So, you are going to retire. Congratulations! You’ve worked long and hard for years.
Lucky you, you are a member of a defined benefit pension plan (DB). This means that you know on retirement how much your monthly income is going to be, to the cent. You will collect that income til death do you part. After which, your plan will likely continue to pay your spouse / partner until that “2nd death”, this latter at a lower amount, usually.
“Ok Bruce”, you say. What is “usually”?
I use that word because each person and each pension plan is different. For example, some pensions only offer 66% “survivor benefit“. Other pensions allow the retiring employee to choose an amount between 50% – 100%. Some plans allow you to entirely waive this. So, each person and each plan is different. Go to our site and book a free 15 minute chat to address your personal situation.
Now, one of your choices, “usually”, is to ‘take the cash’. i.e. take the commuted value money from your plan INSTEAD OF taking the pension over your life time. The commuted value (CV) is the lump sum of capital needed to pay you & your partner for life. The CV is a big number. Commonly, the CV will be $500k – $800k. I’ve also seen amounts north of $1 million.
Age: there is “usually” a maximum age for the CV choice: teachers, 55; cops & fire, 50; auto workers, no age limit. Check your pension doc to see what is your maximum age limit to take the CV. BTW, if your plan max is 55 and you are already > 55, you’re cooked. Your pension plan administrator will NOT make an exception for you. Go cry! Be sure you know this age while you’re still ‘young’.
Why would anyone forego cash for life? That sounds like a lottery winning. Your plan will pay you / your partner forever? ‘What if I live to age 105?’ No problem, pensions pay until 2nd death, whatever that age may be.
Well, why would anyone take the CV? There are a few reasons:
- Bad health. If you have heart problems in the family, and you may only live into your 70s, the math is horrible. Just calculate how much you would receive to age 75, then compare that to the CV. That math is not good.
- Debt. Here’s a scenario: take the CV. Pay off your debt. Keep working. This is your new lease on life: life without debt payments. Two keys here: first, keep working at a new job; secondly, stop digging. By that I mean: if you have dug yourself a hole of debt: stop digging.
- Freedom & flexibility: you can draw on the CV or not. Think of the CV as inheritance from your granny. One day, you’re a working stiff, the next day you have $700k in your investment accounts. Again, I encourage clients to keep working. Here’s the thing: after you quit that job that you hate or don’t like, set the CV aside and find a job that you like which pays your cash flow. That may be part time. That may be mindless OR maybe you can work at a job you like with hours that you decide. You have what is called “shove it” money. That refers to this: you’re working, your boss tells you to work the weekend. You say “shove it” and walk out. You have that freedom.
- Money grows over time. Take the CV. Invest the $700k or whatever. Let it grow. At 7% your money doubles in 10 years: Rule of 72. So, 10 years after retirement, you have a mountain of dough. Or, you bought a yacht, so you have a smaller mountain.
- Legacy. Remember, if you take the company pension, after the 2nd death, payments stop. When you take the CV, anything left over goes to the kids, or your nieces & nephews, or your charities. We just settled and estate. The locked-in LIRA goes to the surviving spouse non locked-in. That money went to the RRIF.
On the contrary, for which reasons wouldn’t you take the CV?:
- You are too nervous about investments. My dad was a stock broker. He recounted any expression: “Sell to the sleeping point.” By that is meant, sell you volatile holdings til the portfolio is calm, so you can sleep peacefully at night. I have people tell me this often. And, with GICs paying precious little, your CV has to be invested in equities (stocks) to make this choice work for you. Otherwise, if you ‘stuff it in your pillow’, you won’t get the income sufficient to replace the pension. So, take the pension.
- There is a huge tax bite on CV. True, “usually”. There exists a nasty piece of tax legislation call the “Maximum Transfer Value”, MTV. This states that there is a limit on how much money you can transfer from a DB pension via the CV. I’ve written a 1 pager which you can request. This nasty piece of ………, will cost you money. For example, your CV is $700k, only $300k is within the MTV limit, so you must take the residual, $400k as cash. That’s right, your income in this calender year is up by $400k. Imagine the tax bite. Or better, go to a tax calculator to see the tax you’ll pay. Yes, you’re right. Stuff as much as possible into your RRSP first. Your spouse / partner RRSP room? Nope, doesn’t help. Your TFSA? Nope, use that after you have paid the tax.
- “I’d rather have the steady income.” Fair enough, in other words, you don’t want the vagarities of investing. But let’s look at steady income. Consider this, you put your CV into the investments portfolio (in fact: LIRA / LIR, RRSP / RRIF, Tfsa, etc. We, the investment company, deposit money to your bank account every month, just like a pay cheque. That’s how we deliver steady income.
- Storytime: we have a client who retired recently, after 20 years, who took the CV. There was a BIG tax bite. He / she is working and earning enough to ‘pay the bills’. No longer does money go to savings, income taxes are lower, nor to union dues nor to gas & car expenses nor work clothes & lunches. In other words, your expenses drop when you retire. So, take a part time job that you enjoy. On your way to work, stop at Tim’s where their pension isn’t the golden egg that you got. Ask your plumber, your trades person or the taxi driver. Their pension is junk. You are blessed to have a pension.
So, everyone is different. Every pension is different. If you want to talk commuted value, connect with us! Click here to book a 15 minute free chat on Zoom.
Bruce Youngblud, CFP
Pension Solutions Canada