038: Demystifying Pensions | Ed Rempel

Money Mechanic
Hello, listeners. Welcome to Explore FI Canada, where we sit at the roundtable with Canadians, and share their thoughts, ideas and personal journeys to financial independence.

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Welcome back listeners Explore FI Canada, Money Mechanic with you again today and Chrissy’s with me as usual. Chrissy…

Chrissy
Hi, Money Mechanic, how are you doing?

Money Mechanic
Fantastic, fantastic. Exciting show today. We have a guest with us. And we’ve had I get listener questions as well. I know you have as well. The topic of pensions comes up and DC, DB, we’re gonna throw some terms around and get into that and our guest today is Ed Rempel. Thanks a lot for coming on the show. Again. This is your second appearance as as our our resident expert. So welcome the show again, Ed.

Ed
Glad to be here. Thanks for inviting me.

Money Mechanic
Now Chrissy, we received an email from a listener.

Chrissy
That’s right, a listener named Kate. She emailed us with a list of fantastic questions that she wanted to get a pension expert on to answer and she thought it’d be a great show topic, not just to answer her questions, but to help our audience in general because pensions tend to be a bit mysterious for many of us and Money Mechanic and I are actually not all that knowledgeable about pensions. I know nothing he knows a little bit. So we thought that you’d be a great expert to bring on because you work with a lot of retired people. And I’m sure you’ve dealt with a few pensions in your time working with clients.

Ed
Oh, yes, written 1,000 financial plans and a lot of people have pensions. In fact, quite a few years ago, we actually did a series of seminars on pensions where we had a group of our clients all were getting pay equity settlements. So know lots about them.

Chrissy
Fantastic.

Money Mechanic
So just in case our listeners didn’t hear you the first time you’re a fee-only financial planner. So just a very quick overview of who you are for our listeners.

Ed
Yeah. Okay, so I’m a fee-for-service financial planner, I’ve been a financial planner for about 25 years. And I’ve written about 1,000 financial plans. And the very unique thing about me I think, is while most financial planners claim to write detailed plans, I actually write them and actually very in depth, you end up with eight or 10 pages custom written for you it’s so I try to provide a very high quality service. And so I basically did two things. One is write a future plan, you know, for a fee, so you know, it’s good to actually pay it, pay for it because then you know, you’re getting a quality plan. And then after that, you can either do it yourself, or we take on a certain number of clients full service, where we help you implement the whole thing and we help you look after all parts of of your financial Including looking after all your investments doing your tax returns the whole bit. So details are all on my blog.

Money Mechanic
Right, you also have a blog, and that’s called Unconventional Wisdom.

Ed
Unconventional Wisdom.ca, not .com. Or go to Ed Rempel.com. And it’s there too.

Money Mechanic
Right. Awesome. Okay, well, let’s dig into this pension question. Chrissy, did you wanna start us off?

Chrissy
Sure. So our listener Kate, she wrote us an a lengthy email, but I’ll just read out the starting paragraph so that we can dive into this. So she says, could you find a Canadian pension expert to come on and talk about the things those of us who are paying into pensions should be thinking about when analyzing our options for quitting and our FI number? And so she goes into quite a few questions, which are great, but I think we should start off first by defining a couple of terms that you’ll hear thrown around when talking about pensions, and that’s DC which is defined contribution and DB, which is defined benefit pension. So can you explain what each of those are and the differences between them?

Ed
Right. Okay, so yeah, I guess it, it tells you what they are so defined contribution pension, basically, it looks like an RRSP. So it’s your contribution that’s defined. So usually, you put in 3% or 5% of your pay, and your employer matches it. And you get a short list of investment choices that you can put the money into, and it grows and basically, your pension, what you’re going to get later on is all based on what the investments grow to. So they’re very happy, you can do a projection, it’s just like an RRSP. Basically, a defined, defined benefit plan is the benefit that’s defined. So you’re putting in like, for example, a lot of government employees, they’re paying 10% of their pay goes in, their employer puts money in but you have no idea how much they’re putting in and you’d have no idea how big the account is. But there’s a formula that tells you what pension you get, and that’s so it’s the it’s the pension that’s defined Usually it’s something like 2% times the average of your best five years or something like that. So does that there’s that formula you have to it’s good idea to always know what that formula is. Because then with that you can you can estimate what your pension is going to be.

Chrissy
Okay, and what majority or which one would you say is the majority of types of pension? Is it DC or DB?

Ed
DC are more common now, DB used to be more common. Today, there’s actually outside of government employees, there’s not not a lot of companies that have DB anymore.

Chrissy
Okay.

Ed
I think they’re very expensive for non-governments.

Money Mechanic
In the event that somebody were to choose to leave a job to a non-pension job or to retire early, quit working all together, what are the options with either the DC or the DB pension? Can you get lump sums from either them? How does that look?

Ed
Yeah, either one. You could get you can get options, thank different especially the DB pension sometimes have only limit certain options that they allow. And it’s they usually give you a pension book or you can actually just phone the pension company and ask them what your options are. Or what you can do is, you could often ask for a quote, like if you’re thinking of retiring in a couple years, you could call them ahead of time and say, give me a pension estimate based on two years based on this date. And they’ll be able to tell you what, what your options are. But normally, there’s three possible options. One is to you know, to take a pension or a deferred pension. So either when you started when you leave the company or or at 65, another one is to transfer the value of that usually called a commute is the word commute the value which is transferred to an RRSP. And the third one is to transfer it if you’re switching jobs to a new company, and they have a pension and they Allow it to be transferred in. Occasionally you can transfer it to another company’s pension. So those are basically the three options.

Chrissy
So if you were to transfer it to another company with a pension or their fees, is it similar to transferring an RRSP? From one brokerage to another where you transfer in kind? Or does it depend on whether they can hold the funds in the receiving pension?

Ed
Yeah, depends on whether they can hold them. Actually, a lot of times it seems like that doesn’t really work. But it’s actually you don’t actually know what’s happening because there’s actuaries that work. At the pension, you’re leaving as an actuary that figures out what it’s worth. And then at the other pension, the new company does an actuary that figures out how heroes you get and nobody explains it in a very opaque whether or not they’re charging fees. I’m sure they are but nobody tells you what they are. Usually I we don’t usually consider that option. Okay. Yeah, look at the other two options.

