Take the Guaranteed Pension Plan or the Commuted Value

Case-1-837x1024Mr. Sharp is a 55 year old married senior executive who has been offered a retirement package and wants to know his options. He can either take a lifetime indexed pension of $108,000 per year, with a 60% survivor benefit, or take a lump sum commuted value of approximately $1.95 million before taxes.

Claudio’s Recommendation:

Indexed, lifetime pensions were at one time a relatively safe and attractive option. In recent years, however, pension indexing is disappearing and some defined benefit plans are significantly under-funded.

Given Mr. Sharp is a recent cancer survivor, he was concerned a premature death would result in his survivor pension benefits being reduced by 40%. In addition, when Mrs. Sharpe died, the pension plan would cease and there would be no further benefits payable to anyone. He was also concerned that the pension plan would not remain fully funded and the payments in the future could be decreased or halted.

If Mr. Sharp takes the pension

Projected guaranteed annual pension: $140,000 ($108,000 gross company pension plus $32,000 in CPP and OAS including MRS. Sharp’s benefits)
After tax projected joined income: $109,580 (assuming pension splitting legislation remains in effect?

If Mr. Sharpe takes the commuted value

Cash distribution from investments: $108,000 (withdrawn portion only)
Additional income: $32,000 (CPP and OAS)
Projected combined gross annual cash flow: $140,000
After Tax Projected Joint Income: $118,210
Net Annual Pure Tax Savings: $8,540

Mr. Sharpe opted for the lump sum payout. By taking the lump sum payment and building a diversified investment portfolio of dividend paying stocks, Mr. Sharp can income split the investment income with Mrs. Sharpe. He can also take advantage of the preferred tax treatment of capital gains and dividends, giving the Sharp’s an additional $8,540 per year after taxes. In contrast, if Mr. Sharpe opts for the pension payments, that income is 100% taxable.

The Sharps are earning approximately $27,000 additional annual investment income that can cover inflation and unforeseen future expenses.

By using some of the excess annual investment income to purchase a life insurance policy, the Sharps ensured that the final taxes on their estate would be paid and their heirs would receive approximately $2.0 million after all taxes in today’s dollars. The Sharps are also considering helping their children open a family business, using some of their non-registered investments.

For the Sharps, the extra risk of foregoing a guaranteed pension plan (for now) was more than offset with the benefits of taking control over their pension assets during their lifetime and knowing they would leave a legacy for their children and grandchildren.

Contact Claudio

Claudio Piron CPA, CA, CFP®, CSWP, TEP
Senior Investment funds Advisor
Insurance Advisor

HollisWealth Insurance Agency Ltd.
4 Director Court, Suite 110
Vaughn, Ontario, L4l 3Z5
Phone: 905 712 9302
Fax: 905 712 9330
Email: claudio.piron@holliswealth.com

Mutual Fund Dealers Association of Canada