As some of you know, I left my full-time job in January of 2018 to freelance and spend more time with my daughter. What you may not know is that I was still technically an employee since I would do the occasional shift during a major event. Oh, it also allowed me to keep all my benefits.
In 2019, I was rarely working at the TV station anymore, so I decided it was time to formally end my employment with Rogers. The main reason I did this was that I wanted access to my pension. Since I was barely working, my pension wasn’t really growing. I figured it would be better to invest the pension on my own.
When my pension papers arrived, I took a quick look and was given a few options. I was pretty sure that transferring my pension into a Locked-In Retirement Account (LIRA) was the right move instead of waiting until I required to get my monthly sum, but I wasn’t 100% sure. I reached out to my friend Markus Muhs, CFP®, CIM® (www.muhs.ca), an Investment Advisor & Portfolio Manager at Canaccord Genuity Wealth Management, located in Edmonton, Alberta to help me run the numbers.
Barry’s pension data
- $1041.28/mo starting Jan 1, 2047 (unreduced), no indexation
- Solvency of 80% as of Jan 2019
- Lump sum commute value of $141,468.17
If Barry is to take the lump sum, there is an excess amount is $15,776.98 that cannot be transferred into a LIRA. Barry has RRSP contribution space which would lower his taxes, however with a lower expected income in 2020 due to COVID-19, paying the tax on the lump sum may help with his cashflow.
To start with some terminology: Locked In Retirement Account (LIRA) is used fairly interchangeably with Locked in RSP (LRSP) to mean pretty much the same thing; an RSP that has extra restrictions on it in order to follow the rules of the original pension plan it was commuted (transferred or “rolled over”) from.
Whereas an RSP can be withdrawn from whenever you want. You just pay the tax, fees, and permanently lose your contribution room. LIRAs typically don’t allow you to withdraw prior to the age of 50 or 55, except in extenuating circumstances. In retirement, they convert to LIFs (Life Income Funds, interchangeably Locked in RIFs, or LRIFs). They require you to take minimum payments (like an RSP) while also limiting you to maximums in order to ensure the money lasts into your 90s. Other than that, they’re identical to RRSPs/RRIFs and can be invested exactly the same way.
In Barry’s situation, he has left the employ of a large Canadian communications company (Rogers) —one of the last places in private industry where you can still find DB pension plans—and he’s still in his 30s, so his normal retirement date of January 2047 is still a ways off. **Note, new employees of Rogers no longer get a DB pension, they get a defined contribution pension.
As is typical of most private DB plans, there isn’t any indexation to this plan; it’s a flat benefit of $1,041.28 per month, which might seem decent today but won’t amount to quite as much in buying power in the 2040s and beyond. By comparison, my estimate of what Barry’s CPP income would be at 65, after 40 years of maximum contributions, is around $2,700 per month (in future dollars).
Because his employer’s industry is among the federally regulated industries (communications, banking, transport and more), if he chooses to commute the pension, he will need to open up a federally legislated LRSP at the financial institution of his choice. Outside of the federally regulated industries, your pension legislation will generally be provincially legislated.
Right off the bat, there’s one other factor that needs to be accounted for these days that is increasingly becoming a bit of a nuisance when commuting pensions, although really it’s a blessing, resulting from our historically low interest rates, and that is what is usually referred to as the “excess amount.”
The commute amount is derived from an actuarial calculation of what Barry needs as a lump sum today to derive the promised $1,041/mo retirement benefit at prescribed interest rates. In the past when rates were higher, the commute value usually came in lower, but with rates at rock bottom today, the commute value comes in higher and exceeds the legislated amount that can be rolled into a LIRA (calculated based on past income and years of service). This limitation puts Barry with his DB plan on somewhat more equal footing with the rest of us who can only put so much into our RRSPs or DC plans.
I took a fairly straightforward approach to analyzing Barry’s pension options; trying to determine the financial benefit of commuting the plan, in pure accumulated dollar terms. Essentially, I created a stripped down retirement plan, featuring only the commuted assets ($125,691 in a LIRA and $15,777 in an RRSP) and set the retirement goal at a flat (non-indexed) $1041 per month, to see how much the commuted pension overshoots this goal, from retirement to age 95. The benefit of commuting, in future dollars, will ultimately be what Barry’s estate has leftover at age 95, after spending exactly what the defined benefit pension plan would have paid him.
Barry is an experienced investor, having started investing prior to the 2008 “Great Financial Crisis” (a measuring stick I always use for experience: either you’ve experienced a 50%+ drawdown of the markets and economic crisis, or you haven’t), and he still has at least 20 years to go until full retirement, followed by likely 30 or so more years of actual retirement. Therefore, he has the capacity to take a high amount of risk with his portfolio and my base assumption is that his LIRA and RRSP are invested in an aggressive mix of 75% stocks and 25% bonds, for which my financial planning software, Naviplan, by way of Morningstar’s research, ascribes a 5.35% nominal compound annual growth rate. The plan also assumes that in retirement he reduces his allocation to a more balanced 60/40 mix, getting a 4.90% rate of return.