Chrissy
Yeah, sounds a lot simpler. So you outlined three different options. But is there potentially a fourth? Kate asked, Can you also choose to keep the money with the pension plan provider and then receive your distributions at either 55? early? Or at 65?

Ed
Yeah, that is the first option. So first, I need to either take a pension when you quit or a deferred pension, like starting at 65 or something. That’s the first option take just take the pension. Starting at some point, the other option is transfer it out to your RRSP.

Chrissy
I see. Okay, so you could choose to keep it with your current provider. And that might make sense for some people.

Ed
Right?

Money Mechanic
Yes. Just a quick question with that, if you were to choose to keep it say say the hypothetical person here is 45. So they’ve got 10 years before early. They want to take the pension early in that 10 years. Is there sort of a typical management expense ratio or fee that we’re looking at for defined contribution? plans? Is there sort of a industry standard there? Or is it vary wildly?

Ed
Why? You know, it’s it’s actually a lot It looks, it’s actually very much like a group RRSP. So you you get a shortlist, usually of mutual funds or, you know, insurance funds, segregated funds that you can buy, and then they’ll have an underlying MER. Sometimes the employer subsidizes it, sometimes they don’t. A lot of times they don’t even tell you what what it is like insurance companies seem like they don’t have to tell you the MER. They know you the management fee, but that’s only one piece of the MER. So our management fee is only 1%. Yeah, but it’s not the MER. So, so But yeah, so there isn’t usually an a fee other than whatever is built into the specific funds you choose.

Money Mechanic
So I guess that’s an important question for people to ask when they’re if they’re just starting off getting into a DC pension or things like that is knowing that information and knowing what funds are in there that are available?

Ed
Yes, yes, actually, it seems like at least the management fee or something. thing like that needs to be disclosed, because I’ve seen some plans where they give you a list of you know, 12 possible funds. And the only thing they tell you is the management fee. That’s it. They don’t even tell you rank will return if you think that you think that would be important.

Money Mechanic
Interesting. So those are going to be, those are going to be important factors for whether you decide to leave that money in that existing defined contribution plan, or for sort of if it was a 10 year time frame type thing, so it’s important to consider.

Ed
Yeah, if at that time, then yes. Obviously, you learn what investment choices you have,

Money Mechanic
For sure, for sure. So another question Kate asks is, if you choose to take the lump sum payout, is that amount typically the amount you contributed, plus the amount the employer contributed over the lifetime you are at the job? Or do you only get your contributions?

Ed
Okay, I think she’s asking me mostly about the defined benefit pensions, because the defined contribution basically you put money in it’s there’s an account that grows and it’s whatever value the account is. For the defined benefit, it’s not that’s none of the options that she said. What what you actually get is there are actuaries that value how much is in your pension. So you have a pension that says at 65, you’re entitled to this formula. That’s how much pension it is. So when you leave a company, actuaries figure out how much money would they need to be able to pay out that future pension amount, and that’s how much you get. So

Chrissy
It’s not something you can figure out on your own, really.

Ed
You can’t figure it out on your own, yes. So…

Money Mechanic
Sounds like a lot though. I didn’t realize it was that much. What’s that 10% of your pay it seems like a lot.

Ed
For most government employees, that’s how much is being deducted from their paycheck. So they get a generous pension, but they’re paying a lot into it as well. For sure. Yeah. So now those commuted, those commuted values, the pension values and in today’s world market are actually quite inflated there. Because interest rates are so low, you need a much bigger amount to pay out that future pension. So we’re actually we’re actually, it’s quite shocking how much bigger they are. They’re almost they’re probably close to double what they were a number of years ago.

Chrissy
Wow.

Money Mechanic
Now, that’s interesting, because I was going to ask you about that a little bit later as how that how our interest rates affect that commuted value, as you just stated, so when the interest rates are really low, like you said, because the need to be a lot higher in value to because they’re indexed for inflation? Is that correct? With a DB pension? Like you get it forever? Is it indexed? Or is that one amount you get at the beginning of that’s it forever?

Ed
Um, it depends on the pension, some are indexed or not indexed, some are partially indexed.

Money Mechanic
Okay. Getting more complicated.

Ed
It’s a huge factor. Like if you’re going to be retired for 30 years, whether or not your pension is indexed is is a really important detail. What I find with pensions is the ones that index will tell you they index, the ones that don’t, don’t seem to mention it in their pension book.

Money Mechanic
Yeah, of course not. It’s in a really, really small print.

Ed
You can find it, though.

Chrissy
So the next question from Kate, I think you pretty much answered it. She asked, are you compensated for interest in earnings from all that time you’re profiting? They were profiting from investing your money, which is you don’t really know because they do the math to figure it out. Right?

Ed
Right, but in general, you are because it’s you the longer you’re in the pension, the bigger than the amount is you you earn years that you’ve been in the pension for for while you’re in there, plus, usually your income goes up. So that’s you’re getting a decent return on on money that staying in the pension. So yeah, actually, so pensions actually, up until recently, all kind of had a built in rate of return built into them that defined benefit ones. And that was that return that they’ve been using is usually been 5%. I think it’s a bit lower today with interest rates are much lower. But so for example, I sometimes talk to teachers, they’ll say, Oh, yeah, you know, our teachers pension plan made 12% Look how much money I made. And you don’t actually get that. The pension form, it says what you get. It’s based on an internal 5% a year, that’s what you get. You know, in fact, the pension made a lot of money means you can be more confident that you’re going to get your 5% but you didn’t get that 12%

Chrissy
It won’t be passed on to you, directly. Okay, so her next question I think you already answered as well in a previous answer. She was asking if you move to a different job with the pension what what should you consider if you’re looking into transferring the pension to the new job? So it sounds like it can be complicated and often doesn’t work out?

Ed
Yeah, generally, I wouldn’t suggest moving into the new the job either take the deferred pension or transfer to your own RRSP and then, it’s a big decision. And it’s not a reversible decision. So it’s something you have to think about a lot. And me, it’s probably something really important to get advice on.

Chrissy
Okay.

