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 calculationis 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).
Table of Contents
- How Commuted Value Is Calculated
- Getting Your Commuted Value Amount From Your Pension Statement
- Is My Pension’s Commuted Value Enough For My Retirement in 2022?
- How To Receive Your Commuted Value Cash
- Take The Company Pension or Commuted Value?
- What Is A Defined-Benefit Pension?
- Chat With A Canadian Certified Financial Planner
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.
Getting Your Commuted Value Amount From Your Pension Statement
Once you retire, or you are laid off by your employer, they will provide you with apension statementthat 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, thecommuted value of your pensioncould 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 in 2022?
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.
Click here to read our free Retirement Guide.
How To Receive Your Commuted Value Cash
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‘.
If you still have any questions about commuted values, please ask us by calling 1-888-554-6661.
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
Let us analyze your multiple income streams in retirement. We’ll make sure to minimize your income tax.Consult with a professional to help you with this key financial decision.
Click here to book a 15-minute virtual Zoom call to get started. Our services are no cost to you.
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How Do I Calculate My Pension’s Commuted Value? ›
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.How do you calculate the commuted value of a pension? ›
- If the interest rate is 1%, the commuted value of this payment today would be 1/1.01*10,000 = 9,900.99.
- If the interest rate is 5%, the commuted value of this payment today would be 1/1.05*10,000 = 9,523.90.
Present value is calculated as PV = FV / (1 + i)^n, where the present value equals the future value divided by one plus the expected interest rate over “n” number of years.What is my commuted value? ›
A commuted value represents the lump sum present value of the pension you would otherwise receive as a monthly payment for your lifetime upon retirement.How much is a pension worth in salary negotiation? ›
Generally, your pension is worth 2% of your salary.
Pension is calculated with reference to basic pay or average emoluments, whichever is more beneficial. The amount of pension is 50% of the emoluments or the average of emoluments.
However, most will use the average of your three highest years of compensation as a start for your payout calculations. Once this number is clear, it's multiplied by the percentage factor for your plan. You then multiply the subsequent number by the amount of years you were employed at the company.What is the maximum transfer value? ›
The Maximum Transfer Value (“MTV”) is a tax limit that applies to members in DB pension plans who terminate and elect to transfer the commuted value of their pension entitlement to a locked-in RRSP or a DC pension plan.How do you calculate present value? ›
The present value formula PV = FV/(1+i)^n states that present value is equal to the future value divided by the sum of 1 plus interest rate per period raised to the number of time periods.How do you calculate lump sum? ›
You must use the mathematical formula: FV = PV(1+r)^n FV = Future Value PV = Present Value r = Rate of interest n = Number of years For example, you have invested a lump sum amount of Rs 1,00,000 in a mutual fund scheme for 20 years. You have the expected rate of return of 10% on the investment.What is a lump sum pension payout? ›
A lump-sum distribution is the distribution or payment within a single tax year of a plan participant's entire balance from all of the employer's qualified plans of one kind (for example, pension, profit-sharing, or stock bonus plans).