After running the numbers on commuting and investing the pension, and spending the benefit amount, Barry’s estate is left with just under $1.4 million at age 95. Even adjusted downward by inflation, to around $450K, this is a considerable amount. Assuming only the modest growth rates above, his LIRA/RRSP grow to a combined $568K by the start of retirement and his minimum RRIF and LIF payments exceed the required $1041/mo by a wide margin. I have the plan saving all this excess cash flow in a non-registered account, also invested as per above. This mini-retirement plan is further stress-tested by way of a Monte Carlo simulation, to a 99% success rate, and with 10 extra years of longevity, the plan only barely falls short.
Other pension considerations
One thing I advise clients to consider is their holistic retirement income situation: what do the client’s and their spouse’s combined retirement incomes look like? Is it already mostly defined benefit pension income (ie: both spouses have a DB plan) or is it mostly investment assets?
Ideally, I like well-balanced retirement plans with income from a variety of sources: government benefits (CPP/OAS), DB pension, RRIF, TFSA, dividend stock portfolio, etc.
There’s a certain degree of added flexibility too in commuting your pension to an LRSP. Barry can convert his LRSP to a LIF at age 55 and unlock half of the money, transferring it to his RRSP or RRIF, where he has much more flexibility as to when to take the payments. This is especially useful for people retiring early or just planning to spend more in early retirement. Again, it’s especially useful if all other retirement income is defined benefit, paying only fixed amounts from retirement date onward.
Another thing to consider is that private DB pension plans aren’t completely risk-free. Money that the company contributes into the pension plan for you is still invested in the markets on your behalf and while the pension fund absorbs the market volatility for you, it can become underfunded. Beyond market volatility, today’s super low interest rates and the likelihood of increasing rates hampering bond performance over the next 30 or so years can also make it challenging for DB plans to fulfill their commitments.
An additional stress-test incorporated in the above mini-retirement plan is the assumption that the commuted pension is just invested in cash, getting a cash-like 2.34% (long-term) return. Let’s assume Barry isn’t able to take any risk, or assuming the DB plan truly is no-risk, to compare with a no-risk commute option. Then, the commuted pension plan falls short, coming in at being able to cover 94% of the defined benefit to age 95.
Lastly, anyone making the decision of whether or not to commute a pension should also look into what other benefits may be included when remaining a member of the pension plan, if any.
Why you need independent financial advice
Unfortunately, while many Canadians have come to rely on salespeople at their local bank or credit union as trusted advisors, most aren’t trained to be much more than order takers. A customer walks in to do a pension rollover, it just gets done and a sale (mutual funds or GIC purchase) gets made, and no one would or should expect the friendly local bank branch staff to provide any counselling whatsoever as to whether commuting a pension (transferring a lump sum to a LIRA) or keeping the pension is in their best interest. I used to be in that very position as a “Financial Advisor” at a big 5 bank.
Only once I obtained my CFP designation and became an actual financial planner did I learn how significant of a decision this was for the client and the duty of care that needs to go into it. Now, if a pension commute value is in the range of a few tens of thousands for a younger person who worked in a job for only a few years, a full analysis isn’t that crucial. It’s just a matter of getting what you earned in retirement cash out of your old work and moving on to your new job and avoiding having 10 different pension plans when you’re retired. So, if you’re reading this and you’re 25, wondering what to do with a $20,000 pension and whether to pay someone for independent advice, I’ll tell you: don’t sweat the details, just commute that thing.
It goes without saying that for any advisors who derive some or all their income from asset-based management fees, there is some degree of conflict of interest in doing a pension options analysis. My own way of managing this conflict has always been to put all my cards on the table; straight up telling my client before the process begins that it’s in my best interest to have them transfer the whole pension to me to manage, but I will still provide them the information they need to make the best decision for themselves.
Brand new clients seeking a pension options analysis I will usually engage on a fee for service basis only, and I’d advise anyone reading this with a fairly significant pension, looking for truly “independent financial advice” to pony up the money, pay out of pocket for fee only advice, for what can be a crucial decision affecting 30+ years of retirement and your eventual estate.
Many thanks to my friend Markus who provided this analysis. In the end, I set up a LRSP with TD Direct Investing. I invested all of the money into the ETF VGRO which has an 80% equities to 20% fixed income allocation, appropriate for my pre-retirement years. I likely won’t need to look at this account for quite some time.
The preceding case scenario is for general information only and does not constitute legal or tax advice, as pension plans across Canada may be substantially different from each other and everyone’s own retirement income needs and risk tolerance differs. Markus Muhs, CFP®, CIM® (www.muhs.ca) is an Investment Advisor and Portfolio Manager at Canaccord Genuity Wealth Management, located in Edmonton, Alberta. He provides comprehensive financial planning and wealth management to families with assets over $300,000 across Alberta, British Columbia, and Ontario. Markus alternatively provides fee-for-service (fee-only) financial planning to non asset-based clients.