Changes to the calculation of commuted pension values in Canada are making it more challenging for defined benefit pension plan members to determine an optimal day to quit their job and receive the maximum payout, says one actuary.
Peter Gorham, an actuary at JDM Actuarial Expert Services Inc., says while he used to point plan members to bond rates when determining commuted pension values, this method has been complicated following changes to the calculation that were introduced in 2020 by the Canadian Institute of Actuaries’ Actuarial Standards Board.
“I get calls from pension plan members who are concerned with what they’re going to get depending on when they quit — when is it advantageous [to quit] because of interest rate changes?” says Gorham. “If someone wants to know whether to quit on March 30 or April 2, their quit date determines what interest rate will be used to determine the commuted value.”
Under the latest rules, actuaries assume a 50 per cent probability a plan member would start the pension at the optimal commencement date and a 50 per cent probability the member would start at the earliest date they’re entitled to an unreduced lifetime pension. In addition, the discount rate assumption used to calculate commuted value is now based on changes in provincial and corporate bond yields, instead of Government of Canada bond yields.
“I don’t think the actual calculation will ever be understood [by plan members] — taking a monthly pension and determining what it’s worth today,” says Gorham. “But we could at least make it easier for plan members to track things and the people who care about timing [their commuted pension value].”
Gavin Benjamin, a fellow at the Canadian Institute of Actuaries and a retirement and financial solutions partner at LifeWorks Inc., says the new calculation was based in part on anecdotal evidence that indicated former plan members who kept their pension in their plan weren’t necessarily starting their pension at the optimal commencement date, adding he hasn’t heard much feedback in terms of whether the changes have created significant concerns around the complexity of the calculation.
However, he says a commuted pension value is also influenced by other factors, including the plan’s early retirement provision, the former member’s age and potentially their years of service at the time they choose to terminate membership in the plan. And by taking a commuted value, plan members may also lose out on some key advantages offered by a pension plan.
“In my experience, when deciding whether to take a commuted value, the plan member’s focus is often on whether they can invest the lump sum of the commuted value at a higher investment return,” says Benjamin. “From my perspective, by taking the commuted value, the member is taking on all of the investment risk and they’re giving up longevity protection provided by a DB pension. There’s also a tax implication and, if the pension is indexed to inflation, that can be extremely valuable, something that’s being demonstrated in the current environment.”