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The coronavirus has created a tremendous financial opportunity for workers with a pension

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Unique opportunities sometimes come in extreme times.

The one detailed below on commuting the value of your pension won’t be an option for many, but for those with the ability to take advantage, it could meaningfully improve their retirement finances for years to come.

This opportunity is based on three fundamental facts.

First, the current or commuted value of your pension is much higher when interest rates on 5 Year Canadian Bonds are low. The five-year bond is trading near historic lows, at 0.57 per cent at the time of writing.

Secondly, you can use the paid-out pension money to buy some very solid long-term Canadian investments with dividend yields of six per cent or more.

Finally, the effective marginal tax rate on Canadian dividends is very low. In Ontario, British Columbia and Alberta, you don’t pay any tax on such dividends at $40,000 of taxable income, and only 7.6 per cent at $70,000 of taxable income.

Let’s take a look at each of these facts.

Why low interest rates make your pension worth more today

Canadian money and Why low interest rates make your pension worth more today.This only relates to the one-time value of defined-benefit (DB) pension plans, since defined-contribution plans go up or down in value each month based on the investment value of your account.

Low interest rates can be great for DB plans because they are valued on a specific date — usually monthly. This value is essentially meant to compensate you for what the pension would need to set aside to cover your pension payouts.

Let’s say you needed to get $50,000 a year from a guaranteed investment certificate. If interest rates are 10 per cent, you would need $500,000 invested to generate the $50,000. If interest rates are one per cent, you need $5 million to generate the same amount. Today, the pension plan needs to set aside much more money to ensure it can meet the fixed needs of your lifetime pension.

The value of your pension is made up of several factors. Needing $5 million to generate $50,000 is a very generic example, but the difference could mean getting $250,000 or more on a full mid-level pension if you retire today compared to if you retire when rates are two percentage points higher.

Of particular interest is that pension plan managers do not want you to take the commuted value. They don’t want to lose assets at the best of times, but especially not at the most expensive times when interest rates are low. If they wanted you to take out the cash, they would provide more education to make your decision easier. In our experience, you often have to push hard to get answers to key questions that might help you make better informed decisions.

Keep in mind, too, that with some plans you can make the decision to take the cash instead of the pension right before you retire. With other plans, you have to make the decision to take the commuted value of a pension as early as age 50 or 55. This is an important question to ask your manager.

What to do with a cash payment

One of the keys to making such decisions is to understand that this isn’t play money. This is your retirement pension. You want to invest wisely and lean conservative. If a portfolio won’t do as well as your pension, then you should keep the pension.

We often analyze pensions for clients to determine the break-even point if someone was to live to be 90. This point will depend on whether a pension is fully indexed to inflation, and must account for any other health benefits that might be included.

Having said that, because of the low interest rates at this time, the rate of return required to do better than a pension payout is generally in the range of 2.75 per cent to four per cent today. If the pension funds are invested at, say, a three-per-cent annual return until age 90, and funds are drawn out exactly the same as they would be in a pension, the investments will be worth zero at age 90, the same as they would be for the pension if you pass away at 90 with no survivors.

Over the long term, three per cent is a pretty low hurdle to clear. It is much easier now. As an example, we put together three investments with a combined yield of more than seven per cent that could help you achieve this return.

George Weston Preferred Share – Series D: The current dividend yield on this fixed-rate or perpetual-preferred share is 6.2 per cent (at the time of writing). The share price is still down almost 15 per cent from March, but we believe that you will see some decent price recovery in addition to the dividend.

Canadian Imperial Bank of Commerce common shares: The current dividend yield is 7.5 per cent. No Big 5 Canadian bank has cut its dividend since the 1930s. It is possible they would, but very unlikely. The stock is still trading almost 30 per cent lower than it was in mid-February, but even if the stock price never goes up, and the dividend never rises, 7.5 per cent a year is a decent return. The good news is that both the stock price and dividend are very likely to meaningfully rise during your retirement years.

Bridging Income Fund: Bridging Income is a well-run firm that offers secured private lending and factoring. The fund has delivered consistent annual returns of eight per cent or more, with little correlation to stock markets. It has also provided positive returns for the past 70-plus months without a single negative month. We have worked with the fund since its inception seven years ago, and this has provided investment benefits to our clients.

