Your Money: Buying back pensionable service. Can you give your retirement a boost?

By Neil Mardian on June 15, 2019.

neilmardian@td.com

Canadian employees who are members of a defined benefit (DB) pension plan may have an opportunity to purchase years of service for periods when they did not participate in their employer’s pension plan. Perhaps the employee waited to join the plan. Perhaps he or she took a leave of absence for a variety of reasons such as starting a family, travelling or pursuing continued education.

A buyback may result in increased pension benefits upon retirement. Typically with a DB pension plan, a formula is used to determine the monthly pension a member will receive upon retirement. The formula takes into account the years of pensionable service along with the member’s earnings.

With most pension buybacks, plan members have the option of funding the buyback with cash (i.e. from accrued savings/investments), or by transferring funds from a registered account (such as a registered retirement savings plan [RRSP] or a locked-in plan), or a combination of both.

To reflect the value of the additional pension purchased, a past service pension adjustment (PSPA) may be part of the buyback process.

Pension administrators are required to calculate and report PSPAs to the Canada Revenue Agency (CRA) for approval to ensure that the tax limit on contributions to an RRSP are not exceeded. Where applicable, the CRA will reduce the available RRSP contribution room by the amount of the PSPA.

Funding a buyback using non-registered proceeds or cash will usually result in a PSPA, however the full amount may be tax deductible in the year the buyback is completed. If registered proceeds are used to fund the buyback, a PSPA may not be required; however, no tax deduction is available as it would have already been received when the contribution was made to the registered account.

There are several advantages and disadvantages of buying back pensionable service to consider when evaluating whether to complete a pensionable service buyback.

Some potential advantages may include the opportunity for enhanced pension income at retirement, or the potential to retire earlier. Next may be the reduced risk by providing a fixed income stream at retirement. Also, having creditor protection available and the availability of a tax deduction depending on how the buyback is funded

Some potential disadvantages may include your reduced RRSP contribution room now and in future. No access to the pension funds in an emergency, as compared to RRSP funds that can be withdrawn (less any applicable taxes). The limited estate planning options available can be a drawback. Also that DB pensions have features such as spousal/survivor pension benefits; however, pension payments cease upon the survivor’s death. Personal savings (non-registered and registered) on the other hand can be transferred as part of an estate or directly to named beneficiaries (where available). Finally, the opportunity cost that the contributed capital may outperform the increased income stream from the pension buyback.

Deciding to buy back pensionable service from a DB plan involves weighing several factors and may involve complex calculations. Speak with your pension administrator, a tax specialist, and your certified financial planner (CFP) when evaluating your buyback options.

For a further discussion around your financial and investment planning strategies, please contact me, Neil Mardian, CFP, FSCI, CIM, M.Sc. (Mgmt) 403-504- 3026 (neil.mardian@td.com). (neil.mardian@td.com).

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