Investing

Pension payout, withholding tax and flow funds

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  • Aug 18th, 2020 8:12 pm
[OP]
Sr. Member
Nov 21, 2007
539 posts
61 upvotes

Pension payout, withholding tax and flow funds

Asking for a friend...
After a separation from his employer, they are offering him a pension payout.
Given the Canadian law, he was told that $300k must go to a lira account. Remainder, another $300k will be paid out after a 35% withholding tax. Additionally the remainder 65% will be counted towards his current annual income and will be subjected to his income tax bracket fees at the end of year.

What is the best approach to avoid loosing >50% of the funds which can not be in the lira?

He was told there might be a “flow fund” option. After reading I think it’s very risky.

Any thoughts would be appreciated.
18 replies
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May 11, 2014
4019 posts
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Iqaluit, NU
Navon01 wrote: Asking for a friend...
After a separation from his employer, they are offering him a pension payout.
Given the Canadian law, he was told that $300k must go to a lira account. Remainder, another $300k will be paid out after a 35% withholding tax. Additionally the remainder 65% will be counted towards his current annual income and will be subjected to his income tax bracket fees at the end of year.

What is the best approach to avoid loosing >50% of the funds which can not be in the lira?

He was told there might be a “flow fund” option. After reading I think it’s very risky.

Any thoughts would be appreciated.
Based on details, this is likely a DB pension.

First option for your friend is to avoid the whole issue by going for the pension payment. He could get an annuity where he can wait to 65/whatever the retirement age of his pension is
Benefits: - no immediate tax consequences, there is often health insurance as well so in old age may be well worth it, some/full inflation protection and guaranteed income for life
Drawbacks: Usually no chunks of cash, may not get full benefit of pension if dies early, may increase taxable income making withdrawing from RRSPs/RRIFs harder

Now if he wants the payout, the only real way to avoid the taxes is to use the taxable portion and deposit it into an RRSP account assuming he has room. This is where it can be tricky. If he has no further RRSP room, he must either eat the tax bill or consider the annuity option.

Not sure what this "flow fund" option is. Possibly a way to annuitize a portion of the pension maybe? Without details, I can only speculate.
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[OP]
Sr. Member
Nov 21, 2007
539 posts
61 upvotes
xgbsSS wrote: Based on details, this is likely a DB pension.

First option for your friend is to avoid the whole issue by going for the pension payment. He could get an annuity where he can wait to 65/whatever the retirement age of his pension is
Benefits: - no immediate tax consequences, there is often health insurance as well so in old age may be well worth it, some/full inflation protection and guaranteed income for life
Drawbacks: Usually no chunks of cash, may not get full benefit of pension if dies early, may increase taxable income making withdrawing from RRSPs/RRIFs harder

Now if he wants the payout, the only real way to avoid the taxes is to use the taxable portion and deposit it into an RRSP account assuming he has room. This is where it can be tricky. If he has no further RRSP room, he must either eat the tax bill or consider the annuity option.

Not sure what this "flow fund" option is. Possibly a way to annuitize a portion of the pension maybe? Without details, I can only speculate.
Thank you for your input.

Yes it is a DB pension.

My friend is in his mid 40s. He thinks since the current interests rates are low and his current payout is relatively high (due to current rates), he can do much better even if he loses the withholding amount.

As you mention there are numerous draw backs to the first option of leaving it as is and waiting for pension payments upon retirement.

Taking into calculation the amount he’ll be eligible, he would break even if he lives 20yrs after 65.

Investing the lira funds or remaining amount post tax would yield a greater return. In his opinion over the next 20yrs.

The flow funding is apparently an option to invest in oil, gas, gold startups which provide you tax write off. After a holding period of 2yrs, provided the startup is still around you can withdraw based on price at that point...something like that based on what I googled.
Deal Addict
Mar 10, 2011
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Toronto
OP, is there no option to split the taxable cash portion into 2 payments over 2 years? That way a certain amount is taxed this year and the rest is taxed next year.
I don’t know too much about flow through shares other than a friend purchasing them over 15 years ago and he didn't do very well with them.
Deal Addict
Jul 12, 2008
2411 posts
561 upvotes
GTA
Putting it into RRSP is the main way. If your friend is going to another firm with a DB pension, he can buyback some time there to get a deduction similar to an RRSP contribution since he can’t take some and leave some with his current employer.