The above three are clearly not meant to be an investment portfolio, but they represent a sample of what can be purchased today, often at higher yields than normal because of the decline in markets.

Tax and dividend considerations

Usually, the commuted value of a pension is paid out in two forms. The first would be funds that are tax sheltered and paid out into a registered retirement savings plan or similar account. You don’t pay tax on the transfer, but you will pay full income tax on the funds when they are ultimately withdrawn from the account.

The second form usually comes out as a taxable lump sum. There is a maximum transfer value for a pension, with anything above this amount considered taxable income. The general rule is that the larger your annual income as an employee, the higher percentage of your pension payout will likely be taxable. There are some strategies to lower the tax payment, but it is important to fully factor in the tax bill when determining what pension option makes sense.

In the three investments mentioned above, the George Weston and CIBC investments pay out eligible Canadian dividends, while the Bridging Income payout is considered interest income.

For a pension payout, we would hold Bridging Income in a tax-sheltered account. For the Canadian dividends, we are very comfortable holding them in a taxable investment account, because of the low tax rates on this income. Even for someone who has a total taxable income of $90,000, the tax rate on Canadian eligible dividends is just 12.2 per cent in Ontario and 7.6 per cent in B.C. and Alberta.

One of the negatives of a pension is that you don’t have control of the cash flow. It comes in every month, fully taxed, whether you need the cash or not. If you take the commuted value of your pension, you have much more control over cash flow and income, and this can be very valuable over time, as shown by the Canadian dividend income example.

The bottom line is that historically low interest rates along with higher-yielding investments can be a very rare opportunity that comes out of unfortunate circumstances. If your company or organization is strong and you are very risk averse, then keep your pension as is. If you don’t fall into that group, you should at least explore your options, especially now.

Reproduced from the National Post newspaper article 14th April 2020.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

Pensions 101: The importance of understanding your pension

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I have been involved with the Financial Facelift articles since 2013 and in the financial planning industry since 2000. In my time working on the Financial Facelifts, I have been asked many questions about my calculations and recommendations; but bar none, questions about pension calculations have been the most frequent.

With that in mind, there is no time like the present to give a refresher course on how pensions work, how their value is calculated and why they are so important.

There are two main types of employee pensions in Canada, defined contribution (DC) and defined benefit (DB). Both are important to the financial well-being of their members in retirement, though they both work in different ways.

DC pension plan

The DC pension is more like a registered retirement savings plan (RRSP) in the way it works than what most people would traditionally think of as a pension. In this type of pension typically both employee and employer make contributions to the plan. They are usually based on a percentage of income, up to the contribution limit. These contributions are then invested in underlying investments directed by the employee and vetted by the employer.

How the contributions affect RRSP room is fairly straightforward to understand as well. For every dollar contributed, the employee accumulates a dollar of pension adjustment and thereby their available RRSP room is reduced by a dollar. This is regardless of who makes the contribution. The only difference in the contributions is the employee contributions are eligible for a tax deduction and the employer contributions are not.

The purpose of the pension adjustment is to equalize the retirement savings an employee with a pension can make versus someone who does not have a pension.

On retirement, the employee can transfer the value of the plan to a locked-in retirement account (LIRA), use it to purchase an annuity or a combination of the two. With recent federal budget changes a variable payment life annuity (VPLA) or an advanced life deferred annuity (ALDA) are also options to consider.

The current value of this pension is easily known by taking a look at the value of the underlying investments. What is unknown is what future income this pension will produce. As the name says, it is a defined contribution pension, which means the contributions to the plan are known, but the retirement income is dependent on the investment returns earned and contributions made.

One of the main benefits of a DC pension is that it forces the employee to make retirement savings. By having it as part of the employment culture, and the savings coming right off of one’s pay, it encourages employees to save for their future.

The other key benefit of the DC pension is the employer contributions to the plan. Each plan is different. Some employers may choose to match employee contributions, some may choose to make contributions regardless and some may combine the two in some fashion. No matter how they do it, the benefit is clear to the employee, it is free money toward their retirement savings.

