What is a Commuted Value?
The commuted value is the lump-sum equivalent of the future pension income you’ve accrued to date in your defined benefit pension plan (“DB plan”). Simply put, it is the amount your future pension is “worth” at the moment you end your employment, reflecting current economic conditions. It represents the amount that would need to be invested today, at current market rates, to reproduce that future pension income over your lifetime.
Often, a portion of your commuted value is “locked-in,” meaning it can only be transferred to another locked-in vehicle, such as a LIRA, a LIF, another company pension plan (if your new employer allows), or used to purchase a life annuity from an insurer. The remainder is considered “non-locked-in” and can be taken as cash (subject to withholding taxes) or transferred directly to your RRSP, provided you have sufficient “RRSP Room”. The closer you are to age 55, the larger the proportion of your pension that is locked-in. The formula dictating the “locked-in amount” is mandated by pension legislation and is designed to preserve funds for retirement income.
What Should Younger Workers Know About Their Commuted Value?
Employees under age 55 in DB plans are generally presented with two options upon termination of employment: withdraw your commuted value as a lump sum or defer your monthly pension until a future retirement date (typically between ages 55 and 70). The option to take a lump-sum can be attractive, but it comes with trade-offs that should be seriously considered.
Withdrawing your pension allows you to invest the amount yourself, potentially growing it more aggressively. However, it could also result in significant losses depending on market conditions and investment choices. It may provide more control over your assets for estate planning purposes.
Withdrawing the non-locked-in portion of your pension also triggers a significant tax liability, unlike deferring your monthly pension, which allows tax to be deferred. The trustee will withhold a standard 30% tax on the non-locked-in portion if it is not transferred to an RRSP. This is a withholding tax, and you may be eligible for a partial tax refund—or may owe additional taxes—depending on your income for that tax year.
The commuted value is subject to market volatility; it may increase or decrease significantly based on interest rates in effect at your termination or at the date of payment. Taking the lump sum also means giving up the guaranteed income of a DB pension, including potential cost-of-living adjustments, continued monthly payments to a survivor or beneficiary, and possible bridging options.
How do Interest Rates Affect the Commuted Value?
Commuted values are based on interest rates calculated according to regulations set by the Canadian Institute of Actuaries and governed by provincial regulators. These rates are derived using a weighted average of provincial and corporate bond yields.
Since commuted values represent the present value of your future pension, higher interest rates yield lower commuted values. This is because a smaller amount needs to be invested now at higher returns to generate the same future pension income. Conversely, lower interest rates result in higher commuted values.
Interest rates change monthly and are unpredictable. You may receive an estimated commuted value months before your termination date that differs significantly from the final amount calculated at termination. The commuted value is not equivalent to a savings account that grows steadily over time.
Bottom Line
A monthly pension offers predictability; it is a guaranteed, fixed income payable for life, regardless of market conditions or interest rates. You may also receive additional benefits, such as annual inflation adjustments or continued payments to a spouse or beneficiary.
A commuted value offers flexibility and the potential for higher (or lower) returns instead of a guaranteed retirement income. Actual returns depend on market conditions, and you may end up with retirement income that is smaller than what a guaranteed monthly pension would have provided.
You should discuss these options with your financial advisor or pension administrator. Consider your comfort level with investment risk, your financial literacy, and whether you value flexibility or predictability. You should also factor in any other retirement savings or pensions you will receive.