pension plan

[ourkid8]

Hey all,

 

I need some advice from what other astute individuals have done. I just left a company in Canada with a defined benefits plan which I have worked and contributed for about 10 years. (I am 33 years old) I just received my pension statement with 3 options:

 

1. Start drawing on a pension - I don't require the money yet

2. Leave it with the company (based on actuarial assumptions they expect 1.9% return for 10 years and then 3.4% whiich IMO seems very low)

3. Move it into a LIRA and I manage it myself

 

What have others done as I assume others have been in similar situations and do you have any recommendations?

 

Any advice would be greatly recommended.

 

Thanks,

S

[EliG]

Ask the same question on FWF. A few regulars there are very knowledgeable about pensions.

 

http://www.financialwisdomforum.org/forum/index.php

[Txvestor]

With that sort of time frame in mind, if you move that money into a LIRA and split it is 4-5 ways and

buy companies like FRFHF, MKL, BRKB etc. and look back in 30 yrs which is when you will need the $$, i suspect you will come out much further ahead than 3.4%.

If you don't get 3.4% with the likes of those, then I suspect your so called assured pension would not be so assured either! Your advantage is the certainty of not needing that capital for such a long period of time.

[nodnub]

Hey all,

 

I need some advice from what other astute individuals have done. I just left a company in Canada with a defined benefits plan which I have worked and contributed for about 10 years. (I am 33 years old) I just received my pension statement with 3 options:

 

1. Start drawing on a pension - I don't require the money yet

2. Leave it with the company (based on actuarial assumptions they expect 1.9% return for 10 years and then 3.4% whiich IMO seems very low)

3. Move it into a LIRA and I manage it myself

 

What have others done as I assume others have been in similar situations and do you have any recommendations?

 

Any advice would be greatly recommended.

 

Thanks,

S

 

What kind of advice are you looking for?  The way you've written it looks fairly clear: option 1 and 2 look like non-starters. Therefore, take door #3. 

 

[EliG]

The options may be not as straightforward as he presented them.

 

For example, the maximum transfer value to LIRA may be less that the pension commuted value. He may be forced to take the difference as a lump sum income and pay tax on it.

 

There may be a few other factors in play, such as indexing, health benefits, pension splitting, early retirement provisions. See Manulife document for discussion:

 

https://repsourcepublic.manulife.com/wps/wcm/connect/f0e79b80431cf4b58b168b37985f10c7/inv_trs_mk1982.pdf?MOD=AJPERES&CACHEID=f0e79b80431cf4b58b168b37985f10c7

 

The bottom line is, the real hurdle may be higher than the stated actuarial rate of return.

 

[ourkid8]

Thanks, the manulife document was great.  Let me do a bit of research.

 

Tks,

S

 

The options may be not as straightforward as he presented them.

 

For example, the maximum transfer value to LIRA may be less that the pension commuted value. He may be forced to take the difference as a lump sum income and pay tax on it.

 

There may be a few other factors in play, such as indexing, health benefits, pension splitting, early retirement provisions. See Manulife document for discussion:

 

https://repsourcepublic.manulife.com/wps/wcm/connect/f0e79b80431cf4b58b168b37985f10c7/inv_trs_mk1982.pdf?MOD=AJPERES&CACHEID=f0e79b80431cf4b58b168b37985f10c7

 

The bottom line is, the real hurdle may be higher than the stated actuarial rate of return.

[augustabound]

How much does this pension represent of your overall portfolio?

 

I was in the same boat and figured since I wouldn't be adding to it, I'd make that a dividend portfolio and kind of put it on cruise control until I was retired.

Or invest in only owner operators that I could hold long term. (again, since I can't add to it I wanted more of a set it and forget it type)

 

Another board member here made his LIRA a very high conviction account. One or two ideas with high risk/reward characteristics. Kind of the theory, bet big when the odds are in your favour.

 

Another suggestion was to make it a purely mechanical portfolio, Magic Formula etc.

 

My natural tendency in the TFSA is concentrated and I like owner operators in general so I'm still leaning towards the dividend strategy for the LIRA.........................I think.