Money Mechanic
Yeah, that’s one thing that an issue that we went through my wife had a defined contribution pension. And when she left that job, she actually ended up going to the federal government. And there’s the you have the option to do a service buyback. So you can take that defined contribution amount, and apply it as it would look like years of service in the defined benefit pension. So we did a lot of reading on that. But I found it very complicated. It was hard to sort of do a side by side comparison and see whether it was going to be worth it or not, because we didn’t know what the eventual value of the defined benefit pension was going to be. So definitely something we found very confusing. I was talking with Chrissy earlier about how difficult it was there was a lot of paperwork involved. It seemed like the defined contribution plan was reluctant to give up the money. So at the end of the day, we decided to put it into a LIRA. So that kind of spins us into the next question. If you can just fill us in what is a LIRA? And what are the rules?

Ed
Yeah, LIRA, you think it’s you know, Italian money, but actually it’s a type of RRSP. So a LIRA is actually it’s a locked-in retirement account. Basically, it’s an RRSP. Except it’s got some restrictions. The base, the main restriction is, you can’t do any withdrawals from it.

Money Mechanic
Until you’re 55.

Ed
Until you’re at least 55. Yes, and you can’t do it as a LIRA. It’s when you retire, you have to convert it to either a LIF or a locked-in RRIF. And then you can take money out, you know, money monthly or annually. But you can never take a lump sum out, okay, even after you retire. So you know, with an RRSP when you retire, you convert it to a RRIF. Once you convert it, there’s a minimum you have to take out but you can take out as much as you want with a LIF or RRIF, there’s a minimum and a maximum of how much you can take out each year.

Chrissy
Okay.

Ed
Other than that, it’s basically the same as an RRSP.

Chrissy
Just out of curiosity, what happens to the LIRA if you pass away? Does it go to your beneficiaries, but how does it work when it goes to them?

Ed
It goes to your beneficiary exactly the same as RRSP. So with the LIRA, you you, you list a beneficiary, most commonly you you list your spouse because that would be a tax-free transfer directly into their RRSP.

Chrissy
Okay, and it’s it remains as a LIRA. If it goes to your spouse.

Ed
Um, no, it actually goes in as a as an RRSP.

Money Mechanic
So if you open a LIRA to commuted DC pension, does that affect your RRSP contribution room? Does it use up room from what you had or?

Ed
No, it doesn’t. So that’s a direct it’s a direct transfer. So So I guess you know, a bit of advice there on whether or not to do it. If you have a defined contribution pension. It’s almost all always worth it to transfer to your own RRSP. And unless you are, you know, really not confident in your investing. But the reason is in your your defined contribution pension, the company usually gives you 10 or 15 different funds that you could pick. And that’s all of your choices. You transfer to your own RRSP you’ve got thousands of choices, and probably including the 10 that you have over there. So you could transfer it over have the same investments, but you still manage it, you know, or you could have all the thousands of other investments. So I will find with a defined contribution, it’s basically always better to just transfer it out yourself. You know, it’s all it is. It’s an RRSP either way, and but you just get way more investment options. With a defined benefit, It’s much more complicated.

Money Mechanic
Right. Yeah, we that’s what we ended up choosing to do was to remove the DC or get rid of the DC pension. We opened up a LIRA at Questrade. It was it was difficult getting the process done. It took a lot of time, there seemed to be a lot of paperwork that has to get shuffled around. But once it was all said and done, we’ve got the lump sum in the Questrade account. And we just did we do some index investing in there with ETFs. And it’s great, right? We’re managing it ourselves. We know what our costs are. And I think one thing we haven’t mentioned that maybe you can speak to a little bit is where the defined contribution pension, you’re taking on the risk if you if you stay in the pension, or you take the money out to a LIRA is you’re taking on the market risk, whereas with a defined benefit pension is you’re not taking on that risk.

Ed
Exactly defined benefit really there the pension company and the employer are taking on the market risk, you’re guaranteed that pension amount based on the formula regardless of what happens you know, unless the company goes bankrupt and then which case you don’t get it but…

Money Mechanic
Sears?

Ed
Nortel, we had a lot of Nortel people.

Money Mechanic
Oh, yeah.

Ed
Yes, that can happen but for the most part that’s what you get a guaranteed amount they’re taking the market risk right. With a DC or an RRSP, you’re taking the market risk. But you know, you also have the market opportunity.

Money Mechanic
Right.

Ed
Yeah. So I didn’t quite answer your situation there Money Mechanic, when you when your wife was looking at should she buy back the credits?

Money Mechanic
Yeah.

Ed
Well, here’s my insight into that. A big factor in whether or not you should transfer out a pension or transfer into a pension is how you invest. Okay, because the pensions generally have a guaranteed rate of 5% built into it, I believe it might be a bit lower now with interest rates so low but basically around 5%. So now if you’re a confident equity investor, you would expect over the long term that you’re going to make quite a bit more than that. And so therefore, you’re probably better off investing yourself and you’ll do better. If you’re a really conservative GIC person, you know, you’re going to make less money anyway. So then the guarantee is worth a lot, you know, for equities. are very erratic short term and even medium term, but they’re actually more consistent than people realize long term. For example, the worst 25 year period for the S&P 500, the last nine years has been 7.9% a year 8% a year. So long term, it makes a really good rate of return. And more than you’d get on your on the pension. But when you while you’re in a pension, you’re putting money in and your employer is matching it. So it’s worth the biggest advantage of being in a defined benefit pension is your employer is matching it, you’re getting a guaranteed in essence, a guaranteed 5% rate of return, but you’re starting with double the amount of money. So that all works out well. Now, when your wife had an option to buy back past credits, there the company is not matching it. So it’s only her money going in.

Money Mechanic
Right.

Ed
Right. So if you’re you know an equity type investor You know, where you get to have a good return, then you’re better off not putting it in because you do better. But, but you know, if any case where the employer is matching your contributions, you probably want to do it. Any case where they’re not matching you, you probably don’t want to do it.

Money Mechanic
Okay, that’s an interesting way to look at it. I didn’t think of it from that point of view before I’ve always heard people say that, you know, definitely participate in your company pension plan, if the employer is matching you it’s quote unquote, free money, but I hadn’t looked at it from that buyback perspective before so

Ed
The buy-back, they’re almost never matching you on that part of it. So it’s not usually worth doing.

Money Mechanic
Right. Okay. That’s interesting. Good to know. Chrissy, do you want to move on to we were we kind of got into LIRAs a little bit, but we wanted to learn a bit more about them there. Question seven, Chrissy?

