How does a pension purchase work? – Money sense

A common situation is when you were on leave, including maternity or parental leave. Another example could be that you switch from one DB pension to another at your new job and the new pension has a more lucrative pension formula.

Financing a buyback

When you buy back service, you can use money that is part of your Registered Retirement Savings Plan (RRSP). This is not considered an RRSP withdrawal. The money can be transferred to retirement on a tax-deferred basis and increase your future payments in exchange for giving up some of your RRSP savings.

While you can use money in a tax-free savings account (TFSA) or from another source if your RRSP is insufficient, there may be a limit. If your pension buyback exceeds your available RRSP room, you may not be able to buy back the full service.

The Canada Revenue Agency (CRA) requires an application for a past service pension adjustment (PSPA). Form T1004 Application for certification of a provisional PSPA. If the cost of the repurchase is less than your available RRSP contribution room, approval is guaranteed. Even if the cost is higher than your RRSP limit, there may be some flexibility. There is an $8,000 overage limit so you can exceed your available RRSP room by up to $8,000.

One exception is if a pension plan has a retroactive change to improve benefits for at least 90% of participants. In this case, a pension may be able to apply for a CRA exemption.

Using non-RRSP funds to repurchase services will result in an adjustment to your RRSP room in the following year and a tax deduction in the year of repurchase.

Buyback service in the future

You may be able to buy back additional service in a future year as your RRSP room increases. Most retirement plan participants will receive at least $600 in new RRSP space each year thanks to the retirement matching formula (PA), although some may receive more depending on the plan.

That is striking Current year retirement contributions do not reduce your current year RRSP room. Pension contributions lead to a pension adjustment that reduces your RRSP space in the following year.

Should you buy a backup service?

It depends. It may be worth hiring a professional to analyze the numbers if you can’t do it on your own. Some pensions offer calculators to help you.

There are a few factors to consider.

1. The trade-off

What would your future retirement income be if you left the money in your RRSP, compared to increasing your pension? This requires an understanding of the pension formula and a comparison to a reasonable future RRSP growth rate and identical withdrawals for the increased pension.

2. Unreduced pensions

An important consideration is whether there is any part of the pension formula that negates the early retirement discount that would otherwise apply if you retire before a certain age. This is often based on age plus years of service equaling a certain number, for example 80.

If you still have a few years of service left by proceeding with the buyback, you may be able to retire earlier with a higher pension. This may be less important for someone who does not expect to stay with an employer for the rest of their career, or who is entering a plan later in life.

3. Life expectancy

If someone has a short life expectancy, a health problem or a poor family history, they may want to pass on the pension buyback, especially if they are single and do not have a spouse who could receive a survivor benefit upon their death. Having money invested in an RRSP or other investment account can be financially beneficial or provide more flexibility for estate planning.

4. Risk tolerance

The lower a person’s investment risk tolerance and desire to invest in stocks, the better a pension buyback will be for him or her. A DB pension offers guaranteed benefits that are not subject to the ups and downs of the stock market.

A higher-risk investor may be able to achieve better investment returns and have a higher retirement income.