How to model commuting a pension
This article details how to model a scenario where your client takes a commuted value for their defined benefit pension plan.
There will be 2 parts to illustrating this scenario:
- Tax-deferred amount: Update the locked-in account value on the Assets page to include this amount.
- Immediately taxable amount: Enter a lump sum taxable income in the first year of the projections. Ensure the after-tax portion is contributed to the applicable assets (ie. non-registered, TFSA, registered, etc.).
Let's use an example to demonstrate. If the client takes his commuted value immediately, $165,000 would be entitled to tax deferral and go into a LIRA. The remaining commuted value of $250,000 would be taxable in that year. If the client has unused RRSP contribution room, it is possible to contribute some to an RRSP, and the rest to a TFSA and/or non-registered account.
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Part 1 - The tax-deferred amount
Under Scenario Setup -> Assets, add the tax-deferred portion of the commuted value to one of the existing LIRA accounts, or create a new LIRA account.
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The immediately taxable amount
Create a new income column in the projections for the portion of the commuted value that is taxable. Go to Scenario Setup -> Incomes and select Add Income.
Enter a Description (e.g., Commuted Pension), the Amount, a Type of Other, and change the Taxable column to Yes. It is not RRSP eligible and the From Age and To Age would be the client's age in the first year of the projections.
On the Planning page, you'll see the $250,000 amount under the new column for the commuted pension taxable amount.
Any surplus cash remaining after taxes will be contributed to the assets according to default logic. In this example, the maximum RRSP contribution is $16,200 based on the RRSP contribution room. The remaining surplus is contributed to the TFSA and non-registered accounts. You don't have to manually contribute to the assets if automatic cash-flow management is turned on.
Tips
- To help your client decide whether or not to commute their pension you can create 2 scenarios. In the first scenario, model the defined benefit pension plan (DBPP). In the second scenario, exclude the DBPP and include the commuted value as shown above. One value to compare between scenarios is the projected Estate After Tax at different ages. You can view a comparison of the Personal Estate - Estate After Tax chart under Trends within Compare Scenarios.
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- You may also show partial unlocking of the LIRA upon conversion to a LIF account.