Chrissy
Yes. So Kate asks, I understand if you get the lump sum payout, you can only put a portion of it into a LIRA. Is that true?

Ed
That’s true today. It wasn’t true, you know, 10, 15 years ago. So So here’s what happens is, so you’re transferring it. So you’re leaving a job, you want to transfer it to your own RRSP or to own LIRA, the company does a pension valuation, you get this commuted value they’re going to transfer over. But But under pension rules, there’s a maximum amount that can be in the pension. Okay. Today, with interest rates being so low, the commuted values are really inflated, you know, because you needed a large amount to pay off that future pension. So most of the time, there are a lot more than then what you need what you’re allowed to transfer to an RRSP. So you get a large amount that’s, that’s on top of it, that would be taxable. So if you have RRSP room, you can contribute to an RRSP. If not, you end up with a big huge tax bill on it. And some people think, well, I don’t want to pay this big tax bill. But So the interesting thing is, if you go back 10 or 15 years ago, when rates were higher all the time happened as computed values were lower and you didn’t get the extra cash amounts, you just got the amount that got transferred in. So all that extra amount is taxable, but you don’t just think of it as a bonus.

Chrissy
Yeah, you’re still ahead.

Ed
Yes, you’re still ahead. If your company offered you a big bonus, that’s taxable. Do you want it or not? So, yes, I want it. Right. So that’s kind of how I look at it. It’s actually some you might be surprised how big the values are, like a typical government employee pension, the commuted value, you know, when you’re around 60 years old, the pensions probably worth a million million and a half. It’s that it’s that kind of amount. And so often see them now it’s, it’s, you know, it’s 1.2 million, but we can only put $700,000 in the LIRA, there’s $500,000. That’s has to come out in cash. That’s taxable.

Chrissy
Wow. So can you can you clarify what is it that sets the limit of the LIRA?

Ed
This it’s the I guess, the pension act, there’s a maximum. Okay, based on the pension that you’ve earned, there’s a maximum amount that it can be that it can be held.

Chrissy
I see. Okay, so you get that maximum into the LIRA. And whatever’s left over is a cash lump sum that comes to you that is fully taxable at your marginal tax rate.

Ed
Yes. But all that I was looking at that it’s kind of a good thing. The larger it is, the more inflated the value is. The bigger benefit from it.

Chrissy
Yeah, exactly.

Money Mechanic
So you’ve got a limit to what can go into the LIRA. But if you also have RRSP room, you can put some into there. Now, the other thing that I was thinking about, which may be an important consideration is is your tax rate for that year? Do you have the option of sort of deferring and then saying, Well, I’m not going to quit? December 31. I’m not going to work for the next year and then I’m going to take my commuted value to get a zero earnings year tax rate. Can you do that?

Ed
Yeah, I mean, usually, they want you to do it as of the date that you leave the company, okay, you can think about it, install it. And yes, if you’re going to transfer to an RRSP and you’re and you’re retiring, a good option, a good time to do it would be right at the beginning of January. Yes, it’s not otherwise, you know, if you had your job the year before, and now it’s on top of that income, then right, you know, you just tax that much more. So, try to stall it to the first of January, if you can.

Money Mechanic
So strategic timing here plays a role in all this.

Ed
Now, it doesn’t work if you’re starting off you switching to a new company, because we’ve had, you know, a fair number where they’re going to a new company, they transfer out their defined benefit pension to their LIRA. There’s a big amount, but they’re switching to a new company at a higher pay. Well, then there’s no point in waiting because it’s even higher pay next year.

Money Mechanic
I have just a bit of a like an anecdotal question. Just out of curiosity. You’ve done thousands of financial plans? Do you find that people generally choose to commute a defined benefit pension? Or what sort of people to decide to keep it? I mean, just anecdotally, what do you find?

Ed
Yeah, so there’s, there’s a couple of very big advantages and disadvantages of either option. I think our clients are probably not typical of the public. But so the big reason why you would keep the pension is because it’s guaranteed. And that’s a factor for a lot of people. And especially if you’re not good at investing or nervous about investing, you’re getting a guaranteed 5% plus you’re paid for life, no matter how long you live. So that guarantee can be worth quite a bit to people. And if that is then maybe that’s the option you should you should take. Now for investors if you’re confident like as I mentioned, the you know, the stock market actually is really reliable long term. So if you’re a confident you know, investor you can, you can invest make a higher rate of return than that. Plus you can still be confident in your future and probably get more money if you if you’re if you’re a high equity investor. So a big factor is how you invest. You know, people that want to invest are good, good investing themselves and have a high equity exposure would would be worth doing. So okay, cuz you make more money that way. But there’s a couple other big factors. One is when you get a pension, you get the same amount every year regardless, right? You just that’s what it pays out. So if you have the money in your own LIRA, and then usually there’s a chunk that’s now else, you know, ends up being non-registered. You can take when you’re retired, you can take as much or as little as you want out of that every year. So you have a lot of variation. You know, when you’re taking a big trip, you can take more money out, you can take less out in under a year and so you can you control it all. Okay, so that’s another big factor you get. So on the one side, you get the guarantees if you keep it guaranteed income for life, on the other side You get probably potentially a higher rate of return if you’re good investing, plus you have control of how much you take every year. Plus, the other big factor is the inheritance factor. So with a pension, in most cases, if your spouse lives you they get 60% of the pension. Occasionally, there’s other option to get 80 or 100, but they usually get 60% of your pension. And once the two of you are gone, the company keeps all the rest. And so your kids get nothing.

Money Mechanic
Oh, yeah.

Ed
Your own RRSP your spouse outlives you they get the entire amount. And then once both of you are gone, your beneficiaries are your kids they get the entire amount whatever is left.

Chrissy
So wouldn’t it make sense for anyone who has a DB pension as soon as they retire to transfer into it LIRA?

Ed
Well, so again, so you got to be a good investor with it right? So you’re a GIC investor then don’t do it. If you’re an equity investor, you get it, and getting good advice or confident about your investing then usually You want to do it because you give it a higher rate of return And you get that control. Plus, it’s a question also, how important is it to you to leave money for your kids? You know, some people that are single have no beneficiaries, that doesn’t matter. But if you have kids that then that could be a big factor. And see the thing about commuting or not or leaving with a pension. It’s not a reversible decision. Right? There’s big factors in one way or the other, and you make a choice and whatever just you decide you’re stuck with for the rest of your life. So there’s one other piece that you should know is because you know, there’s all those tricks if you transfer to your LIRA, there’s a bunch of restrictions on it.

