Commuting your pension
Pensions are valuable assets. They protect workers in retirement. They last for life. Often, they last for a spouse’s life, too. Some pensions can be “commuted”. This means they can be terminated in return for capital that can be invested.
In commutation, the retiring employee releases the pension plan from all claims in return for a cash payment that is advanced to a “Locked-In Retirement Account” or LIRA. This is similar to an RSP, but generally not cashable except in periodic instalments. The employee will likely also receive a taxable cash payment that can be rolled into an RSP, if there is "room". If not sheltered in an RSP, the taxable portion is often taxed at the highest marginal rates, near 50%.
It takes an expertise in math, such as an actuary has, to calculate the risks and benefits of commutation. Clients cannot do this for themselves. The actuary hired by the pension fund is not in a position to give advice to the client.
Commutation often appears to involve over $1 million. Who would not be tempted to grab the cash? The safe choice is the pension and the investment has more risk. The client bears all the risk when they choose an investment over the pension.
- There are substantial taxes up front. Often greater than the client would ever pay from the monthly pension.
- There are commissions and fees to pay, often very substantial and also often, undisclosed. There are no fees to receive a monthly pension.
- Markets go down a lot every few years. You can only recover from a loss if you stop withdrawing money. Who can live on nothing?
- Financial advisers claim to be excellent asset managers, but they often do under-perform the markets by the amount of their fees or more. Is your financial adviser that much better than all the others?
The bottom line - why take the risk?
After commutation, the client has to invest the money, in the LIRA and in the taxable account. Hopefully - and it is only hope - the investment returns are greater than the monthly amount the pension would have paid - guaranteed. Investment returns are not guaranteed. Markets drop. Investors lose money even with good advice.
If the markets drop and the client still withdraws money, then the balance remaining must increase even more just to break even with the pension. After fees.
conflict of interest
Financial advisers who recommend commutation face a major conflict of interest. If paid a commission to sell the investments after commutation, they are well compensated for the commutation. In the event of a financial disaster and subsequent law suit, “Who benefits?” In this case, it may be the adviser. The client may have lost investment money and cannot afford to live in the lifestyle assured by a monthly pension.
To read an article on the subject of commuting pensions, click here.