Please click on the question below to read our response.
How does an actuary determine the value of a defined benefit pension?
Does the value of a pension have to be adjusted to reflect income tax?
Do supplemental pension plans need to be valued by an actuary?
Do RRSPs or LIRAs need to be valued?
Answers to Frequently Asked Questions
Can I hire an independent actuary to value my Ontario regulated pension in accordance with the Ontario law (instead of going to my pension plan administrator)?
The law in Ontario specifically states that the plan administrator of an Ontario regulated pension plan must provide the marriage breakdown value on request (this does not apply to federally regulated pensions plans). As a result, there are several issues with having an independent actuary provide a valuation for an Ontario regulated pension plan:
- Only the plan administrator can divide the pension, so an independent valuation will not permit a division of the pension. Other assets will need to be traded against the pension.
- The value provided by the independent actuary will not be exactly the same as the value provided by the plan administrator due to some possible differences in calculation methodology and assumptions; in most cases the values should be very close.
- If a division of the pension is desired in the future, the value will need to be requested from the plan administrator and the regular process followed (which includes paying any fees required by the plan administrator).
Due to the issues outlined above, it is advisable that most pension plan members of Ontario regulated pension plans request the marriage breakdown value from their plan administrator. However, there are reasons why a plan member would want an independent valuation: they cannot wait for the value from the plan administrator, confidentiality reasons (when the value is requested from the plan administrator, both spouses receive the value by mail).
For additional information on requesting a pension valuation, click here.
How does an actuary determine the value of a defined benefit pension?
An actuary determines the value of defined benefit pension benefits, or the capitalized value of defined benefit pension benefits, using the actuarial present value method. Under this method, the capitalized value of the pension benefits is determined as the amount that would need to be invested at the valuation date in order to provide either a monthly pension commencing on a future assumed retirement date, or in the event of death prior to retirement, a lump sum death benefit. The monthly retirement pension is assumed to be payable for the lifetime of the member. Each future payment is discounted with interest to the valuation date and adjusted to reflect the probability that the member survives to receive payment. For example, the present value of each pension payment in retirement is adjusted to reflect the probability that the member lives to receive payment.
Basically, the capitalized value of the member’s pension benefits represents the amount of money that they would require in an RRSP to provide the same amount of pension commencing at their assumed retirement date for their expected lifetime.
The interest rate assumptions (which are based on government bond yields) and mortality rate assumptions that are used by the actuary are specified by the standards of practice of the Canadian Institute of Actuaries.
Since Ontario family law requires a net family property statement to be completed, all assets need to be after-tax. As a result, the contingent income tax needs to be deducted from all tax deferred assets (i.e. pensions, RRSPs, DPSPs, etc).
An actuary can determine an income tax adjustment for a member’s defined benefit pension (i.e. the contingent income tax). Please click here for information on how to retain us to do this calculation.
Prior to retirement, income tax has not been paid on the funds in an employer pension plan or the funds in an RRSP. The contributions made to these registered pension plans were tax deductible and the investment income earned has not been taxed. As a result, income tax will be paid on any payments the person receives from these plans. So $100,000 in an RRSP (or a $100,000 defined benefit pension) is not equal to $100,000 in a chequing account because the person will have to pay income tax on the $100,000 from their RRSP (so the $100,000 in their RRSP is worth less). In order to compare the value of pensions to other assets, they must be reduced to reflect the anticipated income tax that will be paid in the future. This reduction to the value of the pension is also referred to as an income tax liability or contingent income taxes.
Be aware that even in the situation where a couple equalizes the pension assets (i.e. and agree to leave the pension assets out of the equalization calculation), in some cases income tax calculations would need to be performed to ensure that both spouses end up with the same after-tax amount of pension assets. This is because a pre-tax asset is worth more to the spouse with lower income (in the lower tax bracket). For example, suppose a couple had earned $100,000 in RRSPs during marriage and one spouse is projected to have significant employment income in retirement (and not the other spouse). Suppose that they decide to equalize the $100,000 in their RRSPs by each taking $50,000. In retirement, the spouse with the employment income will be in a much higher tax bracket and will receive much lower after-tax payments from the $50,000 in their RRSP compared to the spouse with no employment income in retirement. To equalize the after-tax value of the RRSPs, a larger amount would need to be transferred to the spouse in the higher income-tax bracket.
In the previous situation, however, it is advantageous for the couple to transfer RRSP assets to the spouse without the employment income as they will pay much less tax on withdrawals from the RRSP which will effectively increase the after-tax value of the family assets. In general, a separating couple can increase the after-tax value of their family assets by transferring all tax-deferred assets (i.e. RRSPs) to the spouse with the lowest regular income and in exchange, transfer after-tax assets to the spouse with the highest regular income. In addition, this often this makes sense from a financial planning perspective since the spouse with the low income will be provided with assets that can be used as income.
In accordance with Canadian actuarial standards, when an actuary performs a defined benefit pension valuation, they will estimate the effect of income tax on the pension. This will depend on the member’s assumed retirement income. The more income they are expected to earn, the higher their assumed tax rate, which will result in a lower after tax value of their pension. For other retirement assets such as RRSPs, an income tax calculation would need to be performed to determine a fair adjustment.
Click here for our fees for determining an income tax adjustment (i.e. contingent income tax).
Do supplemental pension plans need to be valued by an actuary?
The Income Tax Act limits that amount of pension that can be paid from a registered pension plan and supplemental pension plans generally pay any pension in excess of these limits. Supplemental plans are generally either available to every member of a pension plan whose pension exceeds income tax limits or the supplemental plan is restricted to a certain class of employee (i.e. executives). Generally speaking, a member’s earnings have to be fairly high in order to have benefits in a supplemental pension plan (i.e. $160,000 or higher). Supplemental pension plans can be either a defined benefit pension plan or a defined contribution pension plan. Defined contribution pension plans are fairly simple to address as they are just investment accounts. Supplemental defined benefit pension plans are more complex and are more difficult to divide on divorce.
Plan administrators are not required to provide valuations or divide a member’s pension benefits under the law in Ontario since supplemental pension plans are not registered and not bound by the Ontario Pension Benefits Act (which is where the pension valuation and division rules are specified). As a result, some plan administrators provide the Ontario family law value for supplemental pensions and some do not.. If either spouse is a high earner and a member of a defined benefit pension plan, it is advisable to investigate the possibility of supplemental benefits and to ask the plan administrator if the member’s supplemental pension is being included in any values or information provided.
Note that for federal civil servants, any supplemental pension benefits are automatically included in the maximum transfer value paid from the Pension Benefits Division Act, click here for more information on the Pension Benefits Division Act.
Do RRSP’s need to be valued?
RRSPs and LIRAs do not need to be valued. This is because, unlike with a defined benefit pension plan, RRSPs and LIRAs are simply tax deferred investment accounts and so the value at any point in time is equal to the account balance. For this reason, a valuation is not necessary to determine the pre-tax value for these assets.
However, in many cases, it is necessary to determine an income tax adjustment (contingent income tax) for RRSPs. Often the income tax adjustment is set arbitrarily, resulting in after-tax values that overstate or understate the fair value by thousands of dollars. In addition, some of the funds in an RRSP may have originated from a defined benefit pension plan, which will require a more careful analysis. For more information on RRSPs on divorce, click here.
If you have any additional questions, or require clarification, please do not hesitate to contact us.