Does buying back a pension after a leave make financial sense? When I finished my maternity leave after a year with my firstborn, I was conflicted as to what I should do, whether I should buy back my pension or not.
It was a lump sum of money, about $7000 that I could contribute. $7000 is a large chunk of change and something to sneeze about. In this post on whether buying back your pension is worth it, I run the numbers for my situation so you don’t have to.
When I was calculating whether buying back my pension was worth it, all I could think about in my head was:
Missy Elliott’s Work It:
Is it worth it? Let me work it
I put my thing down, flip it and reverse it
Before we go into whether buying back a pension after a leave is worth it, let’s review what a defined benefit pension is.
What is a Defined Benefit Pension? The Holy Grail of Pensions
Ahh, the defined benefit pension. The Cadillac of all pension options because they are so generous. They are becoming less and less common in the workforce, with mainly the public sector in Canada having this option. Government workers such as teachers, federal employee workers, health care staff such as nurses or occupational therapists, are just some of the few employees in Canada who likely have a defined benefit pension.
As mentioned in a previous post on defined benefit pensions, I liken them to Scratch & Win Set for Life tickets, where you are ‘set for life’ and will get a certain amount (depending on your contributable service) regularly every month for the rest of your life (adjusted for inflation). I am a big fan of my defined benefit pension and it makes me feel more relaxed about retirement when the markets are not doing so well.
The amount you get per month from your defined benefit pension in retirement is calculated based on a formula of the average five highest years of salary and the years of pensionable service. The more pensionable service you have, the higher your defined benefit pension will be when you retire.
Related: How Much Should Have Saved by age 40?
What is a Pension Buy Back?
During leaves of absences, like for example, if you took some time off for general leave, for education leave, or for parental or maternity leave, you are not contributing to your pension. This means that you are not adding to your years of pensionable service.
When you return back to work from your general leave, educational leave, or parental leave, you are given the option to buy back your leave. You may be wondering if you can buy back pension years. Yes, you can buy back pension years.
You can buy back your pensionable service. Usually, you can buy back your leave within 5 years, as long as you are still working with the company. Obviously, you can’t buy back the leave when you leave the company already.
There are rules about the lifetime maximum that you can buy back according to the Income Tax Act:
- Five total years of general leave
- Three total years of maternity, parental or adoption leaves
Defined Benefit Pension Plan Calculator: Cost of Buy Buack
How much approximately would it cost to buy back your pension? I used the calculator from my defined benefit pension provider and then ended up getting it officially calculated through my human resources department. There was a bit of a difference, with the cost of buy back being cheaper through my human resources department (they knew the exact dates I was off on parental leave so it makes more sense).
Your pension plan provider should have a buy back calculator on their website so that you can estimate how much it would cost to buy back your leave of absence. Otherwise, I found a pretty accurate buy back calculator here from the Public Service Pension Plan. It asks for your current pensionable salary, your pensionable years of service, your birthdate, and the number of months you want to buy back your pension.
For more accuracy with your own pension buy back situation, you should definitely check with your pension provider to get it officially calculated so you have the real numbers in front of you.
How Much Could your Pension Increase?
Depending on the amount of pensionable service you buy back, this is how much your monthly pensionable service could increase. You multiply the approximate monthly increase by the number of months.
So let’s say your average annual earnings at retirement was $80,000 and the monthly increase is $9 per month, and you buy back 9 months of pensionable service, this would be an extra $81 a month, or approximately $972 extra a year.
Let’s say your buy back costs $7000. That would mean it would take 7 years of receiving your pension to break even– which is not too bad provided that you would live longer than 72 (if you started at 65)!
This is all part of my phased retirement plan, to continue adding to my pension but on a part-time basis.
Here’s a chart of average annual earnings at retirement and the approximate monthly increase to your pension- you multiply it by the number of months.
|Average Annual Earnings at Retirement||Approximate Monthly Increase|
The Pros and Cons of Buying Back Pension
One of the major downsides of buying back your pension is that you will lower your RRSP contribution room for the taxation year that you buy back your pension.
It can even lower your RRSP contribution room to a negative amount, which may not be ideal if you like to invest in your RRSP too. This will affect your contribution room for future years. As you can see, a little planning is important to factor in whether or not to buy back your defined benefit pension to add pensionable service.
The other downside is that you’re out of a lump sum amount of money (in my case, it was around $7000) that you could have working for you for the next twenty years— because when you contribute this amount, you won’t see it until your retirement date- which would be approximately age 55 in my case of phased retirement.
Let’s say the $7000 would allow me $70 a month extra in pension payments for the rest of my life, or about $840 annually. If I put it in now (I am 35), I won’t start receiving my $7000 back until age 55. At that time, I would start getting paid $70 a month and then it would take me 8.3 years to break even with my $7000. Therefore when I am 63, then I start getting a real return on the $7000 I put in 28 years ago.
Let’s say instead I put the $7000 and invested it and got a reasonable and conservative 5.5% return for the next 28 years.
That $7000 will become $31,344.90 in 28 years.