He is correct about the rate though. How many years of service?
Sr. Member
Apr 18, 2017
587 posts
286 upvotes
Navon01 wrote: Asking for a friend...
After a separation from his employer, they are offering him a pension payout.
Given the Canadian law, he was told that $300k must go to a lira account. Remainder, another $300k will be paid out after a 35% withholding tax. Additionally the remainder 65% will be counted towards his current annual income and will be subjected to his income tax bracket fees at the end of year.

What is the best approach to avoid loosing >50% of the funds which can not be in the lira?

He was told there might be a “flow fund” option. After reading I think it’s very risky.

Any thoughts would be appreciated.
If he is willing and able to become non-resident, it's possible to have the entire amount taxed at 25% per Part Xlll, lump sum payout.
Dependent on the country of choice, there may be additional taxes to pay to that country.

What is his skill set? he may be able to set up an IPP and have the entire amount self administered, deferring taxes until retirement.

Or, possibly start a business with high initial capital costs to maximize deductions.
[OP]
Sr. Member
Nov 21, 2007
539 posts
61 upvotes
qman23 wrote: If he is willing and able to become non-resident, it's possible to have the entire amount taxed at 25% per Part Xlll, lump sum payout.
Dependent on the country of choice, there may be additional taxes to pay to that country.

What is his skill set? he may be able to set up an IPP and have the entire amount self administered, deferring taxes until retirement.

Or, possibly start a business with high initial capital costs to maximize deductions.
I don’t think the non resident is a viable option for him.
He is in IT and is currently self employed.

From what I understood from, there is a maximum amount he can transfer into LIRA ~$300k. A 30% withholding tax will apply to the remaining amount follow by the final amount used as income hence further taxation will apply. For example if it is $200k the net amount could be $100k.
Sr. Member
Apr 18, 2017
587 posts
286 upvotes
As self employed, he could definitively look into setting up an IPP, as that is what they are designed for.
http://www.fsco.gov.on.ca/en/pensions/l ... plans.aspx

In this case, the entire amount would be transferred free from tax into his IPP.
I don't know what the fee structure might be to administer it. 100k might not be worth the effort.
Member
Nov 25, 2009
232 posts
155 upvotes
Edmonton
xgbsSS wrote:
Now if he wants the payout, the only real way to avoid the taxes is to use the taxable portion and deposit it into an RRSP account assuming he has room. This is where it can be tricky. If he has no further RRSP room, he must either eat the tax bill or consider the annuity option.
I believe one can get a Pension adjustment reversal on the RRSP contribution limit. Since over the years, your RRSP contribution limit is adjusted based on pension contribution. This will open up the principle amount of pension contributed by the employee. But obviously if you're taking the commuted value of the pension, the RRSP won't be able to cover all of it.

Though I'm just replying here for outsiders curious on this topic. It seems OP and their friend realize they can't shelter everything in the RRSP and are hoping to find some other vehicle to tax shelter.
Sr. Member
Apr 18, 2017
587 posts
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1k3 wrote: I believe one can get a Pension adjustment reversal on the RRSP contribution limit. Since over the years, your RRSP contribution limit is adjusted based on pension contribution. This will open up the principle amount of pension contributed by the employee. But obviously if you're taking the commuted value of the pension, the RRSP won't be able to cover all of it.

Though I'm just replying here for outsiders curious on this topic. It seems OP and their friend realize they can't shelter everything in the RRSP and are hoping to find some other vehicle to tax shelter.
I believe this is what the $300k LIRA portion is based on, the pension adjustment value/lost contribution room.
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May 11, 2014
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1k3 wrote: I believe one can get a Pension adjustment reversal on the RRSP contribution limit. Since over the years, your RRSP contribution limit is adjusted based on pension contribution. This will open up the principle amount of pension contributed by the employee. But obviously if you're taking the commuted value of the pension, the RRSP won't be able to cover all of it.

