Many workers have missed years of service in their employment history. Years away from work to raise children, recover from an illness or injury, go back to school, or other absence can reduce future pension payments. If you are enrolled in a defined benefit pension plan you may be allowed to buyback those periods during which you did not participate in the plan.
With defined benefit pension plans, your pension amount is tied to your earnings, age, and length of service. This number is called the pension factor.
A pension buyback can:
- Increase your pension amount and survivor benefit, or
- Allow you to retire sooner with no pension reduction.
Allowable periods and the amount of the buyback purchase vary according to the plan. Also, you have to still be employed with the company. You can’t have left your job, or be already retired.
Crunch the numbers
When you are faced with this decision it’s important that you do the math. The cost is the “actuarial value” (what the future value is worth today), and it depends on such things as your age, your salary, how many years you want to buyback, and when the past service occurred.
To know if the cost is worth the increased pension amount, compare the difference between what your pension will be with, and without, the buyback.
You can get a rough estimate of your benefits by using an online pension buyback calculator such as this one for HOOPP. For greater accuracy on your particular situation, check with your pension benefits administrator.
Consider these issues
There are a number of other issues that can affect your decision to buyback pensionable service:
- Length of employment. The longer you work for the same employer, the more likely a buy-back will benefit you.
- Your age. The younger you are, the less costly it will be. Buying back service in your mid-30’s may just set you back a few thousand dollars, but after age 50, the cost could be ten times more.
- Employer contributions. In most cases your employer will also be making some contribution, so you will actually be only paying a portion of the true cost.
- Can you afford the cost? The earlier you buyback past service, the less costly it will be. You can finance your buyback service with non-registered funds, or you can transfer directly from your RRSP. Sometimes your employer will allow you to buyback service over a period of time rather than force you to come up with one lump sum.
- Life expectancy. Pension income will pay for as long as you live. If you think longevity is on your side, and you have no current health issues, an increased pension may make more sense. The survivor benefit may be worth it if your spouse is much younger than you.
Pension Buyback vs RRSP
For those enrolled in a defined benefit pension plan, it can be a cornerstone of your retirement income. Do you want the peace of mind of having a pension for life? A pension will give you steady income that is often partially or fully indexed to inflation. But it is more restrictive.
Consider the opportunity cost of removing capital from your RRSP for the years until age 60 or 65. Consider your expected rate of return for those years. An RRSP allows some flexibility to spend lump sums if you want to do that, or if your priorities change down the road.
The younger you are, the more you can save in your RRSP. But, if you have a smaller balance it may not be enough to maintain a decent standard of living or last the rest of your life.
Do you want to pass along an estate to your children or other beneficiary?
Final thoughts
While $100 – $200 extra per month may not seem like a big improvement, consider the long-term return of an increased pension amount.
A pension will provide a secure income for the rest of your life, and the life of your spouse. But, you will pay a price for that certainty.
Only you can decide whether a pension buyback is worthwhile for you.
