Earning an income from your locked-in pension

In my last article touching on financial independence topics, I talked about the value of doing "the numbers" and making a habit of tracking expenses and income every month. 

In this article, we're going to shift to warp speed and talk about pensions. This article will apply most for readers who:

- have (or had) jobs with "defined benefit" (DB) pension plans. Most government jobs in Canada have DB pension plans;

- are considering their options for retirement prior to becoming eligible to receive a pension immediately upon retirement or have already transferred their pension value to a locked in RRSP or LIRA; and

- would like to earn usable income from their pension value NOW and not wait until age 55 or later.

Please note that I am primarily speaking of "Federally regulated" DB pensions, which are similar to each other, and apply to employees of the Canadian Armed Forces (CAF), Royal Canadian Mounted Police (RCMP), Federal Public Service, Canadian Border Services Agency (CBSA), Corrections Services Canada (CSC), etc. Other employee pensions (including for provincial and municipal government employees) will usually be regulated under their respective provincial legislation, which may have some key differences depending on the province. If this is you, and you want help, we can figure out your case together! Send us a note!

I originally posted most of this content in an advanced FI group on Facebook. That group is full of personal finance nerds, so don't feel bad if you need to read something twice. When I first wrote it I left out some of the more basic concepts that form the foundation of the subject. I brought some back, but everyone has different start points, so if you have any questions or want help understanding this topic, send us a message!

This is a relatively long post…but still just a short summary. Stick with me because the best trick is near the end!

If you are a Canadian government employee, like we were, and you have dreams of doing something else in your life prior to reaching your eligibility for a pension (typically 25 years of full time work or more), what would happen to your pension value when you leave? If you are considering such a transition, the first step is to contact your pension office for your numbers and options. 

Typical options you will be presented when you are leaving will include: 

(1) Deferred Pension.  This means that you get nothing now but will get a “deferred annuity” at a later date, typically at age 60 or 65. In this option, your employer holds your pension value and manages it until you are older, and then they start paying a monthly amount to you until you die. Once you die, if you have a surviving spouse they may continue to get a portion until they die (half is typical), and then payments stop, with no lasting benefit to your estate. 

To me, this option is best for people who know nothing about personal finances or investing, and don’t care enough to learn. Or perhaps for the risk-averse who want to rely on someone else for their cash flow in retirement, and don't have any need for income prior to being older. That said, while large government pensions are “pretty safe”, not all pensions are.  Just ask any Sears Canada pensioner… Sears Pension cut

(2) Transfer Value (also known as Commuted Value). In simple terms, this is a calculated amount that you can take and run with when you retire. It is a representation of the current dollar value of your pension. When you get your transfer value, you can invest it how you choose. Due to currently low bond yields, transfer values these days are pretty fabulously high. Your pension plan office or provider should be able to give you an estimate of your expected transfer value based on today or a hypothetical future retirement date. Be aware that the values may fluctuate month-to-month, up or down. If you take the transfer value, part of it must be put in a registered “Locked In” account (LRSP or LIRA…terminology depends on your province).  Because the money going into a LRSP is “tax-sheltered” like an RRSP, there is a maximum limit (the “inside limit”) to how much of your Transfer Value goes into it. Any remaining money in the Transfer Value payment is called the “outside limit” and is taxable in the year you receive it. For example, your Transfer Value may total $400,000 of which $200,000 goes into a LRSP (the inside limit), and $200,000 gets paid to you as a taxable benefit (your outside limit). For amounts that big, you will be hit with a 30% withholding tax on your outside limit amount, and only receive $140,000 in our example in cash. And then you may end up paying more at tax time (or getting some back, depending on your personal tax situation). But these days usually it’s still worth taking the transfer value if you know something about investing. Another way to shelter your outside limit from tax is using any RRSP contribution room. In that case you can send some of your outside limit to your RRSP to save some tax. 

One of the good things about the Transfer Value is that when you die, it stays as part of your estate, and goes to your beneficiaries (typically your family). We don’t have any kids so this isn’t as big a deal for us, but I still didn’t like the idea of our money just disappearing when my wife and I die, which is what would happen with a monthly pension payment or deferred annuity option. 

