After working for years, decades even, to build a nest egg so you can retire comfortably, having a moment where you think your pension plans are at risk can throw you into a bit of an anxiety spiral. That’s what happened to our reader Marshall’s father when he received a pension wind up letter. Follow along as our financial expert, Mubina, walks through what a pension wind up is and how to navigate your way through.
Hi Experts,
Marshall G.
Got a call from my father today. He’s on edge right now because he opened what he thought was going to be a normal letter from his pension plan. Turns out it was a pension wind-up letter. Neither he nor I know what this means. He’s already struggling with debt, so this, as I said, has pushed him to the edge. Can you please clarify what this all means?
Thanks in advance!
Marshall, first up, you can take a deep breath. A pension wind-up letter is serious news, but it does not mean your father loses everything. His pension plan is closing down, but there is a way to protect him. First, let’s break the letter down.
A pension wind-up happens when an organization shuts down its pension plan. This could be because either the employer went out of business, is merging with another company, or they simply decided to stop offering this type of retirement savings benefit.
When a plan winds up, it does not mean that the pension money disappears. Canadian law requires the plan to settle all its obligations to every plan member, which includes your father. The pension fund must either pay out benefits or transfer them before the plan can fully close. The pension term for this is ‘commuted value’. There are a couple of options to repark these funds.
The Wind Up Process
A lot of the wind up process depends on the kind of plan your father has. There are two main types of registered pension plans in Canada:
Defined Benefit Plans: This plan promises a fixed monthly income after retirement. The amount is usually based on years of service and pensionable earnings. It’s common in the public sector and some older private sector jobs. The majority of Municipal Pension Plans (MPPs) are also defined benefit plans.
Defined Contribution Plans work more like a savings plan. Both the employee and the employer put money in. The final retirement income depends on how those investments perform over time.
Your father should check his original pension documents or call the plan administrator to find out which type he has. This will affect his options.
Options After a Wind-Up
Once the wind-up is announced, your father will receive a statement showing the value of his pension benefit. He will then be offered choices for what to do with that money.
Here are the most common options available to Canadian pension plan members:
1. Transfer to a Locked-In RRSP or LIRA: Your father can transfer the value of his pension to a Locked-In Retirement Arrangement (LIRA) or a locked-in RRSP at a Canadian financial institution. These funds stay locked in for retirement income later. He cannot freely withdraw from them the way he could from a regular RRSP.
2. Transfer to a Life Income Fund (RRIF) He may also be able to transfer the value to a Life Income Fund (LIF), which is a locked-in registered retirement income fund at a Canadian financial institution. This option is usually available to those who are close to retirement age.
3. Transfer to Another RPP If your father changes jobs and his new employer has a pension plan, he may be able to transfer his pension benefit credit to another pension plan in Canada, provided the new plan allows such transfers.
4. Purchase an annuity. The plan administrator may also use the funds to purchase a deferred annuity from a Canadian life insurance company on your father’s behalf. This would give him a guaranteed monthly income in retirement.
5. Transfer to Individual Pension Plan (IPP): If your father is self-employed now, the funds may be transferable to an Individual Pension Plan (IPP). However, this is a specialized vehicle with strict CRA rules, so do take professional advice before considering this route.
6. Withdraw in cash: In some cases, you may be able to take the money in cash if the balance is below a specific amount. However, this amount would be added to your father’s taxable income for that year. The Canada Revenue Agency (CRA) would treat it as pension income, and income tax would apply.
What to Consider
If the pension amount is transferred directly to another registered pension plan, an RRSP, or a RRIF, your father does not need to include any part of it in his income, and it’s not tax-deductible either.
However, the Income Tax Act limits the amount that can be transferred out on a tax-deferred basis from a defined benefit provision of an RPP to a money purchase provision of an RPP, an RRSP, a PRPP, an SPP, or a RRIF. If the amount transferred is more than this limit, your father would need to include the excess in his income, and it would be subject to taxation.
It can also be tempting to use a pension wind up as a chance to pay off debt. This needs very careful thought. If your father cashes out his pension, it gets added to his taxable income. This could push him into a higher tax bracket for that year, and a significant portion may go straight to the CRA. He could end up with less than expected and still have the debt.
A better approach might be to transfer the pension to a locked-in plan for now and deal with the debt separately. Our article on using your RRSP to pay off debt can help you think through when it makes sense to use retirement savings for debt and when it does not. You may also want to read our guide on what to do with an unexpected influx of money before making any calls.
Speak to a financial services professional or the plan administrator before making any decisions.
What About CPP and QPP?
A pension wind up only affects your father’s workplace pension plan. It has no impact on Canada Pension Plan (CPP) or, for those in Quebec, the Quebec Pension Plan (QPP). These are government-run retirement plans, and he will still receive those benefits when he is eligible, regardless of what happens to his employer’s pension.
What Should Your Father Do Right Now?
Here is a simple checklist to get started:
- Read the letter carefully. It should include a timeline and a list of options.
- Contact the plan administrator. Ask for a pension statement showing the value of his benefit.
- Do not rush. There is usually a window of time to make decisions. Use it.
- Talk to a financial advisor. Especially given the debt situation, professional guidance is worth it.
- Do not take cash without getting tax advice first. The CRA will treat it as income, and the tax bill can be large.
If he is already struggling with debt, now is also a good time to look at the bigger picture of retirement planning. Our resources on RRSP season and why you shouldn’t wait to contribute to an RRSP are a good place to start thinking about how to rebuild retirement savings going forward and plan retirement.
The Bottom Line
A pension wind up is not the end of your father’s retirement planning, but it does require careful decisions. The key is to act calmly, get the right advice, and avoid taking cash without fully understanding the tax impact. Canadian pension law is designed to protect plan members like your father. Make sure he uses all the protections available to him.