The DB pension plan

The DB pension is what most people think of when they think of a pension. This type of pension provides a known future income stream to the employee – in other words, a defined benefit to the employee. For this benefit the employer, and sometimes the employee, make contributions to the plan that are invested to provide the future income stream. Depending on the investment performance, this may require more or fewer contributions from the employer.

While the end result – a guaranteed income stream – is easy to understand, getting there is a bit complicated. For starters, the DB pension adjustment is harder to calculate than its DC counterpart. Formulas that determine your future benefit involve such inputs as one’s yearly maximum pensionable earnings (YMPE), final average earnings (FAE) and years of service.

To further complicate the DB pension calculation, some pensions have Canada Pension Plan/Old Age Security integration. This is where a bridge payment is made between when the pension commences and age 65 to be later offset by the receipt of CPP and OAS. To note, this integration is not perfect, often being different than the actual CPP and OAS received.

There is also the matter of survivor benefits. If the pensioner is married/common-law, then the pension will pay out a survivor benefit to the spouse upon the death of the pensioner. The automatic selection is typically 60 per cent of the full pension amount, but a higher or lower percentage can be selected. This will raise or lower the actual calculated pension payment based on mortality rates.

So now that we have a base understanding of how the pension gets paid out at retirement, we can discuss the next problem: What is the pension worth today? Unlike the DC pension which has an easily determined value, the DB pension “commuted value,” is another matter entirely.

So, how much money is needed today to pay the employee a pension for the remainder of their life? The main factors that can influence this calculation include:

· Age at retirement

· Penalties for early retirement

· Mortality of the pensioner and, if applicable, the spouse

· Current age

· Expected rate of return on the investments (often called the discount rate)

· Pension indexed or not

· Rate of inflation

Change any one of these factors and the commuted value can change drastically. Why is this so important? For a number of reasons.

First, if the employee dies before starting the pension, often the surviving spouse does not receive a survivor pension. Instead they receive the commuted value of the pension eligible to transfer into their RRSP. This happens without tax implications, much like an RRSP rollover on death.

Even if the pensioner does not die but ceases employment with the employer who has the pension plan, then one option is to take the commuted value and transfer it into a LIRA in their name. Depending on the length of service, this is a common outcome versus waiting to take the pension at their normal retirement date.

Finally, at retirement the pensioner can choose to take the commuted value instead of taking the pension. Why would someone do that? I have gone through this exercise with many clients over the years and some of the main reasons for making this choice are:

· Financial flexibility – With pension unlocking rules available in some provinces, the pensioner can access more of their funds earlier or keep them tax-deferred longer. Either way, there is increased choice about how to deal with the asset.

· Limited life span – The commuted value can provide a larger death benefit for the surviving spouse. (With most survivor pension benefits being a percentage of the full pension payable or having to take an actuarially reduced pension to receive 100 per cent survivor benefits, the full commuted value can provide more value than taking the payments at a reduced level.)

· Company/pension concerns – though this is rare and there are some funding guarantees, one only has to look at the collapse of Nortel or, more recently, Sears Canada to see examples of where a DB is not fully secure.

· Increased wealth potential – As I mentioned previously, each pension is different. It is prudent to take a look at what the breakeven rate of return is. In other words, what would the portfolio created from the commuted value have to earn to match the pension payments. If the comparable rate of return is reasonable, the pensioner may consider in their best financial interests to take the lump-sum. This happens more often than you might think.

Regardless of what option is chosen, the benefits of the DB pension are apparent. Most of the savings required and all of investment risk in building the retirement portfolio is the responsibility of the employer. This takes the decision to save for retirement out of the hands of the employee.

The value of the DB pension – especially if indexed to inflation – of a long-standing employee will provide a solid base on which to retire, even if the employee has no other assets. If someone worked 35 years at an employer with a DB plan, they could conceivably replace 70 per cent of their pre-retirement salary if they had a pure 2 per cent pension formula. This would, of course, also drive a substantial commuted value if that option was chosen.

For those of you lucky enough to have a workplace pension plan, understanding how it works is an important first step in financial literacy. They don’t teach this in school, though I think they should. Whether it is the more straightforward DC pension or the more complex DB pension, understanding how to maximize the benefits and choose the best options available are important steps on your road to financial independence.

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The DB plan: crunching the numbers

The pension adjustment (PA) for a defined benefit pension is more complicated to calculate than its defined contribution counterpart.

