COLUMN: Ask the Money Lady – Using LIRAs and LIFs

Hey there, time traveller!
This article was published 18/11/2023 (532 days ago), so information in it may no longer be current.

Dear Money Lady,

My investment advisor wants me to convert my pension into a LIRA/LIF and don’t know if that’s a good idea. Will I have to pay a lot of tax if I do it? I know it will give me a bigger investment portfolio and my advisor would love that, but really why should I do it? Thanks, Brian.

Great question Brian. I am so glad you asked it. The first question I would ask you back would be: Are you on your own, married or have dependents? Your answer will help make your decision.

When you leave an employer a lot of people are not sure if they should leave their pension or move it to a LIRA – which stands for a locked in retirement account. The reason for moving it to a LIRA would be so you could have full access to your pension amount to invest as you choose. A defined contribution pension is relatively easy to transfer the whole amount to a LIRA, however a defined benefit pension plan is different. Often times when you want to convert a defined benefit pension plan there will be a commuted value that is not transferable and can only be taken out as a taxable lump sum amount. Now if you have RRSP room, you could reduce the tax burden by moving all or part of the lump sum into your RRSP, but if this lump sum amount is too much you will have to pay taxes on it as income in the year you do your conversion.

I want to work out an example for you so that you can make an educated decision when deciding to convert your pension. Let’s say you are 50 years old, and you have a commuted pension value of $350,000 and your annual pension benefit at age 65 will be $27,000. Now because this is a defined benefit pension plan you would only be allowed to transfer $253,000 to a LIRA. If you are wondering how I got that number it is based on a transfer factor assigned to your age and multiplied by the annual benefit amount. So now that we know you can only transfer $253,000 to the LIRA, that leaves $96,000 that will be paid out and taxed. So, if you didn’t have room in your RRSP you would most likely get about $53,000 after taxes based on a 45 percent tax rate.

Okay – let’s go a little deeper with this situation and work out whether it was worth cashing out.

You’ve got $253,000 in your LIRA. If you still wanted to get the pension benefit of $27,000 per year at 65 off this smaller amount, you’re going to need to ensure a 5.132 percent compound rate of return on the investment until the age of 65. Which, I have to say, is probably quite doable. Now if you added in the $53,000 that you cashed out of your investment portfolio and you didn’t spend it, your rate of return would only need to be approximately 3.761 percent compounded annually, (and this is very doable). That would give you approximately $530,000 as a total investment by age 65 and would allow you to take out an indexed pension amount of $27,000 annually.

With my example scenario it makes sense to do the conversion and I would recommend it if you were single without dependants or a spouse. The other reason you may want to consider it is if you question the long-term stability of your employer. If you have any doubts that your employer might not be able to sustain their pensions, then that would be another reason to cash out. Now before you do so, there is one more thing to consider: your benefits. You want to find out if health and dental benefits are voided once you do the conversion. Often times companies will only include benefits in your retirement if you are collecting a company pension. So, if you take the commuted value of your pension, just make sure you ask if this changes your benefit eligibility. And if it does, makes sure you are okay with it.

There could be a number of reasons to stay in your pension plan or to cash out and take the commuted value. Really a decision like this needs to be discussed with your financial advisor and it really should be mathematically determined if it’s worth it. You also want to discuss tax options with your advisor – can you take advantage of income splitting or are there limitations based on the plan being provincially or federally regulated. If this is the case, you may only be able to do a partial unlocking. You want to find out all the options and then make the decision that is right for you.

Christine Ibbotson is a Canadian finance writer, radio host & YouTuber. For more advice check out her YouTube channel: ASK THE MONEY LADY – Your Canadian Finance Coach.