Your health and expected lifespan play a significant role when evaluating your pension options. A defined benefit pension plan provides a guaranteed monthly income for life. The longer you live, the more total value you receive. If you are in good health and expect a long retirement, a defined benefit pension may offer a greater lifetime benefit.

Example

Consider Sarah, age 65, with a $3,000 monthly pension with no indexation ($36,000/year).

• Lives to age 75 → receives $360,000 total
• Lives to age 85 → receives $720,000 total
• Lives to age 95 → receives over $1 million total

Longevity significantly impacts total value.

If you are single and expect a shorter life expectancy, the total value you may receive from monthly payments could be lower, since payments usually stop at death unless you have a guaranteed payment period (e.g., 10 or 15 years). However, if you have a spouse or partner, it's important to consider the total value that both of you may receive. Survivor benefits - often 60% to 100% of your pension - can help ensure income continues to your spouse for as long as they live. The specific options and amounts depend on your plan’s rules.

Tax can be an important consideration when you decide whether to take a lump sum payment. When you commute your pension, not all commuted value can be transferred tax-deferred. This legal limit on tax-deferred transfer is called the Maximum Transfer Value (MTV). Think of it as a ceiling:

• The amount below the MTV moves to your LIRA tax-deferred
• The amount above the MTV becomes taxable income. However, some or all can be sheltered from tax if you contribute this amount to your RRSP, provided you have unused RRSP contribution room available to make the contribution.

If you decide to commute your pension, excess taxable cash could push you into a higher tax bracket and create a substantial tax bill in the year you take a lump sum.

Bottom line

It's important to review your pension statement to understand how much of the commuted value exceeds the MTV and what that means for your tax situation.

Transferring a lump sum from your pension plan to other investment accounts means you accept responsibility for investing your pension savings (which may form a large part of your retirement income). Your future income will depend on how well your investments perform.

• If you feel comfortable making investment decisions, working closely with a financial advisor, or have other sources of reliable retirement income, you may appreciate the flexibility that comes with commuting your pension value.
• If you prefer stable, predictable income, want to avoid worrying about market fluctuations, or have other limited sources of reliable retirement income, remaining in the defined benefit plan may feel more secure.
• If you want stable, predictable income but do not wish to remain in the pension, you can consider using specific insurance products such as an annuity or segregated funds with a Guaranteed Life Withdrawal Benefit (GLWB). This strategy involves using part of the commuted value to purchase an annuity or GLWB. Both contracts provide a pension-like income stream, and while there are some key differences between the products that should be discussed with your insurance advisor, both can help manage market risk, inflation and longevity risk.

Consider past events

In the 9-month period between June 2008 and March 2009, the TSX fell by 50%. Similarly, after the pandemic declaration in 2020, the TSX fell by 37% but rebounded by 9.4% in a single week in March. While not all investments experience sharp short-term swings, seeing a significant decline in your investments can be stressful. A defined benefit pension can provide protection from this volatility.

Taking the commuted value gives you more control and flexibility since assets are invested in a LIRA or other investment accounts. This puts you in control of:

• Deciding how your money is invested
• Your withdrawal strategy (within minimum/maximum limits)
• The assets that stay in your name and form part of your estate

However, in exchange for this flexibility, you give up the stable and guaranteed income that the monthly defined benefit pension provides for life. 

The commuting trade-off

In exchange for the flexibility of commuting, you give up the stable and guaranteed income that the monthly defined benefit pension provides for life.
 

You may also take on: 

• Additional time and involvement in managing your investments, depending on your investment preferences
• More planning decisions (e.g., when to convert to a LIF, how much to withdraw)
• Exposure to market risk and volatility
• Longevity risk (what if you live longer than expected?)

A defined benefit pension is designed to provide secure, lifetime income, but the value to your estate as an asset to be passed to your heirs is usually limited.

• Staying invested in the pension plan: Pension payments normally end when you pass away, unless you selected a spousal survivor benefit (where available). Even then, your spouse typically receives a reduced amount. Usually there is no remaining asset value for children or other heirs.
• Commuting your pension: The lump sum is transferred into a LIRA or similar account and remains your asset. Any funds remaining in the account when you pass away can usually be passed on to your beneficiaries, giving you more flexibility and control in your estate planning (subject to governing pension legislation). 

Summary

A defined benefit pension provides income security, while the commuted value option may give you opportunity to meet your legacy goals.

It is also important to consider the financial health of your pension plan and its sponsor. If a pension plan is underfunded (meaning it does not currently have sufficient assets to cover all future pension promises), this may signal potential risk for the plan sponsor over the long-term. If your plan sponsor's long-term stability is uncertain, some members may choose to transfer out the commuted value to secure their financial future.