The calculation for the PA equals nine times the value of the benefit earned for the year (2 per cent of final average earnings is the maximum value of the benefit permitted by the government in pension calculations – someone with a 2 per cent pension who works for 35 years would have 70 per cent of their former income in pension) minus $600.

  • For example, if the employee had a 2 per cent pension with a $100,000 salary, the PA = 9 x ($100,000 x 2%) – $600 = $17,400. Note: While the PA will reduce the amount of available RRSP contribution room available, only a portion – the employee’s contributions to the pension – is tax deductible.

So, based on this example, the DB plan will reduce this person’s RRSP contribution room by $17,400.

The formula to calculate the future benefit varies as well. Most DB pensions work on a percentage of earnings. Often the earnings are a final or best average of some time period, such as three or five years.

Next, a percentage is applied to the average earnings figure. As stated above, 2 per cent is the maximum per year, though the percentage can be lower than this. Plans may also have tiers of earnings often separated by the average year’s maximum pensionable earnings (YMPE) over the final three or five years.

(YMPE is the earnings level set by the government – $55,900 for 2019 – where an employee maxes out on their CPP contributions. So any income above YMPE does not require a payroll deduction for CPP. It is often used in pension formulas as part of a CPP offset.)

Lastly, are the years of service an employee has in the DB pension. The formula of earnings and percentage is multiplied by the years of service.

  • A typical formula for an employee with a salary of $100,000 and 30 years of service may look like this: (1.4% of Final Average Earnings (FAE) up to YMPE plus 2% of FAE above YMPE) x Years of Service, or
  • (1.4% x $55,900 + 2% x 44,100) x 30 = $49,938 for $100,000 of FAE.

So, in this example, the employee can expect to have a future benefit, or annual income post-retirement, of $49,938.

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor
matt@tridelta.ca
(416) 733-3292 x230

The golden opportunity of a pension windfall might be slipping away as interest rates rise

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You have been told time and again that you are one of the lucky ones. You have a defined benefit pension — meaning that when you retire you will get a fixed monthly payment for as long as you live.

I agree you are one of the lucky ones, but not exactly for the reason that you might think. You are one of the lucky ones because you might be able to get an extra-large lump sum payout when interest rates are close to their historic all-time lows. But this opportunity could be slipping away.

As you may be aware, a low interest rate at the time you take what is called the commuted value payout of your pension, can add hundreds of thousands or even millions to the value of that payout depending on the size of your overall pension. As interest rates rise, that payout gets smaller.

The key interest rate for most Canadian pensions is the Bank of Canada five-year bond yield. This is often the number used to help calculate your commuted pension value. On Feb. 10 2016, the five-year yield hit an all time low of 0.41 per cent. That was the best day for a commuted value pension (or best month as they are usually valued monthly). As I write this, the five-year yield is now 1.14 per cent — or almost triple where it was in mid-February.

Before you think the pension opportunity is now gone, keep in mind where it has been: In March 1990, the five-year yield was 11.6 per cent. We are still at unbelievably low bond yields, and you are still in a golden period for getting huge lump sums in place of your pension. Time will tell if this golden period is coming to an end, but some analysts believe that we will never see a rate as low as 0.41 per cent again in our lifetimes.

To better understand the power of interest rates on your pension value let’s start with the humble annuity. A pension is essentially like buying an annuity. In this case you would pay a lump sum today and in return you would receive a monthly payout for the rest of your life. An annuity is also kind of like buying a lifetime GIC and locking in the rate. Today, you wouldn’t get very excited locking in a lifetime GIC that pays out 2 per cent. You also wouldn’t get that excited locking in an annuity with that type of return. For example, today you would need to put in $1 million as a 65-year-old couple in order to guarantee a payout of $51,000 a year until you both pass away. As unexciting as those rates and payouts would be, a pension commuted value is the opposite. Today it is tremendously exciting.

Thinking about that same $1 million it would cost you to receive $51,000 a year, if you take the commuted value or cash today instead of your pension, you are essentially getting paid $1 million today instead of the $51,000 a year. Another way to look at it would be how much needs to be invested at 2 per cent to pay out $50,000 a year. At 2 per cent, you would need to invest $2.5 million in order to get $50,000 a year in income. At 5 per cent, you would need to invest $1 million in order to get $50,000 a year in income. Today, your same pension commuted value payout might be $2.5 million, but if interest rates jumped to 5 per cent, it would be $1 million.

