Pension Dilemma (or Opportunities Abound!)

For someone facing the choice of receiving a fixed monthly pension income from a company or in the form of an annuity from an insurance company, versus receiving a commuted value and having to invest the amount oneself does present a dilemma.

Let’s look at the details using some very realistic numbers assuming one is indifferent between monthly pension income or annuity.

	Monthly Pension or Annuity (Option 1)	Commuted Value (Lump Sum) (Option 2)
Amount per month	$600 fixed, guaranteed for 5 years	$130,000. Invest conservatively in fixed income to yield 4% or $433 per month
Principal remaining at end of life	$0	$130,000
Monthly amount	About $167 more than option 2	-
Risk	Guaranteed by insurance company for 5 years, or in the case of private company pension, guaranteed by PBGC	Default risk if company goes bankrupt. Can opt to invest in Government of Canada bond, but yield 1% less . Also face reinvestment risk if rates are lower. However, rates are at historic lows and can only go up.
Ancillary benefits	Some companies may tie in health benefits with monthly pension	May forgo health benefits if opt for CV
Dependents/(or surviving spouse)	Monthly benefits may be reduced (assuming company pension and opting for Joint and Survivorship). If opting for annuity, once guaranteed period ends, $0 for dependents or surviving spouse)	Dependents or surviving spouse can inherit the principal balance if included in will
Taxes	Taxable income; annuity may have some tax advantage	Taxable income or capital gains at a lower rate
Life expectancy	Based on mortality tables, would be advantageous to receive monthly amounts if expected to live a long life (above 80 years of age)	Not applicable

So what is the conclusion? It all depends on the person’s situation. If I were a betting person, have a spouse or dependent, and can tolerate some risk, and assuming that we are in a historically low interest rate environment, I would choose Option 2.  I would choose to accept a lower income now, wait for rates to go higher (or at least above the $600 per month in Option 1), and then invest the whole amount and obtain more than $600 per month in later years. When I pass on (hopefully many years later), my surviving spouse or children can still inherit the principal amount of $130,000.

If one is in need of income and also cannot tolerate any risk, then choose option 1.  Mind you, in addition to this pension ,there are also other government benefits such as CPP (current maximum per month -= $1,114.17 at January 1, 2017) and also OAS (current maximum per month -= $578.53 at January 1, 2017)

There are other options that I can think of, but for now, I do think that this opportunity warrants further discussion with your financial advisor before making a decision. Because rates are at historically low, and we are starting to see the U.S. Federal Reserve Bank beginning to hike interest rates, CV or lump sum payouts may never be this high again and one can reinvest the CV or lump sum to one’s advantage.

Stars Alignment

I can’t seem to recall when was the last time all the stars were aligned in the world of investments.  We currently have a roaring stock market reaching new highs almost every day (at least in the United States), higher interest rates , which is good for retirees or people contemplating retirement, and a irrationally exuberant real estate market (mostly in the Toronto area and part of United States).

When will this come to an end? Or is this the start of a wonderful era? I seem to recall back in November last year, the world was coming to an end once the results of the United States Presidential election were announced. If only I had a crystal ball then. Hindsight is always 20/20.

With that in mind, I would like to take a moment and put on a reality check hat and use my financial training to properly chart a long lasting and sustainable retirement plan for my clients as well as for myself.

See my assumptions below and if the situation applies to you , and if you need further assistance, please contact me at Razorback2628@gmail.com for further assistance . For full disclosure purposes, I am Certified Financial Planner professional (CFP) based in Toronto, Canada.

Assumptions (very conservative):

Age and Family: Somewhat Irrelevant, willingness to relocate is a plus!

Total Net Worth of $1 million and upwards consisting of home in Toronto or GTA (depending on your equity, approximately $750K and upwards), other financial holdings such as RRSP, TFSA ($250K and up).

Plan:

List your home, expect multiple bids, and sell for at least 30% above your wildest expectations. Pocket $800K net after commissions and other expenses .

Relocate to another city, preferably  Ottawa and the long lasting winter comes to my mind.  It has been ranked the number 1 city to live n in Canada for the past couple of years.  Purchase the same type of home for $300K. Net  savings $500 to invest.

Start looking for a job, preferably with the federal government or at a municipal level. Ideally, start the process before you move.  You could potentially be earnings less (or more), or if you are retiring , does it really matter?

Oh, and make sure your better half and your kids are on board as well. I recall my daughter asking for a pony when we had to relocate for a job once.

Final analysis

The additional $500K can be invested in a combination of low cost ETF and laddered GIC and earn 5% a year almost guaranteed.   You will be surprised  at how few so-called experts financial managers fail to even attain this return. In addition, the same amount pocketed will l take one approximately a lifetime to save assuming one saves 10%-15% of his or her paycheck each month, continue working at your dreadful  job,  and pray to God that the market returns (before fees!) are in line with the mutual funds with huge fees that the  financial advisors at the bank sold you.   If you are onboard with my analysis so far, you can essentially retire early (or at least continue to have one person working while the other one stays home (notice that I did not refer to either “He” or “her” in this equal opportunity world.

Contact me at Razorback2628@gmail.com if you are interested!