Is it better to cash out a pension? ›
When deciding whether to cash out your pension, compare the total monthly income that you will receive in retirement with your planned monthly expenses. If your income just covers your expenses, you may want to stick to monthly pension payments. You will depend more on that income to stay afloat in retirement.What does the total value of my pension mean? ›
Your fund value is the total amount of money in your pension savings with us at a particular point in time.What is commuted cost? ›
Commuting expenses are costs that are incurred as a result of the taxpayer's regular means of getting back and forth to his or her place of employment. Commuting expenses can include car expenses, biking expenses, and public transportation costs.How much is a $30000 pension worth? ›
As an example, examine how much an earned pension income of $30,000 would add to a person's net worth. A defined benefit plan income of $30,000 annually is $2,500 per month, which is 25 times $100.What is the 6% rule for pension? ›
To determine this number, consider the 6% rule: which states that if your monthly pension offer is 6% or more of the lump sum offer, you should choose the perpetual monthly payment option. If the number falls below 6%, you might do as well (or better) by taking the lump sum and investing it yourself.What is the #1 rule of salary negotiation? ›
So how aggressive should you be when negotiating salary? A good rule of thumb is to counter offer between 10% and 20% above the offer amount.Is it better to take a monthly pension or lump sum? ›
The Bottom Line. For some, a lump-sum pension payment makes sense. For others, having less to upfront capital is better. In either case, pension payments should be used responsibility with the mindset of having these resources support you throughout your retirement.What is the rule of thumb for pension lump sum? ›
As a rule of thumb, it's more realistic to expect your lump sum to earn less than 6% per year in investments. If you can earn less than 6% and still make more than your pension plan payments, the lump sum payout may be your best bet.What is a good monthly retirement income? ›
65-74 years: $59,872 per year or $4,989 per month. 75 and older: $43,217 per year or $3,601 per month.Should I take commuted value? ›
Investing a commuted value is necessary to ensure that it provides income over a long retirement period. Investing a commuted value comes with new risks like investment risk and behavioural risk. One important consideration is that individuals with a defined benefit pension often have very little investment experience.
What is a commuted value transfer? ›
A commuted value is the sum of money that a beneficiary is entitled to receive as a lump sum payment at retirement through a pension plan. This value is estimated based on factors including the future life expectancy of the beneficiary.Is the transfer value of a pension the same as the cash value? ›
The cash equivalent transfer value is the amount your current pension scheme will offer you if you want to transfer out of your defined benefit pension and into a defined contribution scheme. It's expressed as a lump sum, but you won't receive it as a lump sum.How do you manually calculate present value? ›
- NPV = Cash flow / (1 + i)^t – initial investment.
- NPV = Today's value of the expected cash flows − Today's value of invested cash.
- ROI = (Total benefits – total costs) / total costs.
The Value Calculator provides you with rich market data. Each time a buyer uses the Value Calculator, you seamlessly collect data to gain insights on industry, revenue, number of employees, and business challenges.What is present value for dummies? ›
In economics and finance, the present value refers to today's value of future total cash flow. Present value tells you how much you will need today to achieve a certain amount in the future. On the other hand, future values give you an overview of the investments worth at a later time.What is an example of a present value lump sum? ›
For a lump sum, the present value is the value of a given amount today. For example, if you deposited $5,000 into a savings account today at a given rate of interest, say 6%, with the goal of taking it out in exactly three years, the $5,000 today would be a present value-lump sum.What is the difference between a lump sum and a pension? ›
A monthly pension payment gives you a fixed amount every month over your whole life, so you don't have to worry about changes in the stock market. In contrast, a lump-sum payout can give you the flexibility of choosing where to invest or save your money, and when and how much to withdraw.How do pensions pay out? ›
A pension payment may be taken in a monthly payout, called an “annuity.” It provides a steady, known income each month. If you take all the money at one time, it's called a “lump sum” payment. It becomes your responsibility on how much of the amount you spend or invest.How long does it take for a pension lump sum to be paid? ›
How long does it take to receive a pension lump sum? Usually it will take around four to five weeks from the date of your request for your pension provider to release your lump sum.Do all pensions offer lump sum payout? ›
If You Choose an Annuity, Single-Life Option Gives You More Control. Of course, not all pensions have a lump sum option, which means you have no choice but to accept an annuity payment. If that is you, there are a few things to consider before selecting your irrevocable annuity option.
Should you take a cash 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.
Investors can avoid taxes on a lump sum pension payout by rolling over the proceeds into an individual retirement account (IRA) or other eligible retirement accounts.Does a lump sum pension affect Social Security? ›
Receiving a lump sum pension payment won't affect your Social Security benefit amount assuming that you didn't work for an employer that was exempt from withholding U.S. Social Security taxes. It probably will raise your Part B Medicare premium rate, though, at least for one calendar year.What are the disadvantages of taking lump sum pension? ›
The drawbacks of taking a lump sum
Pension value can decrease: If you choose to withdraw and hold the money in cash, for example in a savings account, the value can decrease in real terms. It can mean your spending power falls, in turn, affecting your retirement lifestyle.