Let’s say I have that $31,344 in dividend income producing assets generating a return of 3.5% annually. That would be $1097.04 annually. Even if I start withdrawing money from the $31,344 to the tune of $1000 a year, it would take me 31 years to deplete that $31,344.90, in which case I will be 91.
If you don’t believe me, check out this calculation I did with the compound interest calculator from the government website Get Smarter About Your Money.
Related Post: The 4% Safe Withdrawal Rate vs Never Touch Your Principal
After doing this calculation, the math doesn’t really make sense to buy the pension back. What do you think?
Is a Pension Buy Back Tax Deductible?
Is a pension buy back tax deductible?
Not only will a pension buy back contribution affect your contribution room for your RRSP, a pension buy back will also affect your taxes.
This is because pension buy backs are fully tax deductible the year the contribution is made. This tax deduction cannot be carried forward though. Here’s an article from Moneysense about how a pension buy back will affect your income tax return.
Tips for Making the Most of Your Pension Buy Back:
If you’re interested in buying your pension back and the math makes sense to you, here are some tips on making the most of your pension buy back.
Many defined benefit plans allow you 5 years to purchase your service back. It might be tempting to just defer your buyback until later years, but your income may likely increase (this is what they use to calculate how much it will cost to buy back your pension) which means the cash you need to pay will increase.
When you are younger it makes more sense to buy your pension back. For example, purchase of service after parental leave which is probably in your 20’s to early 40’s. You won’t have to pay as much as if you were in your 50’s and close to retirement and want to buy back.
You can contribute to your pension buy back with cash or with a transfer from your existing RRSP.
If you live a long life (e.g. are your parents in their 90’s? Did both sets of grandparents live until 103? Do you keep healthy and eat well?!) buying back your pension will be more ‘worth it’.
Do you plan to work for the same company for a long time? It will be more ‘worth it’ if you stay with your employer.
Case Study Example of A Pension Buy Back:
This is an example from The Globe and Mail about a 67-year-old woman about to retire who has the option to buy back her pension to provide another $400+ month pension– provided that she forks over $57,000 for her buyback.
It would take over 11 years to get back her purchase amount of $57,000 with $400+ a month- she would be 78 years old.
On the other hand, if she invested the $57,000 with compounding yield of 5% and continues to withdraw $5000 a year (about the $400+ amount per month), she would run out of money at age 16 when she is 83 years old.
As you can see- it’s a toss-up!
Burning questions to ask yourself are—
- Will she her life expectancy be at least 83?
- Which one is a better option?
- There’s no right or wrong answer for her because it’s a large lump sum. If she thinks she will have a long life expectancy then buying back her pension is a better option. If she doesn’t, then using that money to invest would be better– however, having 5% return is idealistic and a bit risky in retirement.
The question to ask yourself when buying back a pension and evaluating whether it is worth it to you is whether or not you feel comfortable managing your own investments or whether you would rather have something guaranteed and steady (and have peace of mind) at the risk of paying a little extra for it to have the certainty versus the uncertainty?
Should I Buy Back My Pension After Maternity Leave?
After my maternity leave, I was wondering whether I should buy back my pension. Every little bit helps to fight back against the Motherhood Penalty, I thought.
I was thisclose to writing the cheque for $7000 to buy back my pension. I had a rough time doing it though and kept delaying it. I realized my intuition sensed something. Then I ran the calculations and it doesn’t really make sense to me.
Using that $7000 to invest seems to make more sense, and I would have that money accessible to me NOW instead of having it locked in for 20 years before I see any results or get to access it. For the next twenty years, I can at least get 3.5% or $245 annually from that $7000.
I think buying back your pension makes sense if you don’t like to invest or you don’t know how, and if you like guaranteed income. For me, I think I’ll take my chances and use that money to invest instead. I do have a few more years to change my mind if that’s what I want to do.
You may also be interested in:
Do you have a defined benefit pension?
Did you ever buy back your pension or did you do a purchase of service?
Does the math make sense to you or should I be buying back my pension?
GYM is a 30 something millennial interested in achieving financial freedom through disciplined saving, dividend and ETF investing, and living a minimalist lifestyle. Before you go, check out my recommendations page of financial tools I use to save and invest money. Don’t forget to subscribe for blog updates, a free dividend yield spreadsheet, and the free Young Money Bootcamp eCourse.
21 thoughts on “Buying Back Pension: Is It Worth It?”
GYM, I haven’t been in a defined benefit plan in a long time. The last one, I cashed out when I was in my early 30’s and rolled the money into a retirement account. I am not sure I’m familar with the “buy back” concept. Perhaps this is unique to Canada or am I missing the point? Tom
@Tom- It’s probably unique to Canada and or public service pension plans. When you are on a leave (e.g. parental leave) you are not contributing to the pension and you have an opportunity to buy it back to keep up the the ‘pensionable service’.