[ourkid8]

It represents 15% of my overall portfolio  - I was surprised how large it was!  Thanks for your feedback, I am leaning towards transferring the funds into a LIRA but going to contact HR to inquire about the points mentioned by Manulife.  If there is a market sell-off, this cash would be handy to purchase high quality companies. 

 

Thanks team!

 

tks,

S

 

How much does this pension represent of your overall portfolio?

 

I was in the same boat and figured since I wouldn't be adding to it, I'd make that a dividend portfolio and kind of put it on cruise control until I was retired.

Or invest in only owner operators that I could hold long term. (again, since I can't add to it I wanted more of a set it and forget it type)

 

Another board member here made his LIRA a very high conviction account. One or two ideas with high risk/reward characteristics. Kind of the theory, bet big when the odds are in your favour.

 

Another suggestion was to make it a purely mechanical portfolio, Magic Formula etc.

 

My natural tendency in the TFSA is concentrated and I like owner operators in general so I'm still leaning towards the dividend strategy for the LIRA.........................I think.

[Uccmal]

Hi ourkid, 

 

Yeah,  With my first pension I hadn't worked long enough to make it worth keeping until I was 60, or whatever.  When I left 14 years ago, the legislation hadn't been changed yet.  Finally, 9 years ago, I transferred  $23,000 to a Lira, which is now worth around 100,000.  I have always run it conservatively, with no options and no leverage.  I can start drawing on it in 5 years, if I can find a way to keep the taxes down. 

 

My second pension has a much larger commuted value - It would be taxed at about 11% if I commute it.  If I leave it alone, I can start drawing it at 60, in ten years.  There are health benefits attached, If I leave it there.  The pension plan is an arms length trust so its as safe from the employers prying hands, as anything else.  I suspect I will leave it and treat it as a long term backup fund.  The commuted value will increase continually.  I dont know the rest of the details yet, as I just quit a month ago, and have yet to receive any paperwork. 

 

Overall, nice problems to have.  My vote at your age is for a Lira, contingent upon what others have said about health benefits etc.  I am guessing you wont get these due to time needed in the plan, if there are any. 

 

 

[FFHWatcher]

Hi ourkid, 

 

Yeah,  With my first pension I hadn't worked long enough to make it worth keeping until I was 60, or whatever.  When I left 14 years ago, the legislation hadn't been changed yet.  Finally, 9 years ago, I transferred  $23,000 to a Lira, which is now worth around 100,000.  I have always run it conservatively, with no options and no leverage.  I can start drawing on it in 5 years, if I can find a way to keep the taxes down. 

 

My second pension has a much larger commuted value - It would be taxed at about 11% if I commute it.  If I leave it alone, I can start drawing it at 60, in ten years.  There are health benefits attached, If I leave it there.  The pension plan is an arms length trust so its as safe from the employers prying hands, as anything else.  I suspect I will leave it and treat it as a long term backup fund.  The commuted value will increase continually.  I dont know the rest of the details yet, as I just quit a month ago, and have yet to receive any paperwork. 

 

Overall, nice problems to have.  My vote at your age is for a Lira, contingent upon what others have said about health benefits etc.  I am guessing you wont get these due to time needed in the plan, if there are any.

 

As I recall, one of the tough realities with a defined pension plan is that if you choose NOT to commute it and just take the regular pension, once you have been paid the commuted value, the plan owes you nothing.  If you have a spouse, your spouse will continue to receive your pension, generally at two-thirds the amount (not including any bridge benefit).  So, in reality, let's say you have a $500k commuted value pension at age 54 and your pension is $40k/yr.  After 12-13 years of receiving the pension, and you die, then the pension plan owes you nothing.  If your spouse is still alive, they would get 2/3's (depending on which option you take, if you have one).  In the above scenario, if you commuted it and transferred the value to a LIRA and took the same amount indexed to inflation, you would still have $200k in value after 13 years if you earned 6%/yr.  If you are single and dead, that potential value/asset is gone.

Another thing that is rarely discussed is the annual limits that you are allowed to take on LIRA's.  You can have a huge balance but it is restricted on how much you redeem annually.

