Many members of pension plans seem to have a fairly good sense of how their pension benefits are calculated and what approximate pension they can expect at retirement. However, in our experience dealing with plan members, we find there is a lot of confusion about what happens to a member’s pension if they terminate their employment before retirement is possible.

When a member terminates their employment and thereby their pension plan membership, we generally receive many phone calls from either the terminated members, their bankers or financial planners, or - very frequently - their spouses. (How come that spouse seems so much more interested in the benefits than the spouse who is entitled to them?)

To help clarify the issue a little, we have created a few scenarios and corresponding options to which the terminated plan member is entitled:

i)If the member is not vested - i.e. he or she doesn’t have the required years of plan membership or service with the employer (typically 2 years’ membership or 5 years’ service, depending on the member’s province of employment) - the member can either:

a) received contributions with interest as a cash payment, less withholding tax; or
b) transfer contributions with interest to his or her RRSP.

These options assume that the pension plan requires members to contribute. Also, if the member elects to transfer the funds to an RRSP, the transfer will not affect his or her RRSP room or income tax return. This is because the benefit has been accounted for in the annual Pension Adjustment.

ii) If the member is vested - i.e. he or she has attained the required amount of years of plan membership or employment service and is entitled to the full benefit accrual - the member can either:

a) leave accrued pension benefit in the plan as a deferred pension until the earliest retirement date, usually age 55, and then have a pension commence (if the pension payments commence prior to the plan’s normal retirement date, the monthly pension may be reduced by an early retirement factor); or

b) transfer the accrued pension benefit to a new employer’s pension plan, if that new employer’s plan so permits; or

c) transfer the commuted value of the accrued pension benefit to a Locked In Retirement Account (LIRA) or Locked In RRSP (it depends upon the province of employment). ‘Locked In’ means that the benefit cannot be taken as a lump sum cash payment, but must be used to purchase a retirement income product commencing typically between ages 55 and 69. In the interim, the funds can be invested in almost the same manner as RRSP funds.

Again, these options and transfers will not affect the terminated member’s RRSP room due to the annually reported Pension Adjustment, nor will it affect the filing of his or her income tax.

In addition, if the pension plan is contributory (the member’s are required to contribute), the terminated member may also be entitled to Excess Contributions (a partial return of their contributions with interest due to the 50% Rule). The options for these funds are similar to the non-vested options - cash or RRSP transfer. (For pension plans registered in Quebec and with the O.S.F.I., the excess contributions are subjected to locking-in provisions, and are to be handled as vested benefits.)

Of course, there are some exceptions to the locking-in provisions outlined above. Some jurisdictions permit the payment of locked-in funds in cash, should the accrued pension or its commuted value be below specified minimums. Generally, if the accrued pension is below 2% of the Year’s Maximum Pensionable Earnings (YMPE) in the year of termination, or if the commuted value is below 4% of the YMPE, the pension plan rules may permit a cash transfer of the benefit. (The minimums are governed by each provincial or federal jurisdiction, so please check with either your plan administrator or the plan text for specifics.) Currently, many jurisdictions are reviewing these minimums with a view to increasing them to approximately 4% of the accrued benefit, or 10% of the commuted value. We’ll keep you informed of any developments.

Within the last six months, plan administrators have been required to start reporting the terminated member’s Pension Adjustment Reversal to Revenue Canada. If the terminated member is entitled to a PAR, then this will affect their RRSP room.

When a plan member terminates from a pension plan, an option form outlining their benefits is issued to them which explain their benefits, to some degree, as outlined above. However, even with the option form, many people are unsure of what they can do with their pension benefit. They may find some assistance through their banker, credit union, or financial advisor, but plan sponsors may wish to copy this article and provide it to the newly terminated member, along with their record of employment and any other termination forms, for their reference.

In addition, Penad helps plan sponsors with education and communications, so feel free to contact our office for information on our educational seminars and services for pension plan members.

Peter Forler is a senior pension consultant and works with clients across Canada on a variety of pension-related issues.