Money Mechanic
Oh, okay.

Ed
Right, because you can’t, you can’t take anything out of the LIRA until you convert it to an LRIF, and then there’s a minimum and maximum and all that. However, when you convert your LIRA to an LRIF, you’re allowed to unlock 50% of it. An unlocked means you can transfer half of it to your regular RRSP.

Chrissy
Oh, great.

Ed
So the kind we often see is, you know, you do a, you do a DB pension, it’s worth a million bucks, they could transfer $600,000 to a LIRA get $400,000 in cash, pay $150,000 in tax. Right now they get $600,000 goes to a LIRA. But when they retire, then $300,000 of it goes to a regular RRSP or regular RRIF. And the other part the other $300,000 goes to a LIRA or, or a LIF, a LIF or locked-in RRIF. So it’s the $300,000 it’s in a regular RRIF is much, much more flexible. You can take much larger amounts out if you want, there’s no maximum.

Chrissy
Okay, and with that $300,000 RRIF, do you have to have room in your RRSP in order to make that happen or is it separate from your regular RRSP?

Ed
Yeah, it’s already included. So they used up some of your room when you put it in, to be transferred out. It’s not using any more room.

Chrissy
Okay.

Ed
Right.

Chrissy
Okay.

Ed
Yes. So see When you have a pen when you have RRSP, you get RRSP room and you put money into it. When you have a pension, what happens is the actuaries figure out how much RRSP room you’ve you’ve used and they send you a pension adjustment, which is usually on your T4. And it just means you get a lot less room. Like most government employees only get about $3,000 a year of RRSP.

Chrissy
Wow.

Ed
Even if they’re very high income, because all the rest is is included in there. Included in their pension.

Money Mechanic
Where are we out here? Chrissy? 11?

Chrissy
Number 11. It’s a tricky one.

Money Mechanic
Yeah, I don’t know how we want to ask this one.

Chrissy
Yeah, so. So Kate is asking, I’ll just read it out and then you can you can go with it. So she asked, how would someone go about weighing the golden handcuffs of a job that they’re not crazy about but they don’t really know what else they want to do.

Money Mechanic
It’s like a psychology question.

Chrissy
I guess she’s asking You know, if this job is pretty cushy, it’s low risk, it comes with a DB pension. It seems like the ideal kind of job that a lot of people want. But it’s not not thrilling. It’s not fulfilling. So what should someone do in that situation?

Money Mechanic
I want to throw something in there before we hear Ed’s opinion, because I’ve just thinking about rereading this question a couple times. The fact that you’re paying in 10%, that would go into making my decision to that question, right? Because you think you’re just getting a DB pension and you’re getting your pay, but that 10% means something right. So what do you think?

Ed
Yeah, actually, actually, let me just speak to your 10% before I get to two, so the question you’re putting in so 10% in a DB pension and theoretically the employer is, is matching it? Okay. You’re going with double the value. What that’s not actually what happens in real life. Here’s what happens in real life. So you you putting in 10% and it theory that the employer matches it, so that you know, and then you make 5% on it. So it’s like you’re each adding 15% in a year. So let’s say you’re like in the teacher’s pension plan where the teacher’s pension investments make 12. Okay, what actually happens is five is what they needed. The extra seven comes off of what your employer puts in. Employer didn’t put 10 in, they just put three in, right. You still got your total 15 value from the employer. But a lot of times when the investments are doing really well, the employer’s putting hardly anything in and often the late 90s during the tech bubble a lot employers were paying nothing into it. Well, no, it’s not happens every year. In reality, they have a they have a three year weighing. So it’s, they have to put money in over a few years. But in the Senate, in essence, that’s kind of how it works, works out. A lot of times they’re actually, the employer’s are putting in a lot less.

Chrissy
I didn’t know this.

Money Mechanic
Well, let’s not kid ourselves pensions are a business to make money too. They’re not just for us, like a financial tool where they’re making money with your money.

Ed
Yeah, they have their they have their fee it’s built into the pension that they’re getting.

Money Mechanic
Yeah.

Ed
I don’t know if we even know what that fee is most of the time, but it’s…

Chrissy
Okay. So back to her question about the golden handcuffs of a job.

Ed
The real question was the golden handcuffs. So that’s not only a pension question, right? Like some people just have, yes, a government job. Essentially, you can’t get fired no matter how bad you are. You don’t even have to show up for work half the time. So the safe job right, if you switch to a private sector job, it’s you don’t have that quite security. So that’s worth, you know, something that’s worth something there. I always figured that, you know, security is being really competent at your work because if you’re really good at your job, Job, even if you change jobs, you can always find another job. Right? So But anyway, so that’s the work part of it. Let’s in this talk, we’re talking about the pension part of it. Yeah, you’re in this pension. And so you’re the biggest benefit of the pension is that your employer is, you know, in theory, matching the money that you’re putting, putting in. So if you switch to another company, that’s the part that you should look at, like if, if another company gives you if you switch to another company, and they give you 10%, higher salary, but they don’t have a plan. Well, that’s basically making up for the 10%. They’re not putting in your pension. So you can be just as well off, like I think so people tend to really overvalue the pension that that’s, that’s their retirement and it’s worth so much, but it is worth value. It’s valuable, but it’s not super value. It’s worth you know, the 10% that they’re putting that there.

Chrissy
You bring up a good point. I mean, pensions have almost become this mythical thing where people all think it’s the best thing ever and you should all try to get a pension if you can, because they’re all going the way of the dodo bird and if you don’t get one it’s it’s a huge loss but it in this conversation, it’s sounding like it’s a lot more nuanced than that they’re not the be all and end all.

Ed
Right, yeah, they have a value but let’s you should understand what the value is and how much it is because that then it’s easier to weigh it against another option. So, yeah, you know, most of our clients, I think our most of our clients are very equity focused investors, like the majority of them are 100% equities. And for our kind of like for that kind of client, commuting, the pension is almost always worthwhile. So we’ve had quite a lot that that commute the pension. The thing about it is so many people were commuting a lot of pensions that they made restrictions to it. So most government pensions now, you can’t take it out as a lump sum once you reach 55. Then when you reach 55, the you have to take the pension, you can’t commute any longer. So for the clients that are in their 40s they’re specifically planning, they’re going to retire at 54 and 11 months.

