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Why have a pension valued by an actuary?

Ultimately, in a family law context, the appropriate value to be assigned to a pension is determined by the law: in a few provinces there is a law which specifies the appropriate value, however, in most cases this is left up to the courts to decide (so there may be case law on the topic). The discussion that follows describes the fair value of a pension from an actuarial or economic perspective. The Canadian Institute of Actuaries has a standard of practice which specifies how a pension should be valued on marriage breakdown to ensure the value is a fair economic value; in the absence of law which specifies otherwise, the value of a pension should be calculated in accordance with this standard. It is within the discretion of the lawmakers or courts, however, to specify a value for the pension on marriage breakdown and this value may be unfair from an actuarial perspective in many cases (i.e. the commuted value). The Family Property Act of Manitoba does not specify the value to be assigned to the pension, however, it appears as if the commuted value specified for the purpose of pension division in the Pension Benefits Act is generally accepted as the value of the pension for marriage breakdown purposes and as a result, an actuarial valuation by an independent actuary is not required (as a member can get the commuted value from their plan administrator).

The reason that the commuted value of a member’s pension benefit is often not a fair value from an actuarial perspective, however, is because this value is only correct if the member is likely to terminate their membership in the pension plan (or is very close to retirement). In reality, from an actuarial perspective, the value of a defined benefit pension cannot be simplified to a single value even though many people believe this to be the case (including some pension plan administrators).

A defined benefit pension plan is very different from a defined contribution pension or a RRSP, both of which are just tax deferred investment accounts. In the case of a defined benefit pension plan, the member is entitled to an amount of pension not an amount of money. The value of a given amount of pension depends on many factors which are unique to an individual, including: when a member plans to retire, possible substandard life expectancy, etc. However, given a set of assumptions regarding assumed retirement age, life expectancy, etc., an actuary can determine the value of a member’s defined benefit pension; the general idea is to try to determine the amount of money that the member would require in their RRSP to provide an equivalent retirement pension (see ‘How does an actuary determine the value of a defined benefit pension?’ for more details). The value of a member’s pension, or the amount of money that they would require in their RRSP to provide an equivalent pension, varies substantially based on individual circumstances. For example:

Many pension plans provide early retirement benefits which allow members to retire prior to age 65 with an unreduced pension only if the member does not terminate prior to retirement. Let’s assume that a member has earned a lifetime pension of $30,000 per year and can retire as early as age 60 with an unreduced pension. If the member terminates membership, however, they can only retire at age 65 with an unreduced pension. If they are assumed to retire at age 65 (i.e. the commuted value), the value of their pension might be $200,000. This means that if they had $200,000 in their RRSP, they would have enough money to withdraw $30,000 beginning at age 65 for their expected lifetime. However, if they are assumed to retire at age 60 the value would be about 30% higher, or about $260,000; the value is higher because they will be receiving the pension for five more years. If they traded their defined benefit pension for $200,000 in their RRSP (the commuted value) and then retired at age 60, they would not have sufficient funds to withdraw $30,000 per year for their expected lifetime; if they are most likely to retire at age 60, $200,000 (the commuted value) would not be the correct value of their pension. As you can see, there is not just one correct value for a defined benefit pension; there are a range of possible values which need to be determined by an actuary. This simplified example does not take into account future salary increases which could be considered and would result in an even larger range of values. The difference between the highest and lowest value that could be assigned to their pension can be substantial, and the correct value can only be selected by considering which value makes sense for a given individual.

Be aware of possible supplemental pension plans; highly paid employees are often members of supplemental pension plans. Supplemental plans pay pensions in excess of income tax limits and are not bound by pension benefits legislation, they are typically not funded, and they can easily be overlooked by divorcing couples. You may need to hire an actuary to determine the value of any supplemental pension benefits. For more information on supplemental pension plans, click here.

Actuaries are the only professionals specifically trained to perform these types of calculations. As mentioned above, the Canadian Institute of Actuaries maintains standards of practice which guide actuaries when calculating the capitalized value of pension benefits as the result of a divorce. In addition, rules of professional conduct and a disciplinary process enforce the actuary’s duty to provide independent, objective and competent advice.