Commuting her pension could allow this Ottawa civil servant to have her cake and eat it too. But is it worth the risk?


This dish is expensive: Annuities sold by for-profit insurance companies aren’t cheap, expert says

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In Ottawa, a woman who will be called Lucille, 48, works for the federal government. She has three children, all teenagers with adequate RESPs, a home worth $800,000, three rentals with an estimated total value of $1,825,000, and debt of $570,000 for the rentals.

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Lucille wants to retire next year, at age 49, and she plans to take the present value of her pension. This is the amount of money needed to generate an expected pension income, which would be $48,000 per year at age 55, the first year she can start receiving income. With interest rates still low, it takes a lot of money to generate the promised retirement income. So now is a good time to think about whether to cash out and take the cash value. Lucille earns $116,000 a year and has a net rental income of $49,217. After her average tax rate of 36.39%, reflecting a tax of $60,043, she has an income of $105,174 per year or $8,765 per month.

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The commuted value of Lucille’s federal pension is $852,000 for two decades of work. She would invest it for what she thinks is a higher return than the high-single-digit yield federal pensions usually generate. The rules of the process are that she would have to accept $342,000 locked up in a retirement account, a LIRA, and walk away with about $510,000 in taxable cash. Tax would take about half that amount, leaving him about $255,000 for his own investments.

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Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, BC to work with Lucille.

Compare pensions

Lucille has made a low double digit return on her savings and is an impressive investor. However, beating a fully indexed federal pension isn’t just about performance. A defined benefit pension has no age. The beneficiary cannot survive him. It is bulletproof in the sense that it is diversified far beyond what an individual can achieve and guaranteed not to lose value at any level of inflation. The disadvantage is that the capital of a DB pension does not belong to the beneficiary. It is up to the Government of Canada in this case.

The difference between leaving the PD pension and taking the money is whether she needs the potentially higher return she could earn on the cash value, with the understanding that the return could also be lower. The essence of the difference between a government DB pension and a private investment is certainty. No stock market flop can depreciate the Government of Canada’s public service pension plan.

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Plus, payouts are indexed, so if inflation spikes, retirees are protected. However, if Lucille takes the cash value, the money is hers to serve as collateral for loans or to transfer by will to her family or charities. Additionally, her own money from the conversion could be used to buy a life insurance annuity that could run until her death even if she lives to be 100 or more. It’s a way to have your cake – control of at least some of your assets – and eat it. But this dish is expensive: the annuities sold by for-profit insurance companies are not cheap.

Matching Returns

Taking the present value turns out to be a life or death decision, in part. If she lives to age 90, she would need to earn an average annual return of 8% after inflation but before tax to beat the DB pension, Moran estimates. Forgoing his federal DB pension could reduce other benefits such as dental and medical care available in Public Service of Canada pensions.

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Lucille has a current net worth of $2.64 million outside of her pension. After deducting the repayment of the mortgage capital from the rents, its cost of ownership is less than 1%. Its largest investment commitment involves three rentals, all effective investments. The $1,825,000 property value of the rentals less the $570,000 of mortgage debt leaves $1,255,000 of equity. After taxes, condo fees, interest only on mortgages, maintenance and accounting, it has a net rent of $49,217. The rent is taxed as ordinary income at a marginal rate of 50.23% in her tax bracket, but she might only pay 35.87% in her tax bracket on Canadian stocks after applying the credit. dividend tax. This makes inventory more tax-efficient and far fewer issues with upkeep, breakage or non-payment of rent by tenants, Moran notes.

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Estimated retirement income

Prior to age 55 and the start of her DB pension, Lucille’s RRSP would earn her $4,976 per year. His TFSA would add $6,220 per year, taxable investment income of $19,050 per year and net rents of $49,217 per year. That’s a total of $79,463. After an average tax of 20%, she would have an income of $5,297 per month. That’s minus the current expenses minus the savings. Part-time work would be required.

From age 55 to 65, she could add her $48,000 pension to increase her income to $127,463. After an average tax of 25%, his income would be $95,597 per year or $7,970 per month. This would cover current expenses without saving

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Starting at age 65, she could add $9,389 in estimated Canada Pension Plan income and $7,707 in OAS income for a total income of $144,560. She would pay an average tax of 25%. The clawback that starts at $79,054 and income tax at 15% above that amount would take back all of his OAS. His final income at age 65 would be $108,420 per year or $9,035 per month, more than enough to cover his expenses.

The effect of an election to take the commuted value of one’s pension is to add uncertainty. The upper limit of his savings, including the present value, could be a return of 10% per year before taxes. Or more. The lower limit could be the total loss of his discounted pension.

Lucille can choose certainty and no control over much of her retirement savings or commuting, pay heavy taxes and try to beat the returns of the indexed federal defined benefit pension. She could, but there are bumps in the best-laid plans. In a market meltdown, she might need strong nerves. If she keeps the DB pension, she might yawn and go back to what she loves to do.

4 Retirement stars **** out of 5

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