Money Mechanic
Yeah.

Ed
And because after that they can’t because they want to commute and take the lump sum and and get the higher rate of return. So but you know, if you have to, it takes it’s not easy to plan to retire at 55 versus 65. You know, you need to when you’ve you’ve written some financial plans, you know, it’s, you got to save quite a bit to be able to retire comfortably.

Chrissy
Wow. So you’re saying if you pass 55 when even when you retire, you’re stuck with with these plans that say you can’t commute after 55 for the rest of your life with the pension?

Ed
Yes. So basically pretty well, all the government pensions have that rule in there. And actually here, Ontario, the teachers pension, you’re stuck at age 50. So to commute…

Money Mechanic
Oh, really?

Ed
You gotta be below, you know, under 50. So you know, about 15, 20 years ago, there were a bunch of companies that did nothing but commute teachers pensions, it’s all they did their seminars, they commuted them like mad, finally got sick of it. So many teachers were quitting early just to commute their pension. They made the rule that you have to be under 50 to commute it. So and there’s no opt out option. You can’t just opt out of the pension, you can opt out of that. No, you know, I think what a lot of fair number of especially teachers, what they often do is they’ll quit their job, take the pension, but then you can go back as a supply teacher, and the limits to how much you could do it, but you can still work, you know, half or three quarters of the time. Makes sense even after you’ve you’ve taken but then you’ve lost the employer’s contribution into it. You know?

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Money Mechanic
So I’m just looking at some of the other questions we’ve got here. Chrissy, I think we’ve covered a fair bit of question 12 Kate asks about modeling scenario. So I think we’ve covered quite well as you know, you figure out what amount that you’re paying in if it’s the 10% example that we’re using, the amount the employer’s paying. That’s fairly straightforward with a defined contribution pension, at least we kind of went into the percentages of that on the defined benefit, which is interesting. So yeah, she’s basically just saying making an Excel spreadsheet type thing. And putting in a compare, she wants to sort of look at a comparison if I did it myself, or if I left in the pension. And I think we talked a lot about that and add your opinions. If you’re a confident equity investor, you’ve probably going to outperform your your pension. So we can move past that, I think, Chrissy, next one?

Ed
Actually, I can I can answer her question more more directly. Because, I mean, there’s the general rule that if you’re making five in a pension, if you’re, if you invest in it and can make more than that, you’re probably better off long term. But mean, there is a bit of an offset because you actually need to plan for the rest of your life and pensions can plan for the average life expectancy. Right. So there is a little a little bit of an offset there. But what we’ve actually done for quite a few clients when when they actually have the pension so now they’re going to leave their job, they get the pension quote says you can retire at 65 on $50,000 a year, or you can get, you know, $100,000. So okay, so then we actually, so then once we have those, like the pension, when you leave, you can get a pension statement or a pension quote, and they’ll actually give you those numbers. And then you can do the actual math.

Money Mechanic
They won’t give you that quote until you decide to quit.

Ed
No, you can usually get it ahead of time.

Money Mechanic
Okay, okay.

Ed
You’re quitting in a few years, you can you can just call the pension company and say, I just, you know, I’m just thinking, you know, and they don’t, they’re separate from the employer. So you can just ask them directly, and just ask as a theoretical when you’re considering retirement options, so can you give me an estimate of, of what my pension would be at this date? And also, if I commuted it, how much would the value be? And then so once you have the specific numbers, then we can give you a much more specific Okay, now, you know, even though there’s a general general guideline, these are millions of dollars, we’re talking our large amount See, you want to do exactly right? Yes, yeah. Then you can look at Well, okay, if I get a bunch that’s not that’s taxable at the beginning, let’s assume that I lose a bit of that right off the top of tax. Okay, now and the rest of the rest, what rate of return do I expect to get? And then when you retire, we often use this, you know, there’s the 4% rule that you can use to figure out how much if you know if you save up a million bucks and probably pay you 4% a year. So again, 4% of the study that I put on my blog, but if you’re an equity investor, you could take 4% of your out of your investment investments. If you’re really conservative, you should take two and a half or 3% out. But you know, so now you can take the lump sum and projected growth and then how much would you take out of it? Compare that specifically to how much the pension is giving you? And then then you have a you know, much more definite answer.

Money Mechanic
Right. That’s, that’s very helpful.

Ed
Yeah. And we’ve done that quest. We’ve done a calculation lots of times for different people, and you Interestingly is 10 or 15 years ago, for equity investors usually commuting ot was ahead, but it wasn’t massively ahead. It was 20 or 30% more. Now with today’s values like we just did one, two weeks ago, and the difference was huge. It was like almost twice as much. It’s because no values are so inflated. Yes, it’s quite surprising how much the difference is now.

Money Mechanic
Okay, that leads me into Sorry, I’m cutting you off. Chrissy. I’m asking this question. This leads me to an example that we had here in the questions. Chrissy, did you come up with this example? Or did Kate supply it?

Chrissy
Kate sent it. Yeah, we’ll put it in the show notes.

Money Mechanic
Yeah, we’ll put it in the show notes. It’s a short video from Edmonton City News in Edmonton. And it’s the lady in the news article says that her commuted value was cut nearly in half. So she was quoted $108,000 the year previous and then due to life circumstances you had to get it requoted was going to take the commuted value in a drop down to 50% or 50% of that’s around $50,000. And she, it didn’t go into a lot of detail. So there’s probably some things that we don’t know about this. But I guess the question I’m asking is, do we need to worry about policy and pension changes that could drastically affect our commuted values?

Ed
Yeah, actually, that’s quite unusual because they the computed value, the actuaries are usually pretty scientific about it. So usually you don’t see it. And drop in fact, from year to year, it almost always goes up. I guess the difference would be is the employer Remember, the employer still runs it? So they can change the rules, right? So you, if you’re, if your pension pays 2% per year times the average the best five years, and they just say, you know what, we’re just changing it to 1% a year.

Money Mechanic
Right? There’s there’s risk. I mean, we can’t control that.

