Defined Benefit Pension Tax Guide

How DB Pensions Work

The Formula

• Years of service × benefit rate × final salary
• Example: 30 years × 2% × $80,000 = $48,000/year
• Paid monthly for life
• Often indexed to inflation (partially or fully)

Employer vs Employee Contributions

• Both contribute during working years
• Your contributions tracked separately
• Employer funds the guarantee

Tax Treatment of DB Pensions

Pension Payments

• 100% of pension is taxable
• Reported on T4A slip
• Tax withheld at source
• Added to other income

Pension Adjustment (PA)

• Reduces your RRSP room
• Reported on T4 while working
• Reflects pension benefit accrued
• 9 × benefit earned that year

Pension Income Tax Credits

Pension Income Amount

• Up to $2,000 credit (federal)
• DB pension qualifies at any age
• Don't need to be 65+
• Worth ~$300 federal tax reduction
• Plus provincial credit

Pension Income Splitting

• Split up to 50% with spouse
• DB pension eligible at any age
• Unlike RRIF (requires 65+)
• Significant advantage for DB recipients

Bridge Benefits

What Is a Bridge?

• Extra payment until age 65
• Designed to replace CPP/OAS until they start
• Reduces after 65
• 100% taxable

Example

• Retire at 60
• Pension: $40,000/year + $12,000 bridge
• Total until 65: $52,000
• After 65: $40,000 + CPP + OAS

Commuted Value Option

What Is Commuted Value?

• Lump sum equivalent of future pension
• Can be offered at retirement
• Or when leaving employer before retirement

Tax Implications

• Part transfers to LIRA (tax-free)
• Excess is taxable immediately
• Maximum transfer limit applies
• Can be significant tax hit

Transfer Limit

Maximum that can go to LIRA depends on:

• Your age at transfer
• Prescribed formula
• Excess taxable as income
• Often 50-70% transfers, rest taxable

Early Retirement Reduction

How Reduction Works

• Retiring before "unreduced" age
• Typically 3-6% per year early
• Reduction is permanent
• May still be worthwhile

Example

• Unreduced pension at 65: $50,000
• 5% reduction per year before 65
• Retire at 60: 25% reduction
• Pension: $37,500/year for life

Survivor Benefits

Typical Options

• 60% survivor pension (most common)
• 100% survivor pension (lower initial)
• No survivor (higher initial, nothing to spouse)

Tax Implications

• Survivor pension taxable to survivor
• Qualifies for pension income credits
• Can be split if survivor remarries

DB Pension vs Commuted Value Analysis

Keep the Pension If:

• Expect long life
• Value guaranteed income
• Poor at managing investments
• Pension is indexed
• Good survivor benefits

Consider Commuted Value If:

• Serious health concerns
• No dependants needing survivor pension
• Sophisticated investor
• Pension not indexed
• Employer financial concerns

Reporting DB Pension

T4A Slip

• Box 16: Pension income
• Box 22: Tax withheld

Where to Report

• Line 11500: Other pensions and superannuation
• Line 31400: Pension income amount
• Form T1032: Pension income splitting

Pension and OAS Clawback

Impact on OAS

• DB pension counts toward OAS clawback
• May push over threshold ($90,997 in 2024)
• Pension splitting can help

Strategy

• Split pension with lower-income spouse
• Draw less from RRIF if possible
• Use TFSA for additional needs

Planning Considerations

Before Retirement

• Understand your pension formula
• Review survivor options
• Calculate pension with/without bridge
• Compare to commuted value if offered

Retirement Year

• May have partial year of salary + pension
• Could be high-income year
• Maximize RRSP in final working year
• Plan pension start date

In Retirement

• Optimize pension splitting annually
• Coordinate with other income sources
• Monitor OAS clawback
• Review beneficiary designations