Great article! Love it! Super detailed! Another thing to consider is if you’ll qualify for GIS benefits in the future. About 1/3rd of seniors qualify for GIS and these benefits have a 50% to 75% claw back rate on income. An extra $1 of pension income would mean a $0.50 to $0.75 reduction in GIS. RRSPs have the same effect BUT they are more flexible, so someone who is eligible for GIS could potentially draw down their RRSP very quickly and put that money into a TFSA instead (which doesn’t trigger claw backs).
It’s a very personal decision to buy back pension, it depends on a bunch of factors, it may be good for some and terrible for others. Great to read how you came to your decision.
@Owen- Thanks for the input Owen and tips on GIS clawback! Yeah, it really is very personal and is dependent on a number of factors. If I wasn’t interested in investing, buying back my pension would have been a no brainer.
Oh, where was this article a year ago??? I really struggled with this decision when I came back from maternity leave. I spent a lot of time of the phone with the pension people trying to figure out if it was worth it. After reviewing all the info I came to the same decision as you. I didn’t do the buy back and instead opted to invest for myself. Many of my co-workers were shocked by my decision and made me second guess myself but I’m happy with my decision.
Very informative article!
@JJ- I’m glad we came to the same decision. I had to write this post out so that I wouldn’t second guess myself as well lol. I still have a few years to change my mind but when I crunch the numbers, it just didn’t make sense.
Hi GYM, Great article. First time here. Retired six months ago and faced a similar question. I have a DB teachers pension and was able to buy back my substitute teaching year. By waiting until retirement to do the buy back 1/2 of the cost was covered by my province. The other half I transferred from my RRSP. This little move added 4.5% plus to my annual pension but the annualized return from the money transferred from my RRSP was around 11.5%. I couldn’t pass that up. It will take 8.5 years to make my money back. This is guaranteed income for both our lives.
If you have a rock solid pension it might be worth it. Not all DB are equal. I probably wouldn’t have done it with a corporate pension. (think Nortel or Sears etc…) I also wanted to transfer the investment risk to a well managed pension fund.
@Gruff- Thanks for visiting! Congrats on the retirement! Yes, just like the Globe and Mail example above, the math makes sense- it seems to for someone who is closer to retirement. For me, I won’t see any of that money until 28 years later so it didn’t make too much sense for me.
Thanks for providing a detailed outlook on how pensions work up in Canada, I don’t know if they have a buy back option here in the US.
I did work for United Parcel Services(UPS) back when I was in college and one of their benefits was a pension plan. I didn’t realize it I had one until a few months after I quit. I got this letter from the union mentioning that I have around $2K in a pension at the time of my resignation. I immediately went to a local bank to show them the letter and advised me to roll it over to a retirement account because if I cashed it out, their would have been a 10% penalty. So I listened to the bank and rolled it into an Individual Retirement Account(IRA). And now after all these years I still have that money in an IRA and contributing to it every year.
@Kris- This is how pensions in the public sector work. DBP in the private sector are becoming more and more rare so I’m not sure how they work and if they have a buy back option. Thanks for sharing- sounds like the $2K in pension helped you get started on good footing with your retirement planning.
I bought back my first maternity leave just recently, about $6000. I’m more of a lazy investor so this was an easy-out for me. I need to learn more about dividend investing and start that after my second maternity leave!
@LR- Congrats on your mat leaves (I am counting down the days until my next one hahaha). Index investing is another great way to invest for lazy investors. Or even robo advisors if buying ETFs regularly is too time consuming. To be honest, I wanted to buy back the $7K so that I would be even more ‘diversified’ in retirement but for now I’ll stick with investing the money myself.
Hi GYM, very interesting topic. I heard about the pension buy back option. One person wanted to retire early, but had not accumulated enough years of service. One option was to buy back. Another purpose is like what you said, to boost the pension. I feel it’s kind of like buying fixed annuity. It matters a lot how long this person will live. Pension is becoming rare in US, and usually it’s for government employees, teachers, etc.
@Helen- Yes, the DBP definitely seems like buying a fixed annuity. Very attractive for some (guaranteed income for life). I think the decision is very personal and situation dependent.
While not important to some, I consider risk as an important factor. Specifically, with the buy back, I won’t have to work those extra years to qualify for full pension. I can retire early.
To me that is less stress, more time with my family, more days/weeks/years added to my life.
The tradeoff is relative.
@Ardy0 Thanks for sharing your perspective- very good point. It’s a very personal decision for sure. I plan to retire early/ live a work optional life even without a full pension with my nest egg outside of the DBP.
I belong to LAPP, which is a public sector DB pension plan. I did buy back my first maternity leave, but not my second. One of the rules of our plan is that the company can provide their match on the first year of maternity buy back, but are not allowed to match any subsequent maternity leaves. So for my second leave, I would have been on the hook for the entire pension contribution (which is approximately 25% of my annual salary). My first leave I only had to pay the employee portion and the company provided theirs. One of the factors for me was to ensure that I could retire a year earlier, as my husband will be eligible to retire a couple years sooner than I will. I don’t want to have to keep working for years after he retires! 🙂
@Leanne B- Thanks for sharing your experience. Interesting that your DB plan has a match the first year but not the second. That’s a great benefit. 25% of your annual salary is a lot to buy back!