Ed
They could change it, and then you’ll get less Of course, you know, they would get a big lot of employee protests if you did that. So it’s rarely done. Yeah. But you do the You do see that sometimes when those companies that are in financial difficulty, because the defined benefit plans are actually very expensive for employers to to have, there’s some reasons that for government governments, it’s, it’s, it’s less of a risk. But for for employee for employers, it’s really expensive. So it’s not just that, that you know, that the 10% that they’re putting in, it’s they have to have it audited, and there’s all kinds of rules, and then when they’re behind when the investments go down, you know, in reality, it’s the employer, it’s not really the pension company that’s guaranteed the pension is the employer, you know, so if, if there’s really bad years, the investments are down a lot like 2008, the investments were down a lot. Most pensions were 30 or 35, or percent under underfunded. Okay. And at that point, it’s it’s it’s not that the insurance company guarantees it if the employer has to put a whole bunch more money in, right Oh, they no If you have one down here and it was back up there, fine, but if it’s, you know, if it’s if it’s extended in the pension stays underfunded for quite a while they have to put more money in. That’s why it’s so risky for a lot of private, private equities, private enterprise companies to be able to, to be able to have pensions. Yeah. And then if you’re if your pension is underfunded, and you go to commute it, then they will sometimes reduce it because of that.

Chrissy
Ah, so I my question then is, how is it fair for the employer to put in less when on yours when the plan does well, why can’t they put in the same amount every year and then there’s a surplus to cover the lower years why don’t they do that?

Money Mechanic
That’s not how you run a business, Chrissy.

Ed
Yeah. Well, yeah, well, there’s, there’s two solid reasons. One is they don’t have to so why. The other one is there actually as I said before, there is a maximum that can be put into it. Okay, so there is even there is a investments are doing really well, the employer is not even allowed to put that amount in because we get you get over the maximum.

Chrissy
Okay.

Ed
Right? I see that with personal pension plans and some small companies can do, they can, you can do a pension plan for just yourself as the employer you own as a you’re a company by yourself, right and you create a personal pension just for yourself and your company is paying into it. And what actually happens, it’s kind of interesting because you actually get more in essence more RRSP room that way than you do normally. But if you’re an equity investor and investments make a higher rate of return, you get to the maximum that you can do and what happens is you can put in less than you get less RRSP room than you normally would, because you’re always up against the maximum that you’re allowed to have in the plan.

Chrissy
Wow.

Ed
The employer an example there is, you know, when there’s when there’s good years, your employer’s putting in less. When there’s bad years they end up having to put in more. They’re in essence, you know, guaranteeing it. So your pension is as guaranteed as the as your employer… profitability, you know?

Chrissy
Yeah.

Money Mechanic
Like everything in life, there’s uncertainty Chrissy. Getting down to the last couple questions here, go for it.

Chrissy
So the option with more certainty appears to be, Kate asks, if you keep the money with the pension fund until you’re 55 or 65. Plus, however, that has a very low ROI, according to her calculations. I guess she’s trying to ask you, is that worth it? I mean, that leads into her last question, which she says at this point, it almost seems most prudent to ignore the pension in her FIRE calculations, because there are too many unknowns, so so she basically has a 10% plus hit to her salary on top of taxes and all other deductions for questionable benefit. And then she gets saved. So she says, tell me there’s a better way to look like a pension is not golden handcuffs at all, but just plain steel ones, or whatever handcuffs are made of.

Ed
Yeah, you know what they’re confusing and I can see where some times people think they put pensions in the category of too hard. So I’m just not understand, I’m just gonna ignore it. But you know, it’s still a big number, you know, and it’s whichever you decide it’s an important piece to make a decision and make the right decision for your case. So it’s, it’s better to, you know, I hope if she listens to this, maybe she’ll understand what, what these are and it’s, rather than putting in the too hard, it’s better to get some advice and figure it out, and you know, and decide what to do. But she’s thinking she’s making a low ROI. I don’t know how she did her math. But remember, in essence, you’re probably making 5% a year on it, you know, plus the plus you’re getting the employer’s contribution, which if you know she’s up If she’s a good investor, then she might well be making quite a bit more than that’s why she may be thinking that it’s low.

Money Mechanic
Yeah, I think all the information that you gave us today, Ed sort of leads into answering that final question that she had, because there’s clearly a lot that we need to need to work out here. And I was very interested to hear that you can get quotes on the commuted value and my wife is going to be super excited to hear that I’m going to force her to stop working before 55 so that we can retire early no matter what.

Ed
Yeah, it can put that goal out there, right. It’s the only way I can create this thing is if I you know, and leave money for my kids and the flexibility and get the highest return return, but I got to retire before 55. So you got to save up a lot before 55 to do that, right. So it’s perfect for the FIRE community you know, to target retiring early in commuting, commuting, the pension I find is, is something people in the FIRE community often want to do.

Money Mechanic
Right? That’s why we got a lot of questions about it.

Ed
Right, and actually, so one other thing is, most pensions won’t even pay you a pension. Like if you retire really early, they won’t even pay you a pension till you’re 55. We had a client that we have the retirement plan was to retire at 52 but, she could even get the pension till 55. So then, so the the only options are commuted, or you’re taking everything from your RRSPs from your own investments for the first three years before the pension starts. There’s always, you know, gotta be careful with pensions. There’s always restrictions. You know,

Money Mechanic
Another item that I picked out of our conversation that I thought was really interesting, and I think is quite applicable to the FIRE and FIRE community is that if you were to do some math, and you chose the commuted value, the advantage for early retirement there is that the LIRA is going to be locked in till 55 which you can sort of plan for, but should you get that cash value even though it’s taxably that you can now work into your financial independence calculations at that time. So I think that’s pretty interesting for our listeners to dig into a little bit as well. So,

Ed
Right yeah, cuz if you’re a you know, like I just wrote a plan for people who are retiring in their 30s.

Money Mechanic
Oh, yeah?

Ed
Right. So if you if you have a DB pension, your 30s. While it’s not going to be a million bucks, it’s not gonna be that huge of a number yet. Yeah, yeah, you may get a chunk of cash here, right that you can use right away.

Money Mechanic
I can work with, yeah.

Ed
At 55, you can convert your LI, your R, your LIRA to a LIF. You can unlock half of it that you can access right away.

Money Mechanic
Yeah.