Disclaimer: My bias and area of knowledge is more specific to the option of TAKING the Transfer Value. I did this twice. Once from the Army, and then once when I left the RCMP. 

There are some things you can do to unlock portions of your “locked in” account, or to get income from them. 

Transfer Value Tips  (from Basic to Advanced).

  1. Time your outside limit payment. When you leave your job, time the receipt of your Transfer Value so that you don’t receive it in a tax year that you already have a high income from your previous employment (or severance pay if applicable). Often you have up to a year to make your "election" (document telling them you want to take the Transfer Value) after you leave your job. Ask your pension office how long it takes them to pay your Transfer Value to you once they receive your election. For example, if you decide to work until November/December, consider delaying the receipt of your transfer value until January or February so that it doesn’t come in as taxable income on top of a full year of employment income….making it get taxed at a high rate.

    For me, I worked until the beginning of December, then made my election January 1st to put my outside limit payment into the next tax year. This reduced my taxable income for the year I received the lump sum outside limit payment, saving me money in taxes because I was in a lower marginal tax rate the year after I retired.

  2. Access the money in your LRSP/LIRA. Your inside limit will be put in a Locked in RRSP (LRSP or LIRA). This is treated just like any other registered account like your TFSA or RRSP, except that you can’t deposit or withdraw from it. Invest in what you normally invest in your registered account (stocks, bonds, mortgage loans, exempt market investments etc). There are a few ways to unlock portions of your account. 

  3. Some unlocking provisions. You could become a non-resident of Canada for at least 2 years. If you plan on doing this when you retire anyway, this might be good for you, as your entire locked in balance would become unlocked. Or if your doctor tells you that you have a lower life expectancy for some medical diagnosis, you can unlock some or all of it. Other unlocking provisions depend on your jurisdiction…federally or by province. TaxTips.ca lays this out in some detail. TaxTips.ca - Unlocking your locked-in pension funds

  4. Low income unlocking. If you are truly retiring early and expect to have years of low taxable income early in your retired life, you can unlock portions under low-income provisions.  For more info on this, check out Unlocking Options (osfi-bsif.gc.ca) for federal pensions. I initially glossed over this when I was first looking at it…but after reading “Retirement Income Blueprint”, I think there could be some opportunity and value in doing this prior to being eligible to receive CPP/OAS at age 60/65. It’s your money anyway, draw that shit down when you are in low tax bracket years….even if you don’t spend it. Put it in your TFSA! You can do this annually….a little bit at a time.

  5. BIG TIP FOR FEDERAL PENSIONS! Do a LIF conversion. Nobody is talking about this, but I think it’s pretty sweet. At any age, you can convert your LRSP/LIRA into a Life Income Fund (LIF) and start taking monthly income from it. You should be able to do this conversion for free (it was free for Questrade and Canadian Western Trust). Do this when you expect to be in lower-income years, so that you can draw your account down with minimal income tax. This can fit well into your drawdown plan and help you “top up to bracket” in low income years. Separate post to follow on topping up to bracket.
    The maximum amount you will get depends on your age, and on a certain bond yield posted in November each year. This year the maximum withdrawal rate is the lowest it has ever been, but for me at age 38, it’s still 3.6653% of my January 1st LIF account balance. Not too far off of a 4% safe withdrawal rate. [For more on Safe Withdrawal Rate and the 4% rule, read https://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/]  

    Note, that if you convert to a LIF there is also a minimum amount you must take. But, if you come into higher earning years and you no longer want any money from your LIF, you can convert your LIF back to a LRSP/LIRA.  
    Here’s a chart with the maximum amounts. Expand item #2: Life Income Funds, Restricted Life Income Funds, and Variable Benefits Accounts (osfi-bsif.gc.ca) https://www.osfi-bsif.gc.ca/Eng/pp-rr/faq/Pages/lif-frv.aspx

    This provision is giving my wife and I about $1,000 in after-tax income at this stage, and because our investments are earning far more than 3.6% annually, this amount will continue to grow year after year. We want to pull as much out as early and tax-efficiently as possible, because if we didn't we expect this account to balloon if not drawn down. Eventually at a certain age you will be forced to take the income from your locked in account, at higher portions and probably higher tax rates. At this point these withdrawals increase your taxable income and so it could screw with some other potential government benefits and means-tested care benefits that you have already paid taxes for most of your life. 

