(Mark Blinch/Globe and Mail)Mark Blinch/The Globe and Mail
Lloyd has to make a big decision soon: A bird in the hand or a lifetime pension.
His wife, Lana, is planning to retire next year from a job that requires some heavy lifting. Lana is 57, Lloyd is 49. They have two children, one of whom still lives at home. Both Lloyd and Lana have government jobs with defined benefit pension plans. She makes $62,000 a year, he makes $94,000. They also have rental income. The offer Lloyd's employer is making is enticing: the commuted value of his pension – $1.1-million in cash. But to get it, he has to make the decision to retire when he turns 50.
"If I do not take it out, I will retire in five years' time with a pension of $4,340 a month, plus a bridge benefit of $1,130 a month for 10 years" (for a monthly total of $5,470), Lloyd writes in an e-mail. "If I do take it out, I will need to find another job for five years at least."
"This commuted value option, which I never thought about until recently, has made things very interesting," Lloyd writes. "Is it worth taking the commuted value, or should I stick to the game plan and the company and retire happily in five years?"
We asked Michael Cherney, an independent Toronto financial planner, to look at Lloyd and Lana's situation. Mr. Cherney holds the certified financial planner (CFP) designation.
What the expert says
Lloyd has been offered $389,052 that can be transferred to a life income fund (LIF), plus a taxable lump sum of $670,022. "Together, these payments exceed $1-million and therefore seem attractive," Mr. Cherney says. However, the lump sum will be reduced to $320,000 after income tax, leaving $709,052.
To compare the two, the planner calculated how much the lump sum would have to grow to provide the same monthly benefit as the pension without running out before Lloyd dies. At an investment return rate of 4.5 per cent, and with a 4 per cent withdrawal rate, this would yield income of about $30,000 a year. About half of this would be tax-preferred because it would come from a non-registered portfolio, Mr. Cherney says. Income from the non-registered portfolio is a combination of capital gains, dividends, return of capital and some interest income, only the last of which is fully taxable. With the registered portfolio, all income is taxable.
Lloyd would be much further ahead by waiting and taking his unreduced pension at the age of 55, Mr. Cherney says. In year one, Lloyd's age 55, his pension income, including the bridge benefit, would be $76,098 in 2022 dollars. His income from investing the commuted value of his pension would be $42,071 in 2022 dollars. He has until March to make his decision about his retirement.
"This percentage loss would increase over the years," the planner says. His calculations assume inflation of 2.5 per cent, return on investments of 4.5 per cent and an actuarial life expectancy for Lloyd of the age 84.
To do a fair, apples-to-apples comparison, the planner assumed Lloyd would retire in March, 2017, and immediately find a job that pays him a salary of $94,000 with full benefits. Even if he were able to do this and he made maximum pension or RRSP contributions for the extra five years to the age of 55, "the comparison isn't even close," Mr. Cherney says.
There are other issues to consider as well. Lloyd may well live longer than his actuarial life expectancy.
Of course, a lot depends on the assumptions. "If Lloyd is able to earn a significantly higher return than 4.5 per cent [a year], the commuted value could be better, but I would not recommend it," the planner says.
Assuming that Lloyd and Lana choose the pension route, they wish to know whether they can afford to retire at the relatively early age of 55 (for Lloyd). Lana is eight years older than Lloyd and plans to retire in 2018. "In 2022, when Lloyd retires, the couple will be able easily to meet their retirement spending goal of $6,000 a month or $72,000 a year after tax," the planner says.
In addition to Lloyd's pension, Lana will be entitled to a pension of $1,838 a month plus a bridge benefit to the age of 65 of $965. Both Lana and Lloyd qualify for very nearly the maximum Canada Pension Plan benefit, though it will be reduced by 36 per cent if they start collecting it at the age of 60.
The couple can split their pension income under the federal pension income splitting rules, Mr. Cherney notes. "This allows you to assign 50 per cent of pension income to your spouse starting at age 55, and 50 per cent for RRIF [registered retirement income fund] or LIF income starting at age 65." As a result, Lloyd will preserve his Old Age Security benefits rather than having them clawed back because of his high income.
In his plan, Mr. Cherney assumes the couple does not sell their real estate holdings, providing "a nice nest egg for their children."
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Client situation
The people: Lana, 57, and Lloyd, 49.
The problem: Should he take the lump-sum cash value of his pension plan or the monthly income?
The plan: Work another five years and take the pension.
The payoff: Financial security for life without having to worry about investing the pension money and the ups and downs of financial markets.
Net income: Employment $9,550. Rental: $1,200. Total: $10,750
Assets: Cash in bank $15,000; his TFSA $50,000; her TFSA $90,000; his RRSP $103,000; her RRSP $71,000; commuted value of his defined benefit pension plan $1,072,000; estimated present value of her DB pension plan $529,500; RESP $35,000; residence $725,000; two rental properties $780,000. Total: $3.47-million
Monthly disbursements: Mortgage payments $500; property tax $400; water, sewer $150; property insurance $100; electricity $200; heating $70; maintenance $100; car insurance $175; fuel $450; vehicle maintenance $150; transit and parking $50; groceries $350; clothing $150; line of credit payment $275; credit card payment $1,000 (gifts, charity, vacation); dining, drinks, entertainment $750; grooming $50; pets $100; sports, hobbies $100; other personal $125; cellphones $250; cable, Internet $150; professional association $90; his pension plan contributions $860; her pension plan contribution $365; group benefits $730. Total: $7,690. Unallocated surplus: $3,060 (goes to TFSAs, debt repayment, savings)
Liabilities: Residence mortgage $117,000; rental mortgage $230,000; cottage mortgage $240,000; line of credit $87,000. Total: $674,000
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