Usually when Canadians buy past service (supplementing a pension), it is due to a work absence—often a leave of a year or two. There are statutory, or protected reasons for missing work, such as disability, maternity or parental leave, and non-protected absences, like, say, a leave of absence to travel as a family or take care of a loved one. Purchasing past service is always available when an absence is considered a statutory reason but may not be available for non-protected absences.
In your case, Jason, you are transferring a pension plan to one that is more generous. Not enough money was contributed to match the benefits of the plan you’re joining, so to match the plan you will have to contribute more in the form of a pension buyback.
Warning, explicit math content
Now, let’s dig into the inner workings of a pension, so you can make this decision. I don’t have all the details of your pension, so, for simplicity’s sake, I will work with a typical pension plan and assume the reason for the buy back is due to time away from work rather than transferring from one pension to another.
The first thing you need to know is how much you contribute to your pension plan. If you search for your pension plan online, “calculating your contributions,” you will see one or a combination of these results:
- You contribute 10.4% of your annual salary up to the CPP (Canada Pension Plan) limit, plus 12% of any salary above the CPP limit, currently $66,600.
How much are you adding to your registered retirement savings plan (RRSP) to build your own pension? For those Canadians without pension plans, note that the above plan requires employees to contribute more than 10% of their gross annual pay toward their pension.
- There is a qualifying factor of 85, age plus years of service. For example, if you are 53 with 32 years of service, then you reached the “85 factor,” which is 53 years of age, plus 32 years of service.
- Unreduced pension (retiring early with no change to retirement income) is calculated as 2% multiplied by years of credit multiplied by the average of the best five years. That is your lifetime pension plus bridge benefit. Once you turn 65, there is a CPP adjustment of 0.45%, so the 2% in the previous example becomes 1.55%, which is your lifetime pension without the bridge.
Calculating the value of pension buy backs
Jason, it’s time to figure out what this means for you, and how it can help you make your decision to opt for the pension buyback or not.
The first step: Figure out the value of your pension when you reach 65, based on your current years worked. This will tell you what you are actually purchasing. I’m going to assume you started working seven years ago at age 25 and have an annual salary of $90,000.
Using the third formula, we have:
1.55% x salary up to the yearly maximum pensionable earnings (YMPE) or CPP limit ($66,600) = $1,032