After his spouse died, Mark was left with a financial decision that he felt involved more than dollars and cents. His spouse had been a teacher, so Mark now has to choose between receiving a lump-sum payout from his spouse's pension plan or a monthly payment for life.
"My financial planner made the lump sum of $682,000 look very appealing by assuming that I could invest it for 5 per cent annually for the next 10 years and then earn 4 per cent per year after that, something I find improbable in this economic climate," Mark writes in an e-mail. Extremely risk averse, Mark feels a responsibility to manage his money carefully.
He has other questions as well. Now 51, Mark is beginning to think about retiring at age 60 from his job as a design consultant in Toronto. When he does, he'd like to maintain his current lifestyle and expand his budget to include more travel. His income now consists of his $96,660 in salary, $1,627 from investments and a $5,436 Canada Pension Plan survivor's benefit.
Mark has a company pension that will pay him about $35,000 a year at age 60, but it's not indexed for inflation. At 65, he will be entitled to CPP benefits of $872 a month, or $10,464 a year. Rather than taking a lump-sum payout from his spouse's plan, Mark is leaning toward the option of a monthly pension that would amount to $44,210 a year beginning at age 60, indexed to inflation.
"I'm concerned that it would be a lot of work and worry to manage the lump-sum investment over time, especially if I became incapacitated and someone else screwed it up," he writes.
We asked John Home, a consultant at Weigh House Investor Services in Toronto, to look at Mark's situation. Weigh House is a fee-only financial planning firm that does not sell investment products.
What the expert says
First the math: On a cash flow basis, keeping the payments equal and with a moderate risk portfolio targeting a 4.75-per-cent rate of return payable to age 90, the $682,000 lump-sum option is the best choice, Mr. Home says. The present value of the monthly pension payment would be about $605,190, for a difference of about $76,800. With a 4.25-per-cent return, the two alternatives would be equal.
But other factors play an important role, the planner adds. The sequence of good and bad investment years can affect the results, as can a significant market drop. The results could fall short if Mark does not follow a well-defined investment strategy to help him weather financial market volatility.
While dying sooner than expected favours the lump-sum option – pension payments would end with his death whereas the lump-sum would form part of his estate – the lump-sum exposes Mark to the risk of outliving his money if his investments prove disappointing.
After talking to Mark, Mr. Home recommends he take the monthly pension because it is more in keeping with his conservative approach to investing. Mark has been disappointed with his investment performance. His portfolio of more than 19 mutual funds leaves him over-diversified, the planner says. "He ... would be better served with lower costs by having as few as four broad-based exchange-traded funds." First, though, Mark should sit down and draw up an investment policy statement to serve as a guideline in structuring, rebalancing and monitoring his portfolio, Mr. Home says.
A policy statement would have flagged the fact that Mark has about 30 per cent of his portfolio in cash earning 1 per cent or less while he is carrying a $23,000 balance on his line of credit costing 4 per cent, "which equates to a 6.5-per-cent before-tax cost at his marginal tax rate," the planner notes. Paying off the line of credit would give him an immediate return with no risk.
While he may be too cautious with part of his portfolio, Mark is taking more risk than he needs to with the rest because he has 59 per cent in equity-type mutual funds. A better balance would be 35 per cent equity, Mr. Home says. As he rebalances his portfolio, Mark can improve its tax efficiency by holding his fixed-income securities in his registered account, allowing him to shelter interest income.
If he chooses the monthly pension, Mark's income will break down as follows. In his first year of retirement, Mark will get $32,748 a year from his company pension, $44,210 from his spouse's pension, $5,945 in CPP survivor benefits, $14,624 from his RRSP/RRIF and $10,805 of investment income, for a total of $108,332 – enough to do all the travelling he wants.
At age 65, his CPP survivor pension will be rolled in with his own benefit and he will begin collecting Old Age Security. His income will comprise $35,279 from his company pension, $47,627 from his spouse's pension, $6,746 from OAS, $12,333 from CPP, $18,843 from his RRSP/RRIF and $11,950 of investment income, for a total of $132,778.
Client situation
The person: Mark, 51
The problem: Choosing between a lump-sum spousal pension payout or a monthly benefit for life.
The plan: Take the monthly pension because it better suits his disposition and gives him more than enough to meet his retirement goal. Draw up a proper investment policy statement. Pay off line of credit.
The payoff: Peace of mind and financial security both now and in retirement.
*************
Monthly net income: $6,970
Assets: Present value of defined-benefit pension plans, about $810,000; RRSP $278,000; TFSA $21,000; non-registered portfolio $22,500; bank accounts $94,000; condo $350,000. Total: $1,575,500
Monthly disbursements: Condo fees $500; hydro $75; property tax $170; telecom, cable, Internet $170; subscriptions $60; arts, entertainment, drinks $220; groceries, takeout $325; dining out $600; travel $800; medical, life insurance $320; charity $300; personal grooming, clothes, miscellaneous pocket money, coffee, transportation $560; hobbies $335; company pension $280; RRSP $125; other saving and investment $370; TFSA $415. Total: $5,625. Cash flow surplus: $1,345
Liabilities: Line of credit $23,000
Special to The Globe and Mail
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