I am definitely oversimplifying a complicated formula here, and the math wouldn’t work out quite as above, but it is meant to show you the directional impact of interest rates on your pension commuted value calculation, and why this golden opportunity might slip away if interest rates meaningfully rise.

I find that many people never even consider taking a commuted value lump sum. After all, their monthly payout in retirement is what they have been working for their entire working careers. However, would you think of it differently if you knew that your employer was really hoping you would not consider taking the commuted value now?

In some cases the opportunity to take the commuted value or “take the cash” is not an option. Sometimes this is an option only at retirement or if taken prior to age 55 or prior to age 50. It is certainly worth finding out what options you have in your own plan.

When thinking about what route you would want to take in addition to thinking about your health, the companies’ health, tax planning etc., one of the key questions is whether you could earn more from the commuted value than from the pension payouts. One set of analysis that we normally do is a break-even comparison. We set things up to be as much an apples to apples comparison as possible.

In most of our pension reviews at the moment, the break even rate of return required is in the range of 3 per cent to 3.75 per cent to age 86. What this means is that if you invested your commuted value, and did monthly withdrawals at the exact same rate as you would have for your pension, you would only need to have earned say 3.5 per cent a year return to fund everything to age 86. If instead of 3.5 per cent, you actually received a 5.5 per cent long-term return, which we believe is extremely doable, you will have not only been able to match your pension payouts dollar for dollar, but would likely have several hundred thousand dollars left at the end for your estate instead of the $0 left with a standard pension.

Now this analysis will come to different conclusions in a higher interest rate world. If the break even needs to be 5 per cent+, in many cases I would consider taking the certainty of the pension. However, as long as the break evens we are seeing are in the 3 per cent range, it means you are giving up returns every year. We believe that taking the commuted value of a pension, if you are lucky enough to be able to do so in today’s interest rate environment, is something to consider strongly.

I am not suggesting that it is always wrong to keep your pension. In most cases, a government or quasi-government pension provides you with certainty on income for the rest of your life. If you and/or your spouse have good genes and are in good health, it is quite possible that you will receive the pension for extra years compared to your peers. There are also sometimes health benefits attached to a pension that provide some real value and peace of mind.

The decision of whether to receive a pension in monthly amounts for life as opposed to taking a lump sum is a complicated matter. What I do know is that your employer believes that paying out the commuted value today will cost them too much, and would likely prefer you don’t even consider it. That is reason enough for you to explore it further.

Reproduced from the National Post newspaper article 6th February 2017.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

How the Bank of Canada’s rate cut may have added $100,000 to your pension in one day

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When the Bank of Canada lowered the overnight interest rate by 0.25% this week, the obvious benefit is for those with variable rate mortgages. They will see an immediate benefit in lower interest payments on their mortgage.

Another group who just received a big win may not even realize it: If you have a pension plan, and especially if you have ever thought about taking the cash value of your plan, you just saw an increase in potential value. In some cases, the rate cut could have added as much as $100,000 in wealth in one day. This option to ‘take the cash’ is usually open to those who are retiring or leaving their employer. Sometimes the option ends when the employee turns 50 or 55.

To understand how this wealth boost works, and how much your wealth could go up, can get a little complicated. The best way to explain it is to pretend that you want $50,000 of income per year and go from there.

You could buy a GIC to pay out $50,000 of income per year, and depending on the interest rate of the GIC, you could determine how much you need to invest: At 10 per cent interest, you could buy a $500,000 GIC. At one per cent interest, you would need to put in $5 million for the same return.

In the pension plan example, if they are committed to paying you $50,000 a year, then at today’s super low interest rates, your pension plan must set aside a lot more money to cover off $50,000 a year — just like the GIC example. Here is where your wealth potentially just grew:  In many cases, you have the ability to ask your pension plan for this lump sum of money (often called the commuted value), rather than taking the pension as a monthly payment.

