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My latest MoneySense Retired Money column looks at the complex question of Pension Buybacks: putting extra money into a Defined Benefit pension to in effect “buy back” extra years of service. You can find the full column by clicking on the highlighted headline: Should you buy back pensions from your Employer? It ran on June 19th.
While this column often adds my own personal experience, this is a topic that I have never had the opportunity to explore. I can say that while I am now receiving pension income from two rather modest employer DB pension plans, the chance to buy back service never arose. If it had I probably would have jumped to take advantage of it as the guraranteed-for-life annuity-like nature of a DB plan strikes me as being particularly valuable, especially in these days of ultra-low interest rates and ever-more-volatile stock markets.
If your DB pension is inflation-indexed all the better. Again I lack such an employer pension and my wife is not in any pension at all, so our only experience in inflation-indexed pensions are the Government-issue CPP and OAS, so far deferred by my partner.
You will need cash for a buyback, or you can tap RRSPs or both. If cash, you must have available RRSP contribution room this year. Buybacks fall under the Past Service Pension Adjustment calculation, or PSPA. The PSPA reduces your RRSP in the current year, and Ottawa permits an $8,000 contribution beyond your RRSP room. Thus, the value of your buyback may be greater than your RRSP room once you consider employer contributions and future benefits.
In the MoneySense column, financial planner Matthew Ardrey of Tridelta Financial says the biggest “pro” for a buyback is simply a bigger pension at retirement. Since pensions reward longer service, buybacks let you buy more past service, and the deal is sweeter still if your employer matches contributions.
Longevity, interest rates, employer matching all considerations
Longevity can be a pro or a con, depending on when you die. The longer you live the more attractive the pension becomes, and with it the value of a buyback.
Cost is another consideration, especially in today’s market. Cost comes down to how much commuted value is needed to purchase in order to receive a year of pension benefits. Because rates are so low buybacks are more expensive than they would be at more normal levels of interest. “All else being equal, the higher the interest rate the lower the commuted value,” Ardrey says, “ With interest rates being at all-time lows, this is perhaps the worst timing you can have for making the pension buy back.”
The column also looks at the question from the perspective of retirement planning for couples. Tom Feigs, a Calgary-based certified financial planner with Money Coaches Canada, says in almost any DB pension decision, the overwhelming factor is longevity. Others are whether the buyback is matched by employers, whether savings are available to purchase the buyback, and client desire for investing control.
Ancillary benefits like inflation indexing make buybacks more attractive but if the actuarial health of the pension or financial health of the company underwriting the pension is compromised, a buyback may not be advisable, Feigs says.
Also consider the retirement plans of both spouses. If your partner is also in a DB pension, you may reach retirement with two lifetime income streams. When one dies, the survivor ends up with two pensions when both may not be fully needed: if everything is taxed in one pair of hands, the marginal tax rate rises and OAS could be clawed back. Feigs says the value of two DB pensions is not quite additive because the income stream moves to the survivor on death of the first spouse. You end up with an unused survivor benefit unless you know for certain who will die first. Topping up years of service may be less ideal.
For early retirees, buybacks increase service years, sweetening the benefit and mitigating the early retirement adjustment. However, Retirement timing needs to be considered if there’s a big difference in the partners’ ages. As Feigs says, “The buyback may close the gap, bringing the younger spouse closer to the older spouse for timing of retirement.”
The column also addresses a specific reader question about buybacks, which is answered by author and CFP Alexandra Macqueen, with links to one of her MoneySense columns on the topic, and a similar one by fee-only planner Jason Heath.