    [Please note that for people with provincially-regulated pensions….often this conversion to a LIF is not possible until later in life, like age 50 or 55 (depending on province). But usually more money can be drawn from them than for a comparable federal plan.]

For me, after I sell a couple of rental properties (short term rent-to-own properties), I expect to have several years of very low taxable income at least until I start getting older and LIF payment amounts start to increase. In these initial low-income years I plan to have my basic LIF payments as my first taxable layer, then to use a low-income provision to unlock a bit more of my LIF account, and then perhaps take an RRSP withdrawal to top up to bracket.  All while sailing around the world and not earning a whole lot of employment or other taxable income.

There’s a lot more to pensions and annuities. Some good resources are the TaxTips website, and the book “Your Retirement Income Blueprint” by Daryl Diamond. He doesn’t talk about early LIF conversions, but does a good job talking about a strategy of structuring your present and future sources of income to be efficient.

There was a lot here to unpack, so don't hesitate to reach out if you have questions or if I got something wrong. Also keep in mind that legislation changes from time to time, and so do pension agreements, so send me any updates you think would be good for this posts!

If you've tried any of these strategies, share your experience in the comments!

4 thoughts on “Earning an income from your locked-in pension

  1. I currently have the Maximum Transfer Value (MTV) from an OSFI regulated (telecommunications career) DB pension plan in a LRSP and have not withdrawn any funds from it since inception in late 2020. We do not expect to have to withdraw any income from the LRSP account before 2023. Even then we will likely only require minimal income from the funds to cover both our non-discretionary and discretionary expenses as we will have income streams coming from a small pension, rental properties and will be starting our deferred OAS and CPP at the beginning of 2023.

    Based what I’ve read and only having a one time opportunity to unfreeze 50% of the account and transfer them to our more flexible RRSP account, can I assume the following is possible. Step 1: Convert the LRSP to a RLIF; Step 2: Withdraw/transfer in kind, at minimum, the mandatory minimum; Step 3: Transfer 50% of the balance to my RRSP account; Step 4: Convert RLIF balance back to a LRSP.

    We would then use the excess funds to fund our TFSA and our non-registered accounts as an ongoing RRSP meltdown strategy. We would then refocus our strategy on our more flexible RRSP funds until such time as both the RRSPs and LRSP must be converted to RRIF’s and RLIF at the end of year we turn 71.

    1. Hi Mark,

      First of all, it sounds like you are well set for your retirement income needs with various income sources, and obviously know a fair bit about personal finances and investing, so all of this is just fine tuning!
      You mentioned the one-time 50% unlock, which is something that I have not done because that requires the account holder to be over the age of 55, which I am not. But given that you will be in receipt of OÀS and CPP we can safely assume you meet the minimum age for the 50% unlock. For other readers, the OSFI reference for this provision can be found here: https://www.osfi-bsif.gc.ca/Eng/pp-rr/faq/Pages/ulfpp-lrsp.aspx
      To answer your question about whether your plan (Steps 1-4) is possible, yes I think it is. But there are some things you might want to consider.
      First, your plan involves taking the minimum and then doing the 50% split. When you convert to the RLIF your account opening forms should ask you what amount (miminum, maximum, or other) you want to draw and at what frequency. So that should happen automatically, but the first payment could take some time. Because this is already in progress on account opening, don’t wait to request the one-time unlock. You only have 60 days to do this once you convert the account.
      Also, why the minimum? If you are planning to contribute to a TFSA and non-registered accounts anyway, consider your other taxable income sources and look at whether taking the MAXIMUM amount might be of better service to you, to assist with your plan of melting down your RRSPs. Because withdrawals from your RRSP, LRSP and LRIF are all taxed as income, you get most benefit from these withdrawals in years when your other income is lower. You may find that you are in lower taxable income years before you start to receive your CPP and OAS, which also count as taxable income.
      That said if you are earning some other high income until 2023, then you may not want the income. In that case, why make the conversion early? Whether drawing from an RRSP or a RLIF, the tax impact is the same.
      One good piece of advice I liked from Daryl Diamond’s book Your Retirement Income Blueprint was to use the LEAST flexible sources of income first, leaving the more flexible options later. A good read if you haven’t picked it up.