Below is a chart for the Bank of Canada Five-Year Bond Yield over the past 26 years. The highest yield was 11.6 per cent, in March 1990. The lowest yield happened this week at 0.7 per cent.

govt_bonds

Imagine this chart represented an opportunity to lock in a lifetime rate for a loan. If you could choose any time to lock it in, this week would be the best time.

A commuted value of a pension works the same way. You are essentially locking in a value for life, and an important determinant of that value is interest rates.

Put another way, if you were ever going to take the commuted value of your pension, now would be one of the best times in history to do so.

For those who like the idea of a monthly payment guaranteed for life, you can purchase a pension any time by buying an annuity. Having said that, in many ways, at today’s low interest rates, now is perhaps the worst time to purchase an annuity.

One potential strategy is to take the commuted value of your pension today, when you would receive the largest amount. In a few years, if interest rates rise meaningfully, you can take your funds and buy an annuity that will pay you a higher monthly amount than you would ever have had with your existing pension.

The decision of whether to receive a pension in monthly amounts for life as opposed to taking a lump sum is a complicated matter. What I would suggest is that your pension plan does NOT want you to take a commuted value lump sum today. It will cost them too much.  Based simply on that, you may want to take a good look at whether that option is open to you, and whether you might want to take it.

Reproduced from the National Post newspaper article 17th July 2015.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

Here’s why you should show your group pension plan some love

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If your boss offered you a $5,000 raise for the same amount of work, would you say no?

That fact is that many Canadians are turning this down by not taking advantage of their companies matching of RRSP contributions.

The obvious reason is that money is tight for many people and the idea of having less in your pocket each paycheque can be painful. But the question must be asked: What else are you doing with your money that will return 100% (if there is full employer matching)?”

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Your Pension – Is now the time to take the cash instead?

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Here is a little known pension fact.

When interest rates are low, the present value or commuted value of your pension is high.  When rates are higher, your pension’s present value is lower.  The difference could mean getting $250,000+ more on a full pension if you retire today, than if you retire when rates are 2% higher.  Even better, someone can take the cash today, invest the funds, and in a few years when interest rates are higher, they can buy an annuity to effectively lock in a better pension.

What this means to you is that if you are close to or considering retirement with a fixed or defined benefit pension, with interest rates still near historic lows, you should take a hard look at whether it makes more sense to take the cash instead of the pension.

Of course, every situation is different, so here are 6 factors to consider before making the big decision to either take the pension or the cash.

  1. When do they think you will die?  This is a serious question without a definitive answer.  Having said that, your current health plays a significant part, along with looking at the health of your parents and siblings, and that of your spouse.  A traditional pension is worth $0 after the pensioner and their spouse have passed away.  If that is going to happen 10 years after retirement, that is a lot of money that will disappear.  In a nutshell, if you think you will live well into your 80’s, taking the pension is likely a good bet.  If you think that you will be lucky to reach 75, then taking the cash is very likely the better option.
  2. 14735352_sWhat rate of return do you need to outperform your pension?  A financial calculation needs to be made based on life expectancy to determine what rate of return would be needed on the cash, to be equal to the value of the pension.  Sometimes this break even rate is as low as 2% or 3%.  In these cases, taking the cash is likely the better option as you’re likely to have at least 4%+ annual returns over time, possibly over 7%.  This can add hundreds of thousands of dollars to your wealth.  If the break even number is 5% or higher,  meaning you need to get better than 5% annualized returns to end up better, then the pension is probably a better bet on this factor – because of the guaranteed nature of pensions.
  3. How healthy is the organization and its pension plan likely to be for the next 35 years?  This answer would be based on a number of factors facing the company in the future.  One important one is how well the plan is funded today.  The credit rating agency DBRS released a major report on pension plans last month.  One of the more interesting items is that it listed the major Canadian firms that were most underfunded as a percentage of its pension requirements.  The following 12 companies were all underfunded by more than 30%.  The numbers show the percentage funded as of December 31, 2012.
    • Magna International 55.4%
    • Catalyst Paper Corporation 60.3%
    • Canadian Oil Sands Trust 62.1%
    • Barrick Gold Corporation 63.1%
    • Agrium 64.6%
    • Talisman Energy Inc. 67.4%
    • Norbord Inc. 67.7%
    • Toromont Industries Ltd. 68.0%
    • Emera Inc. 68.3%
    • Suncor Energy Inc. 68.7%
    • TransAlta Corporation 69.3%
    • Imperial Oil Limited 69.7%