Your annual pension statement usually shows whether your pension plan is fully funded or running a deficit. This is known as the plan's solvency ratio, and reviewing this information can help you decide whether it makes more sense to stay invested in the plan or take the lump-sum value.

Example

'80% funded' or '80% solvency ratio' means the plan has $80 in assets for every $100 of promised benefits. Look for this information on your annual statement.

Your spouse or partner's financial stability may also influence your pension decisions. If your spouse depends on you financially, it's important to plan for the possibility that you pass away first. A survivor pension option ensures that a portion—often 60% to 100%—of your pension continues to your spouse for the rest of their life. This protection can be important if your spouse:

• Has limited personal savings
• Does not have a pension of their own
• Relies on your income to meet daily living expenses
• Has limited investment knowledge

In these cases, choosing a pension with appropriate survivor benefit can offer valuable protection. If your spouse is financially independent with their own pension or assets, you may have less need for guaranteed lifetime income from your pension.

Inflation can affect your purchasing power in retirement. While many defined benefit pension plans offer inflation protection (i.e. indexing, indexation, or indexed benefits), you should review the following:

• Does your pension include indexation?
• How is indexation calculated?
• Is the indexation guaranteed or discretionary? Some plans may only increase the pension benefit depending on the plan's financial health, and these increases may not occur every year.

A defined benefit pension that is fully or partially indexed can significantly enhance your long-term income security. If inflation protection is part of your pension, it may be one of the reasons to consider staying in the defined benefit pension plan.

Here's a counter-intuitive twist: When interest rates drop, your pension lump sum actually grows larger — sometimes by hundreds of thousands of dollars. Sound great? Not so fast.

Low rates increase your commuted value, but they also may make it harder to find guaranteed investments that can replicate the steady, lifelong income your pension provides. That's because low interest rates reduce payouts from annuities and other guaranteed income products.

Consider past events

In 2020-2021, many Canadians saw their commuted values spike during rock-bottom rates. Those who took the money and sought to purchase guaranteed lifetime income products often struggled to match their former pension's guarantees. Others who invested in market-based (non-guaranteed) investments sometimes achieved stronger long-term outcomes — but only with careful planning, professional advice and a willingness to accept market volatility.

Some employers, especially in the public sector, provide extended health and dental benefits to retirees. It’s important to confirm whether these benefits:

• Are only available if you choose the monthly defined benefit pension, or
• Remain available even if you commute, or
• Have a limited duration (some plans provide extended health and dental benefits at a lower price for 10 years etc.)

If you rely on these benefits to manage ongoing health costs, staying with the defined benefit pension may provide additional financial security.

Example

Sarah (57) and Michael (60) are approaching retirement. Sarah is a secondary school teacher, and Michael works for the government. Both have worked for approximately 30 years so their defined benefit pension plans will provide $56,000/year for Sarah and $58,000/year for Michael once they retire.
 

If they transfer out the commuted value, the taxable portion above Maximum Transfer Value would be approximately $350,000 for Sarah and $400,000 for Michael, and each has RRSP contribution room of $40,000 and $50,000. They own a modest home and have around $200,000 in various investment accounts. While they value income security, they remember the significant financial help they received from an inheritance from Sarah's parents. They hope to do the same for their three adult children.
 

Their key considerations

• Health: They are both healthy, and both their parents lived until their mid-80s.
• Priority: Sarah and Michael realize that if they both choose the lifetime defined benefit pension, payments will stop when the surviving spouse passes away. This means there may be little estate value left for their children. They want to leave a meaningful legacy to their children and help them out during their lifetime.
• Maximum Transfer Value: They are aware that a significant amount of commuted value is taxable.
• Commuted Value Provides Flexibility: They learn that if they commute one of their pensions, the lump sum goes into a locked-in account that remains their asset. Whatever isn’t used during their lifetimes can be passed on to their children.
• Balancing Security and Legacy: They want enough guaranteed income to cover their essential expenses, while also ensuring their children receive something from their estate and during their lifetime.
   

Their decision

After speaking with their financial advisor, Sarah and Michael decide to:

• Keep Sarah’s defined benefit pension for stable and predictable income, as Sarah is younger and may live longer.
• Commute Michael's pension so the funds can grow in a LIRA and ultimately be transferred to their children.
• Maximize RRSP contribution to lower his taxable income when he commutes his pension, and design Michael's portfolio with balanced income and growth based on their investment risk tolerance, lifestyle expenses, other income (e.g., OAS, CPP) and investments.
   

This strategy gives them

• A reliable monthly income to cover core living expenses
• Flexibility and control over a portion of their retirement assets
• The ability to leave a long-term legacy for their children
   

It gives them the best of both worlds — security during retirement and the opportunity to pass wealth forward.