calendar year before taking your pension settlement, especially if you’re receiving a commuted value payout.

The Issue with Taking Your Pension This Year

When you take the commuted value of your pension, a portion of the payout comes to you in cash. This cash is taxable, which means it gets added to your income for that year. The more income you have in a single year, the higher your tax bracket, and the more you’ll owe the Canada Revenue Agency (CRA).

Let’s say you’ve been working all year and earning a salary. If you receive your pension settlement in the same year, the taxable portion of your pension payout will be stacked on top of your salary, pushing your income higher and possibly into a higher tax bracket. This could mean paying thousands more in taxes than if you spaced out your earnings over two years.

How Waiting Until Next Year Lowers Your Tax Bill

Instead of taking your pension payout in the same year as your salary, there’s a simple tax-saving strategy you can use: wait until January. Here’s how it works:

• This year: You only pay income tax on your salary. Since you’ve already earned most of your salary for the year, it makes sense to finish the year out without adding a large taxable lump sum to your income.
• Next year: When you’re no longer earning a salary, your taxable income will be much lower. This is the perfect time to take the taxable cash portion of your commuted value because you’ll be taxed at a lower rate. The same logic applies to a copycat surplus.

By splitting your salary and pension settlement between two tax years, you spread out your taxable income, keeping your tax bill lower overall.

Why Now Is the Perfect Time to Plan

If you’re heading into the fall and thinking about your pension, now is the time to start planning. Most pension plans give you a window of time—usually 30 to 90 days, and sometimes up to six months—to make a decision after receiving your paperwork. If you’re expecting your pension paperwork soon, you have a perfect opportunity to plan for a tax-efficient strategy.

Here’s an example of how you can use this window to your advantage:

• November or December: Let’s say you receive your pension paperwork in November. Instead of settling right away, you can complete the forms but hold off on submitting them. This delays the pension payout until after January 1st of the next year.
• January 1st: On the first day of the new year, submit your paperwork to the pension administrator. This way, your taxable pension payout will be counted as income for the new tax year, where you’ll be in a lower tax bracket because you’re no longer drawing a salary.

This simple shift could save you a significant amount on taxes.

How Much Can You Save by Waiting?

The exact amount you can save depends on how much you’re receiving in taxable cash from your pension settlement and what your salary is. For most retirees, the taxable portion of the commuted value can range from $100,000 to $200,000 or more.

Here’s why waiting matters:

• If you take that $100,000 in taxable cash while you’re still earning a salary, it gets added to your income, potentially pushing you into a higher tax bracket.
• If you wait until next year, when you have no salary, the $100,000 is taxed at a much lower rate, and you end up paying less overall in income tax.

Timing Your Pension Settlement: What You Need to Do

If you want to maximize your tax savings by timing your pension settlement for next year, here’s what you should do:

• Get your pension statement: If you’re expecting to receive your pension settlement paperwork in the fall, make sure you get all the details. You’ll need to know how much of your commuted value will be taxable.
• Hold off on submitting the paperwork: Once you receive the paperwork, don’t rush to submit it. Complete everything you need to, but hold the submission until after January 1st.
• Submit on January 1st: The moment the new year starts, submit your pension settlement paperwork. This ensures that the taxable cash portion of your pension will be included in next year’s income, not this year’s.
• Talk to a financial advisor: If you’re unsure about the timing or want help calculating how much you’ll save, speak with a financial advisor. They can help you fine-tune the details and make sure everything is in order for the next tax year.

FAQs About Pension Timing and Taxes

How does the commuted value affect my taxes?
The commuted value includes a taxable cash portion that’s added to your income for the year. The more income you have, the higher your tax bracket, which means you could pay a lot more in taxes if you take it in the same year as your salary.

What happens if I take my pension payout this year?
If you take your pension payout this year, the taxable cash portion will be added to your salary, potentially pushing you into a higher tax bracket. This means you’ll owe more in taxes than if you had waited.

Can I delay taking my pension until next year?
Yes, you can delay your pension payout until next year. Most pension plans give you a window of time to submit your paperwork, allowing you to complete the forms but hold off on submitting them until January.

How much can I save by waiting?
The amount you save depends on how much of your commuted value is taxable and what your salary is. By waiting until next year, when you’re no longer earning a salary, you’ll likely be in a lower tax bracket, saving you thousands in taxes.

Is there a deadline to take my pension payout?
Most pension plans give you a 30- to 90-day window, and sometimes up to six months, to make a decision once you receive your pension paperwork. This gives you time to plan and time your submission for the next tax year.