In my opinion, being single and/or unhealthy heavily favours commuting your pension.  Being married, healthy and thinking you will live until you are 90 makes keeping the pension a good idea.  Basically, it isn't an easy, straight forward no-brainer decision.  If you knew your future rate of return if you manage it yourself, it would be a lot easier.   

[Uccmal]

Hi ourkid, 

 

Yeah,  With my first pension I hadn't worked long enough to make it worth keeping until I was 60, or whatever.  When I left 14 years ago, the legislation hadn't been changed yet.  Finally, 9 years ago, I transferred  $23,000 to a Lira, which is now worth around 100,000.  I have always run it conservatively, with no options and no leverage.  I can start drawing on it in 5 years, if I can find a way to keep the taxes down. 

 

My second pension has a much larger commuted value - It would be taxed at about 11% if I commute it.  If I leave it alone, I can start drawing it at 60, in ten years.  There are health benefits attached, If I leave it there.  The pension plan is an arms length trust so its as safe from the employers prying hands, as anything else.  I suspect I will leave it and treat it as a long term backup fund.  The commuted value will increase continually.  I dont know the rest of the details yet, as I just quit a month ago, and have yet to receive any paperwork. 

 

Overall, nice problems to have.  My vote at your age is for a Lira, contingent upon what others have said about health benefits etc.  I am guessing you wont get these due to time needed in the plan, if there are any.

 

As I recall, one of the tough realities with a defined pension plan is that if you choose NOT to commute it and just take the regular pension, once you have been paid the commuted value, the plan owes you nothing.  If you have a spouse, your spouse will continue to receive your pension, generally at two-thirds the amount (not including any bridge benefit).  So, in reality, let's say you have a $500k commuted value pension at age 54 and your pension is $40k/yr.  After 12-13 years of receiving the pension, and you die, then the pension plan owes you nothing.  If your spouse is still alive, they would get 2/3's (depending on which option you take, if you have one).  In the above scenario, if you commuted it and transferred the value to a LIRA and took the same amount indexed to inflation, you would still have $200k in value after 13 years if you earned 6%/yr.  If you are single and dead, that potential value/asset is gone.

Another thing that is rarely discussed is the annual limits that you are allowed to take on LIRA's.  You can have a huge balance but it is restricted on how much you redeem annually.

In my opinion, being single and/or unhealthy heavily favours commuting your pension.  Being married, healthy and thinking you will live until you are 90 makes keeping the pension a good idea.  Basically, it isn't an easy, straight forward no-brainer decision.  If you knew your future rate of return if you manage it yourself, it would be a lot easier.   

 

Ourkid, If its a meaningful amount perhaps you should contact a pension expert before you sign anything.  There is one group in TO that runs some ads, and has periodic articles in Canadian Money Saver - Ian Burns and Shelley Johnson (not an endorsement as I dont know them).  It is pretty specialized.

[Dustin T]

I'm in the middle of facing the same decision myself. I plan on taking the buyout and rolling it into my IRA.

 

There is some risk but in my case as long as I average over 5% I come out ahead. I'm willing to take the challenge of clearing this relatively low hurdle but I do think the markets current full valuation makes it a bit more difficult than I would prefer.

 

I plan on living a long life but should something happen to me my daughter will be better served with cash on hand.

 

 

 

 

[Viking]

I was in a similar situation twice and both times I chose option 3.) transfer $ to a LIRA. This decision was the best financial decision I have ever made.

 

One immediate benefit was I was allowed some very large RRSP contribution room (the difference between what my allowable RRSP room was each year and the value of the LIRA I transferred for each working year with the company). The Canadian government sent me a notice with the amount that had been added to my RRSP contribution room for income tax purposes that I could claim in future years. I promptly then made large RRSP contributions to use up this contribution room (as I was in a very high tax bracket when still working).

 

So my starting point was the LIRA that I received from my previous company and the subsequent large RRSP contributions that I made. This happened twice over the years.