The 50 – 70 rule is a quick estimate of how much you could spend during your retirement. It suggests that you should aim for an annual income that is between 50% and 70% of your working income.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.Why is my pension transfer value so high? ›
Because the Scheme is a defined contribution pension, its value goes up and down depending on the performance of the investments it uses. This affects the fund value and the transfer value. The fund value is updated each week, usually on a Friday or Saturday.What is an example of commuted? ›
Verb He commutes to work every day by train. She commutes 400 miles a week. The judge commuted his death sentence to life imprisonment.What is a commuted lump sum? ›
When the time has come to retire, you can choose to give up part of your annual entitlement to pension to receive a one-off lump sum payment in return. This is called commutation. However, there are limits on the amount that can be commuted.What does the IRS consider commuting? ›
What Is Commuting According to the IRS? According to the IRS, commuting (p. 25) is the transportation between your home and your regular place of work. Your home, in this case, is the place you live, and your regular place of work is the place where you earn a majority of your income.
Is $3 000 a month a good pension? ›
If you have a low living cost and can supplement your income with a part-time job or a generous pension, then retiring on $3,000 a month is certainly possible. However, if you have a high living cost or rely solely on Social Security benefits, retiring on $3,000 a month may be more difficult.Is $500,000 enough to retire with a pension? ›
With some planning, you can retire at 60 with $500k. Remember, however, that your lifestyle will significantly affect how long your savings will last. If you're content to live modestly and don't plan on significant life changes (like travel or starting a business), you can make your $500k last much longer.Is $600,000 enough to retire at 65? ›
If you manage to stay healthy and never need long-term care then $600,000 could be enough to sustain you in retirement. On the other hand, if you need long-term care in a nursing facility that could take a large bite out of your savings.What is the 80 20 rule pension? ›
An 80/20 retirement plan is a type of retirement plan where you split your retirement savings/ investment in a ratio of 80 to 20 percent, with 80% accounting for low-risk investments and 20% accounting for high-growth stocks.What is the 8% retirement rule? ›
The 8% solution is built on the premise that regardless of what your earned income is, you save at least 8% of it every year for your entire working career. The other portion of the equation is that you also average an 8% rate of return for the duration of your working and retirement saving career.What is the 4% rule for pensions? ›
How the 4% Rule Works. The 4% rule is easy to follow. In the first year of retirement, you can withdraw up to 4% of your portfolio's value. If you have $1 million saved for retirement, for example, you could spend $40,000 in the first year of retirement following the 4% rule.What not to say in salary negotiation? ›
I'm not comfortable sharing my current salary. I would prefer to focus on the value I can add to this company rather than what I'm paid at my current job. I don't have a specific number in mind for a desired salary, and you know better than I do what value my skill set and experience could bring to your company.When should you not negotiate a salary? ›
Don't negotiate your salary until you have a firm offer. Don't try to get one company to match another company's offer. Don't rely on the estimates you see on a salary website. Don't fixate only on money.Can I lose an offer negotiating salary? ›
It is simple: you can lose a job offer by negotiating salary if you make unreasonable demands or by going below what is expected of the request.How do I cash out my defined benefit pension plan? ›
In order to take your funds out of the plan, generally you have to either retire or terminate your employment. However, even in these circumstances, a lump sum commuted value is not always available.
What is a good monthly pension amount? ›
Average Monthly Retirement Income
According to data from the BLS, average incomes in 2021 after taxes were as follows for older households: 65-74 years: $59,872 per year or $4,989 per month. 75 and older: $43,217 per year or $3,601 per month.
The Bottom Line. For some, a lump-sum pension payment makes sense. For others, having less to upfront capital is better. In either case, pension payments should be used responsibility with the mindset of having these resources support you throughout your retirement.What happens when you take a lump sum from your pension? ›
Take cash lump sums
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.