When transferring money from a pension plan, a portion will need to be locked into a LIRA or LIF; a portion can be transferred tax free to an RRSP and usually only a small percentage needs to be taken in cash and taxed; if any. Be sure to find out exactly what your options are for tax sheltering a commutation.
Half of the locked-in portion can become unlocked upon conversion to a LIF. This removes the upper limit on withdrawals for this portion of funds.
The commuted value of the DB pension plan entitlement is calculated using the formula prescribed by the
CIA.
An important factor in the calculation is the bond rate - which is also an important factor in determining annuity payouts. It ain't exact; but the commuted value payout should be about the correct amount to purchase an annuity paying the promised pension benefit. Low bond rate = high commuted value = low annuity rate. A person MAY wish to do this if they feel that the insurance company selling the annuity (or the Assuris coverage) is more secure than the company pension plan.
When I counsel clients on whether to take the commuted value or not, I advise them to look at various factors:
Confidence - Are you confident you can manage your money yourself (or with an advisor) to generate a return greater than the pension or annuity? Are you confident that the pension plan will be able to deliver the benefits promised?
Discipline - Can you discipline yourself to not spend or lose
ALL your money before your meter runs out?
Control - Would you prefer to have control over the cash flow - amount, timing or deferral? Do you want to continue working for a few more years and let the money grow? Do you prefer the "certainty" of the pension plan?
Longevity - Do you expect to live longer or shorter than the average pensioner?
Residual - Do you want the ability to leave money to your estate? A pension plan will offer several retirement guarantee options - including a percentage to a surviving spouse or a number of years of guaranteed income; such as 5 or 10 year guarantee. After the guarantee runs out and you croak, or on the death of the second spouse, there's nothing for the estate. With a combination of RRIF / LRIF &/or LIF, a surviving spouse can receive all the funds to their own account tax deferred; and the estate receives the after-tax residual (if any) on the second death instead of it staying with the pension fund or insurance company.
I have several old widows (or never-marrieds) as clients; and they want to maximize their retirement income while maintaining certainty and have no desire to leave an estate. Life annuities are perfect for them; but then again; they're in their 80's. Rate of return is almost irrelevant to them.
My personal preference is to take the commutation, for three reasons:
1. I DO have confidence that I can achieve a rate of return greater than the current bond rate, over the next 40 years I hope to live; and:
2. Retirement expenses tend to be lumpy. I plan to travel and be active during the first years of retirement while health and energy permit; and this is expensive. Later, sitting around and playing cribbage is quite cheap. At some point in the future, I'll need to replace my hip; re-shingle my roof, and rescue my children (or grandchildren) all at the same time. Or maybe I'll want to blow all my money in a futile attempt to get my cancer cured in China. I want that flexibility.
3. I really don't expect to live that long in retirement. I have bad longevity genes. If I croak at age 60 like my father, do I really want my spouse to have a 40% reduction in income? or have nothing for the estate?
Every person's decision will be different; based on their situation, values, abilities and predictions of the future. The is no one-size-fits-all answer.