 

Here is the crazy thing. Each time I changed companies the reason was to build my skills; I did not chase cash or do this so I could get my hands on my pension $. As my skills grew the $ employers wanted to pay me increased. So changing companies was a great decision in terms of growing my skill set and earning more $. However, the fact that changing companies also allowed me to get my hands on my pension was, in hindsight, the best part of me changing companies. I have been able to compound these investments at about 15% per year (for many years). This put me in a financial position where I was able to quit my day job; this was 10 years ago.

 

If I had stayed with one company I have no doubt that I would still be working full time. Yes, I would have some investments and they would be growing OK. Getting my LIRA and making some large RRSP contributions (I rarely had room to make RRSP contributions when I worked given the estimated value of my pension benefit) gave me a large and critical mass of savings when I was still relatively young (in my 30's) that I was then able to grow nicely over the years.

 

A key to this decision is how good of an investor you will be in the next 10 to 20 or 30 years. Only you can answer that question.

[Uccmal]

Very slightly off topic but related.

 

My concern is that RRSP and Lira is treated as income, and is fully taxable, when it gets withdrawn.  I have moved from adding money to my RRSPs to deliberately not adding to them.  Whatever is in there will grow until its withdrawn organically.  A retired board member pointed this out to me.  He had direct experience with withdrawing RRSP money and watching it get taxed away. 

 

Viking, have you ever crunched the total tax implications of adding funds to your RRSP.  It may have made sense when I had work income, but it doesn't now.  As in, the tax refund I get now is minimal, but the tax I pay when I withdraw it may be significant. 

 

The question then becomes:  Will I be able to compound my tax sheltered accounts at a rate greater than what I will pay down the road.  I am not sure of the answer to this.  There is alot of moving parts, not the least of which is the government which may go after the big RRSP honey pot with more vigour in the future. 

 

 

[Viking]

I want to apologize to non Canadian readers... In the note below I get into a fair bit of detail of investment accounts allowed by the Canadian government over the years; hard enough for a Canadian investor to follow....

 

Uccmal, most of my investable assets are in RRSP's and LIRA's. yes, this is a direct result of my past decisions. I do love the (relatively new) Tax Free Savings Accounts. I think they are a fantastic vehicle, especially for young people. TFSA was not an option for me when I was younger.

 

Today I am drawing down my RRSP and taking the subsequent tax hit. I am not too concerned; when I made my RRSP contributions I was in a very high tax bracket (around 50%) so my tax rebate was quite large. At the time I understood tax brackets and made sure my RRSP contributions did not drop me into a lower tax bracket (where the savings would have been less). I find investing within an RRSP to be very straight forward. One key reason is I do not have to think about taxes when making an investment decision and I find this helps enormously; this has likely helped me get better returns over the years.

 

I also made large spousal RRSP contributions when I was younger. My wife's RRSP today is actually larger than mine. This also has turned out to be a good long term decision as this has given us additional flexibility.

 

Currently, I am trying to grow my TFSA. My best investment ideas go into these funds and they have been growing nicely over the years. For a few years I actually took extra $ out of my RRSP and used the proceeds to max out my TFSA contributions.

 

My balancing act is I am currently drawing down my RRSP's to live. I cannot access my LIRA until I am 55 and 60 (one is domiciled in BC and one is in Ontario and the two provinces have very different rules); I do need to learn more about my two LIRA accounts and what the exact rules are regarding when and how much I can withdraw. My TFSA are not large enough yet that I want to withdraw funds to live. There is some complexity to managing this.

 

I also have a group RESP for my three kids (one account). I made one contribution of $2,000 for each kid about 12 years ago (so a total of $6,000) when my youngest was born and I opened up the account. The government added 20% so I started with $7,200. This account is now approaching $60,000. I think I will be able to pay for about half of my kids university education down the road out of this fund. Pretty crazy given the starting point (what investing $6,000 can get you years later...pay for a large portion of 3 kids university education). Just goes to demonstrate the power of starting early and compounding. The key decision here was, once again, opening an account that I controlled and could invest myself.

 

As an aside, all of my and my wife's accounts (RRSP, LIRA, TFSA, RESP and cash) are held with one of the big banks. Investing/managing/tracking them is very simple and low cost. Canadian investors today are in a very good situation when it comes to managing their finances; much better than when I started down this road about 25 years ago.