Your client has come to you with the news that he has decided to leave his job, and he needs your help in making an important decision regarding his workplace pension.

His question: should he opt for the commuted value of his pension, or should he remain a member of the pension plan and take the pension benefit when it is payable?

This can be a complicated decision. It’s not just a question of how much income the assets received are likely to generate. There are many other factors — such as the client’s health, the financial solvency of the employer and the spouse’s pension and benefits — to take into consideration.

For example, clients in poor health or with a family history of short life expectancy should probably take the commuted value of the pension. Those with a long life expectancy are likely to be better off sticking with the pension.

Clients taking another job, particularly one that will generate a pension or offer benefits, are probably better off taking the commuted value. But clients with a low risk tolerance should probably remain in the pension plan, as the rate of return they can expect from investing the assets in a way that lets them sleep at night is likely to be low.

Women can be better off remaining in the pension plan. In all provinces except Quebec, the commuted value is calculated on a unisex basis — and women tend to live longer than men, explains Jerry Loterman, actuary and senior consultant at the Toronto office of Illinois-based Hewitt Associates Inc.

But even in these cases, all factors should be examined.

The option of taking the commuted value of a pension is normally offered only when the client is more than 10 years from normal retirement. But some plans allow portability at any age before retirement, says Loterman.

Employees usually have two to three months to decide whether to take the commuted value; typically, it is a one-time choice. However, Loterman says, in Quebec, the decision can be revisited every five years to age 55.

The commuted value of a pension is based on the amount required to pay the pension if invested in 30-year Bank of Canada bonds. Currently, a return of 3.5% is used for the first five years and 5% is applied thereafter. There is a debate among actuaries as to whether using long bonds is the appropriate way to calculate commuted value, according to Steve Gendron, a principal with Toronto-based actuarial consultancy Eckler Ltd.

Because the commuted value is based on long-term interest rates, it is higher in a low-rate environment. In such a case, the commuted value may well be higher than Canada Revenue Agency’s limit on the amount that can be transferred into a registered retirement investment vehicle.

It is also important to consider that the value of benefits is not included in the commuted value; nor is the value of “pension bridging,” an allowance offered by some firms that is paid to age 65 to help early retirees make the transition to retirement. This allowance stops at age 65, when old-age security, as well as Canada Pension Plan benefits (if they have not been started earlier), kick in.

The commuted value can be transferred into a registered locked-in retirement account up to a maximum calculated by the CRA. This figure is arrived at by multiplying the pension that the person would receive at retirement by specified age factors. If the commuted value of the pension is higher than the CRA figure, the difference is subject to personal income taxes and can’t be transferred into a registered retirement account — unless the person has unused RRSP room or qualifies for a pension adjustment reversal.

Governments and major corporations often index pensions, but not necessarily to the full amount that the consumer price index rises by each year. Some public pension plans, for example, are indexed to only 60% of the increase in the CPI, says David Ablett, director of tax and estate planning with Investors Group Inc. in Winnipeg.

To help your client make the right decisions, here are the questions you should ask when determining whether the commuted value of a pension should be taken:

> If the commuted value is taken, how much is subject to taxes?

@page_break@> If your client chooses to take the pension, will it be reduced if started before retirement? “We have found that many people just know the full amount they would receive if they start at 65,” says Ablett.

> Will the pension be indexed and, if so, is it fully indexed to the CPI?

> Is indexation included in the commuted value?

> If your client takes the commuted value, will he or she be giving up other benefits? Some firms continue benefits; many don’t. “When you are 55, or even younger, it’s hard to put a value on health benefits,” says Mark Parlee, investment advisor with IPC Securities Corp. in Toronto.

> Does your client have a spouse? Is the spouse employed, and does he or she have a pension or benefits under which the client could get coverage?

> Is your client planning other employment? If so, he or she probably won’t need additional income until he or she retires and should take the commuted value. The new job may also generate a pension or offer benefits.

> What is the financial solvency of the pension plan or the employer?

> What is the minimum long-term investment return required to provide a monthly income equivalent to the pension? If a 7%-8% return is needed and your client is unsophisticated and has a low risk tolerance, he or she should probably stick with the pension, says Parlee.

Furthermore, return assumptions are just estimates, Gendron points out: “Even if the assets are invested wisely, you could have back-to-back years of drops in equities values.”

> What other assets does your client have? If there aren’t many other assets and your client wants to leave an estate, taking the commuted value may result in some assets at death; but there is a risk that your client could run out of money. The pension, on the other hand, will go on for life.

A couple of real-life examples:

> Henry, 51, has worked 33 years with the public sector and earned $115,000 last year. He qualifies for a full pension now and wants to retire. Henry’s spouse has no pension. Henry is not interested in managing his investments.

Henry is entitled to $5,500 a month, indexed by two-thirds of the rise in the CPI each year. His spouse would receive 60% of this if she survives him. He will also receive a bridging allowance of $800 a month to age 65. He now has health, dental and insurance benefits, which he would lose if he takes the pension.

The commuted value is $1.6 million, but only $580,000 could go into a LIRA, according to CRA rules. The income taxes on the other $1.02 million would be $473,382, leaving $1.1 million in total to be invested.

Investors Group ran projections, assuming a 6% average annual return after fees and inflation of 3%, implying that the indexation of the pension would be 2% a year.

“We determined that the annual income generated by the commuted value’s assets was always less than the pension,” Ablett says. “At age 70, the income would be only about 75% of the pension; at ages 80 and 85, it would be 83%.”

> Susan, 45, is moving to a new job after 20 years of service. She could defer her unindexed pension and start receiving $1,875 a month at age 60. She is not eligible for benefits, even if she takes the deferred pension. Her new job will have pension coverage.

The commuted value of her pension is about $164,000. Investors Group ran a projection assuming a 5% average annual return, which would result in about $341,000 in a LIRA at age 60. If invested in a monthly income fund at age 60, that would give Susan about $1,950 a month.

If the return was 6%, she would have $373,000 at age 60, which could purchase an income fund paying $2,200 a month.

“We were pretty comfortable that the commuted value would generate more income, even if there are significant bumps in the market over the next 15 years,” says Ablett. “Susan told us she was comfortable in managing her own retirement assets and, thus, assuming the investment risk. She also told us that it was very important to her to leave a significant portion of her retirement assets to her heirs.” IE