  2. Hi Kevin and Jeannine

    Great article by the way. It’s the first one that I cam across. I intend on reading your other posts

    Thanks for the feedback. To be more accurate regarding the mandatory minimal withdrawal from the RLIF I should have said “withdraw at minimum the annual mandatory minimum. In our situation the minimum would put us very close to “top of bracket”.

    That all being said my advisor has indicated that once a LRSP or a has been converted to a RLIF it cannot be reversed. Following is a quote from him.

    “I have confirmed that once a LRSP is converted to a RLIF, it cannot be converted back to a LRSP. This is a one time event and cannot be undone. RRSPs can be converted to RRIFs and converted back as long as you are under age 71, however locked in plans, you cannot”.

    In our situation we can delay unlocking the LRSP as both of us have sufficient funds in our RRSP that will allow us to annually convert to a RRIF and withdraw the funds to get us to “top of bracket. It may not get us all the way to age 71 when we will be forced to convert all our RRSP/SpRRSP and LRSP, but we’ll go the RRSP to RRIF route for as long as possible. In fact as we will not be requiring all of the funds we will use the excess to fund our TFSAs and non-registered accounts.

    However, as my advisor seems to be contradicting your note that follows Tip #5 above, I wonder whether you may have access to documentation that confirms your understanding and therefore contradicts my advisor’s understanding, as it pertains to “locked in plans? As previously indicated, while not overly concerning for us, as we have alternative sources to accomplish the “top up to margin” goal, many of your readers may not. Not optimally timing the conversion of a LIRA, LRSP or any locked plan, could have unwanted and potentially devastating tax consequences.

    By the way I’m in full agreement regarding Daryl Diamonds excellent book Your Retirement Income Blueprint. Other authors/books your readers may find valuable are:

    Frederick Vettese:
    – The Real Retirement
    – The Essential Retirement Guide – A Contrarian’s Perspective
    – Retirement Income for Life – Getting More Without Saving More

    Moshe A. Milevsky and Alexandra C. Macqueen:
    – Pensionize Your Nest Egg – How to Use Product Allocation to Create a Guaranteed Income for Life

    Alexandra Macqueen and David Field
    – The Boomers Retire – A guide for Financial Advisors and Their Clients (5th Edition)

    1. Hello Mark,

      Following your note about the apparent conflict with your financial advisor’s advice, I searched back to the source and found the following on the OSFI website:

      “If a person transferred funds from a federal locked-in registered retirement savings plan (RRSP) into a life income fund (LIF), can the funds be moved back into a locked-in registered retirement savings plan?
      If the fund holder has not reached age 71, he or she may transfer the funds in the LIF back into a locked-in RRSP. Age 71 is the maximum age set by the Income Tax Act.”
      Source: https://www.osfi-bsif.gc.ca/Eng/pp-rr/faq/Pages/ulfpp-lrsp.aspx?pedisable=true

      This quote says LIF and doesn’t explicitly include an RLIF, but my understanding is it also applies to the RLIF. There is some potential nuance between the LIF and the RLIF, and I’m not sure if it is due to the one-time 50% unlock option that pertains to an RLIF (and is only an option after age 50 or 55). So clearly it’s possible with a LIF. With an RLIF, my understanding is it’s also possible to convert back to a sort of locked in RRSP, but it would be called an RLSP, as defined in the OSFI glossary of terms as:
      An investment account that can only be established as a result of a transfer of funds from an RLIF. Similar to a Locked-in Registered Retirement Savings Plan, however, the funds in an RLSP can only be transferred back to an RLIF, a pension plan, if that plan permits, or to an insurance company to purchase an immediate or deferred life annuity.”

      As I am not a certified financial advisor, please do not take this as financial advice for your particular situation, just a summary of some research I have done.
      Thanks for the book recommendations, I will look them up!

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