Though I'm just replying here for outsiders curious on this topic. It seems OP and their friend realize they can't shelter everything in the RRSP and are hoping to find some other vehicle to tax shelter.

Not quite. The entire amount generally does not get refunded as a chunk of the benefit is in the payment out or part of the LIRA. In general it is the pension adjustment reported minus the commuted value, but the calculation can be convoluted. With record low interest rates, more often than not for DB pension holders, there is no PAR these days because the paid out benefit tends to be higher.
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Sr. Member
Sep 2, 2009
996 posts
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Ottawa
Navon01 wrote: Asking for a friend...
After a separation from his employer, they are offering him a pension payout.
Given the Canadian law, he was told that $300k must go to a lira account. Remainder, another $300k will be paid out after a 35% withholding tax. Additionally the remainder 65% will be counted towards his current annual income and will be subjected to his income tax bracket fees at the end of year.

What is the best approach to avoid loosing >50% of the funds which can not be in the lira?

He was told there might be a “flow fund” option. After reading I think it’s very risky.

Any thoughts would be appreciated.
Just a correction/clarification: it is 100% of that amount that counts as income for taxation. However, the 35% withheld will go towards the taxes owing. (income + 300k = taxes, not income + 195k). At that level though, it is unlikely to change the marginal rate (i.e., 53.53%) and the difference above 35% withheld will have to be made up.
[OP]
Sr. Member
Nov 21, 2007
539 posts
61 upvotes
xgbsSS wrote: Not quite. The entire amount generally does not get refunded as a chunk of the benefit is in the payment out or part of the LIRA. In general it is the pension adjustment reported minus the commuted value, but the calculation can be convoluted. With record low interest rates, more often than not for DB pension holders, there is no PAR these days because the paid out benefit tends to be higher.
I think this is exactly why he is considering a lump sum. What is PAR you are referring to?
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Feb 1, 2012
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Navon01 wrote: I think this is exactly why he is considering a lump sum. What is PAR you are referring to?
PAR = Pension Adjustment Reversal.

Pension Adjustment is a way of trying to equalize tax-deferred savings room among pension members and non-pension members. Earnings contributed to a pension are not taxed when earned; rather they are taxed later when paid as pension income. In that way, pensions are similar to RRSPs, where the money is taxed on withdrawal. Without a pension adjustment, people with pensions would have much more tax-advantaged savings room than people without pensions.

So the Pension Adjustment was created. If you contribute to a DC pension, then for every dollar you and/or your employer contribute to the pension, your RRSP room is reduced by one dollar. For DB pensions there is a more complex formula based on expected pension benefit.

If you leave the DB pension and take the CV, and the CV is less than the grand total of your pension adjustments for that pension, then the pension adjustment reduced your RRSP contribution room by too much. In such a case your pension administrator must calculate a pension adjustment reversal, which restores some RRSP contribution room. The pension administrator must calculate this and advise you.
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[OP]
Sr. Member
Nov 21, 2007
539 posts
61 upvotes
Deepwater wrote: PAR = Pension Adjustment Reversal.

Pension Adjustment is a way of trying to equalize tax-deferred savings room among pension members and non-pension members. Earnings contributed to a pension are not taxed when earned; rather they are taxed later when paid as pension income. In that way, pensions are similar to RRSPs, where the money is taxed on withdrawal. Without a pension adjustment, people with pensions would have much more tax-advantaged savings room than people without pensions.

So the Pension Adjustment was created. If you contribute to a DC pension, then for every dollar you and/or your employer contribute to the pension, your RRSP room is reduced by one dollar. For DB pensions there is a more complex formula based on expected pension benefit.

If you leave the DB pension and take the CV, and the CV is less than the grand total of your pension adjustments for that pension, then the pension adjustment reduced your RRSP contribution room by too much. In such a case your pension administrator must calculate a pension adjustment reversal, which restores some RRSP contribution room. The pension administrator must calculate this and advise you.
Thank you. A bit over my head but I’ll let him know.
Is there any governmental reading material on this?

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