If you’re one of the tens of thousands of Albertans currently owed a deferred public sector pension, you should be aware of a very important change coming on April 1, 2020.
What is a deferred pension?
A deferred pension arises when you stop contributing to a pension plan before you are entitled to start receiving benefits. Typically this occurs if you work for an employer for a number of years, contributing to a pension plan along the way, but then terminate your employment before you’re old enough to start collecting pension benefits (usually at age 65 but it can be as low as age 50 or 55 depending on your pension plan).
As an example, I worked for the City of Edmonton for 13 years and contributed to the Local Authorities Pension Plan (LAPP) during that time. When I decided to leave my job in 2019 to start High Level Wealth Management, I was only 35 years old so I couldn’t start collecting pension benefits immediately. Instead I became entitled to a deferred pension based on my 13 years of contributions, which will begin providing monthly benefits when I turn 65 years old. In other words, I’m entitled to a pension, but it is deferred until I’m 65.
When I became entitled to a deferred pension, I was also given an option to receive a one-time lump sum payment in lieu of my future pension. This lump sum payment is based on the “commuted value” of my deferred pension, which is calculated by an actuary based on many assumptions including my age, life expectancy, and an estimated investment return between now and my death. The LAPP website defines commuted value as:
the present value of a future pension that would be paid for a person’s lifetime after retirement. It is a lump sum payment equal to the amount of money that would have to be set aside today, to generate a future pension.
On November 22, 2019 Bill 22 Reform of Agencies, Boards and Commissions and Government Enterprises Act, 2019 became law in Alberta. It included a provision that, effective April 1, 2020, changes commuted value calculations for LAPP and two other public sector pension plans. Specifically, the calculation will change from a formula set by the Canadian Institute of Actuaries based on Government of Canada bond yields to a new formula based on a pension plan’s actuarial discount rate. As of today (March 2, 2020), the existing formula assumes an investment return of around 2.3% per year while the new formula will use a much higher assumption specific to each pension plan. As an example, LAPP’s most recent actuarial valuation report (December 2017) assumes a discount rate of 5.4%.
To the extent that a higher investment return assumption results in a lower commuted value (and vice versa), the upcoming change to commuted value calculations will result in lower commuted values for those owed deferred pensions.
If you intend to leave your deferred pension assets in the plan and collect your pension benefits when you reach retirement, the upcoming commuted value calculation changes won’t affect you. You will still be entitled to the same monthly pension benefit after April 1 as you are entitled to today. However, if you are contemplating receiving a one-time lump sum payout in lieu of a future pension, you may want to contact your pension plan administrator to get a revised commuted value calculation before April 1, 2020. After that date there is a very good chance that your commuted value will be worth less than it is today, and the younger you are, the more substantial the decrease will be under the new formula.
For more information on the upcoming changes to commuted value calculations for Alberta public pensions, contact your pension plan administrator. If you are a member of LAPP, this FAQ may also be helpful.
Aside from the upcoming commuted value calculation changes, there are many factors to consider before making a decision to receive a one-time lump sum payout in lieu of your deferred pension. The decision is irreversible, so you should consult a qualified financial professional in order to get help in making a decision that is appropriate and specific to your circumstances.