    Some major US companies appear even worse:

    • Moody’s Corp 47.0%
    • Tesoro Corp 51.2%
    • Masco Corp. 56.3%
    • U.S. Bancorp 56.7%
    • Stryker Corporation 56.8%
    • American Airlines 57.0%
    • Procter & Gamble 58.8%

    If your company or its pension is in trouble, you can expect your pension to get squeezed.  This could mean accepting 90 cents on the dollar, or losing some inflation indexing or health benefits.  In some cases, the “guaranteed” pension, isn’t so guaranteed after all.

  4. How much flexibility is needed on cash flow?  Pensions are great because they provide consistent cash flow, but what happens if you want to spend $100,000 in your first year of retirement, but will only need $40,000 in your 20th year.  The pension isn’t flexible on that front.  What if you want to help one of your children with $50,000 today?  This cash flow flexibility can open be of value.  This also has some tax implications in that you have no flexibility to adjust income for tax reasons based on your personal circumstances.  For some this won’t be a meaningful issue, but in certain cases, especially with sizable inheritances, your financial situation may change during retirement, and you may want the flexibility to adjust.  When you get into the Old Age Security zone, in some cases this flexibility will allow you to receive more or all of your OAS for many years.
  5. Do you want to leave money to your kids?  As mentioned, one of the drawbacks of a pension is that when you are gone, so is the pension.  One option some people use to make their pension last into the next generation is to have the pensioner take out life insurance.  The basic strategy is that where possible, if the retiree is in decent health, it makes a lot of sense for them to take a pension with no spousal benefit.  This will make the monthly pension amount higher than any other option.  The problem is that if the pensioner passes away early, what happens to the spouse?  In this case, the spouse is well taken care of because they will receive a meaningful life insurance payout in place of the spousal pension (which is usually about 60% of the pension value).  The other possibility here is that if the pensioner outlives their spouse, they will benefit from receiving a higher monthly pension for their entire retirement, and there will still be a life insurance payout for their beneficiaries.Depending on your lifestyle needs and the portfolio performance, taking the cash may be more likely to leave you with more of an estate, especially given that a traditional pension is guaranteed to be worth $0 upon the death of both spouses.
  6.  Tax Planning.  One potential negative of taking the cash is that in many cases only a portion of the funds will be tax sheltered in an RRSP or RRIF or LIRA.  Another portion may be considered taxable income in the year received.  For a large pension, this could mean a one-time taxable income of several hundred thousand dollars.  Fortunately, there are some tax strategies which can lower the tax rate on that lump sum by over 10% or effectively cutting the tax bill by over 20%.  With the pension keep in mind that every dollar is taxable, but there isn’t usually any large lump sum related tax hit.There is no question that a defined benefit pension brings a level of security that is comforting to retirees.  Having said that, even the pension is not fully guaranteed.  When you look at the current level of underfunding, and then think about how many major companies have gone bankrupt over the past 20 years (Nortel, Kodak, Lehman Brothers, etc.), you realize that there is some real risks that you will be receiving some meaningful percentage less than 100 on your “guaranteed” pension.When you factor in your likely longevity, a financial analysis, cash flow flexibility, estate issues and taxes, it is not an easy decision to make.  When you add in the rare benefit of low interest rates and the impact that can make on enhancing the lump sum value of your pension, taking the cash should become a meaningful consideration to think about.  One other strategy for couples where both will have a defined benefit pension, is to keep one pension and take the cash on the other.  Usually you would take the cash for the person who may have weaker health or is with a shakier organization.While the big benefit of a pension is that you will have an income for as long as you live, most people can achieve the same thing with an income oriented portfolio with a low long term risk profile.  A portfolio of large companies with low debt ratios, and a history of increasing dividends, along with individual bonds and select preferred shares should be able to provide a similar experience to a fixed pension.The bottom line is that the pension decision is among the most important financial choices you will ever make.  Take the time and get the information you need to make the right decision for you and your family.

 

Ted can be reached at tedr@tridelta.ca or by phone at 416-733-3292 x221 or 1-888-816-8927 x221

Reproduced from the National Post newspaper article 7th August 2013.

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