Chrissy
So I have one more question before we wrap up here. So after all this discussion, it’s clear that pensions are quite complicated. It’s not easy to do all this math for someone who’s feeling a little overwhelmed and does want the help. Of course, they can come see you. But what kinds of experts should they be looking for who who is most qualified to help calculate these kinds of pension questions?

Ed
Yeah, you know, that’s actually a good question because if you go to the pension company, they’ll, they’ll answer certain questions, but they often don’t give you the insight. You know, they’ll give you why, here’s the pension amount. They’re hesitant to give the the commuted value because I think that was a part of it that I remember she said that Kate said that when she went to their own pension, pension seminar, they they wouldn’t talk about the commuted value. Why? Cuz they don’t want to get into that whole discussion because then a whole bunch of people say, Oh, that sounds like a good idea. You’re gonna talk about it. But you you know, it’s important one to think about, you know, it’s whatever it’s not not nearly everybody should do it. But it’s, it’s, but you got to get information. And it’s actually hard to find good good people to understand. I think you need a good financial planner that will,

Chrissy
Okay, so not an accountant? Would an accountant work?

Ed
Yeah, but it’s more it’s more a financial planning question than accounting. An accountant would you know look at the tax part of it, okay. But you also have the biases like I think you’ll find an accountant. Accountants tend to be really conservative and thinking like pensions you know even for self employed people I find that a lot of accountants like CPP even though self employed people have to pay double have to pay in double A really lousy rate of return but you know, yeah, I get because it guarantee they’re conservative people that like guarantees there’s a danger if you go to a financial planner, because a lot of them they want you to move the money to you to them. Right? So they’re just always going to say that you should commute it. And you know, like it’s not nearly everybody should do it. You just you want to, you want to get it but But wait, I guess you could probably get a financial planner, someone to do a projection for you and actually show you the projection and then you got to, you know, evaluate it yourself and make sure that they’ve done a good they’ve done an accurate job of it. But yeah, You know, the best thing if you want to get the value is get the pension, quote, get the commuted value and the pension. When you have the two of them, then the math isn’t particularly hard anymore that it’s, you know, it’s this is retiring at 65. Okay, I invest for 10 years, I gotta make one 8% a year or whatever it is, then what does it grow to? I got to take 4% a year out. How does that compare what the pension would pay me? You know, it’s so that if you get those quotes, then the math isn’t, isn’t that that difficult anymore.

Chrissy
Yeah, you’re right. That makes it a lot simpler.

Ed
Yeah. So you know, you need to know the numbers. Yeah. And you can get them.

Money Mechanic
That’s good. That’s important to know, yeah.

Ed
You can get them from the pension administrator. And that’s, and then you can that you can make a decision based on knowledge. I love the Kate’s question. It’s quite funny. Forget it just too hard. Yes, I’ve actually run into fair number one, pensions. seminars around a fair number of government employees that thought it was 100% of their salary. But it’s not, it’s much closer to 50%. So again, you got to look at your formula, because usually it’s it’s 2% a year, but sometimes it’s one and a half percent a year. But let’s say it’s 2% a year times the average the best five years. Most pensions max out of 30, or 35 years is all you’re allowed in there. But let’s say it’s 2% times and you work for 30 years, that’s, that’s 2% times 30 is 60%. So it’s 60% of your average of your last five years. So the average of the last five years is kind of what you made maybe the third year before you retire, and you’re getting 60% of that. Now, that’s what you can get if you’re single. If you’re married, then there’s a cost to the spousal benefits because your spouse gets 60% usually, or sometimes at 100% of your pension, your spouse gets, gets that benefit and that reduces it by five or 10%. And that the difference is based on whether your spouse is male or female and younger or older than you. It’s an actuarial life expectancy numbers, right? So then you’re getting 60% of, you know, third year before you retire, and then it’s being reduced by five or 10%. So it’s, you know, it’s roughly half of what you’re making when you retire. It’s pretty close to half. And then most of the times, especially the government ones are integrated with CPP, which means they give you this formula what you get, but that’s what you get from the pension and CPP combined. So, you still get all in security on top of that, but it’s what you get from CPP and and the and the pension combined. So you’re making 80,000 you’re gonna end up getting 40,000 from your pension and CPP and then, you know, then whatever old age security on top of that plus whatever else you get, and part of why they have this integrated is, let’s say you retire at 60. What actually happens is, so if you’re retiring at 60, your pension is going to be, let’s say $50,000. And CPP is going to kick in, it’s going to be $13,000. But it’s going to start at 65. What happens is your pension pays you $50,000, from age 60 to 64. And then it drops by $13,000 when CPP kicks in, so you’re at the same pension all the way through. So that’s how that’s how they integrate it.

Chrissy
That is interesting.

Money Mechanic
It’s very interesting. I’ve never realized that.

Chrissy
Yeah, and I can see now why Kate might might feel a bit frustrated, ‘cuz you kind of know what, what you’re in for. And if you take a job like this, you can’t opt out of the pension. So you do feel kind of stuck, because in one way, it’s great because you’re getting the employer match, but in on the other hand, it’s not the highest of returns for on your money, right.

Ed
Yes. So Yeah, but you can you can figure out what the amounts you don’t half of what you’re what you’re making at least at least that is fairly close. all the possible good news for Kate is maybe, maybe if she’s talking about retiring at 55 or 65. And it’s quite possible that she doesn’t even have the option to commute that it’s already it’s already too late. And she doesn’t have that option. So maybe the good news is she has no decision to make she just stuck with it. It’s not too hard. You just ask the pension home, you know, administrator, how much am I gonna get? That’s it,

Chrissy
And then work with it.

Money Mechanic
Well, I’m fairly certain this episode is probably gonna spur more questions coming. I think it’s been great information. Thanks so much for coming again on the show, Ed. Ed Rempel, you are a fee-for-service financial planner, and our guests can find you at your blog, which is unconventional, right? I didn’t say uncommon at the beginning, did I?

Ed
No. UnconventionalWisdom.ca.

Money Mechanic
There you go. Yeah.

Ed
Or just EdRempel.com

Chrissy
Perfect. Thank you so much Ed. We always love chatting with you and our listeners really enjoy the information you share. So thank you.

Ed
Yeah, thanks again, again for inviting me It’s always fun talking to you guys.

Transcribed by Otter.ai

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