Pensions: buy out or stay put?

Pensions: Better to buy out or stay put?

Financial Post June 06, 2009

The client: A married couple in their early fifties, living in Alberta. She earns $100,000 a year, he earns $40,000. They have one child living at home with one grandchild. They hope to retire in six to eight years. Their portfolio holds $95,000 in RRSPs and they have $120,000 in mortgage and credit card debt.

The portfolio:

Income: $140,000

RRSPs: A total of $95,000 in six different RRSP plans, all in bank-run mutual funds (75% equities, 25% fixed)

Mortgage: $100,000 (remaining amortization of 15 years) Credit card debt: $20,000

The problem: The higher-income spouse has been offered a pension buyout. She would receive $380,000 to be transferred to a Locked-in Retirement Account. Another $160,000 would be taxable. It’s an attractive offer: The cash could be used to pay off their debt. But this means giving up a guaranteed pension income of $38,000 a year (indexed at 60% of CPI). With one spouse in poor health and two extra mouths to feed, there isn’t much left over at the end of the month to save for retirement. They’d also like start an RESP for their grandchild.

The fix: Dave Cooper, a certified financial planner in Edmonton, told the couple to take the lump sum pension offer. He consolidated the six RRSP plans into one, and rolled the $3 80,000 into a LIRA (Locked-in Retirement Account). For added security in case of death, a LIRA can be transferred tax-free to a spouse or heir (the balance of a typical pension cannot be rolled over if it has been in use for more than 10 years.)

Next, he used $25,000 of the taxable pension buyout to maximize their RRSPs, and the remaining $135,000 ($94,000 after tax) against the couple’s credit card debt and as a lump sum against the mortgage. The couple was able to negotiate a new mortgage for $76,000, plus an additional $50,000 to invest, which they got for a cheaper interest rate (after paying the $3,000 penalty for breaking their contract early.)

The advice: When it comes to your portfolio, forget trying to predict where the market will go and think long-term, Mr. Cooper says. He encouraged the couple to use the $50,000 gained from renewing their mortgage to invest jointly in funds that produce dividends, but defer capital gains (the interest on bonds can be converted to tax-deductible dividends). He put all of their non-registered investments into corporate-class mutual funds. He set up an RESP for their grandchild, and adjusted their asset mix into a 50/50 split between equities and bonds. They remain all in mutual funds, but only some are still with the bank. “With a 5% average rate of return,” Mr. Cooper says, “this new portfolio will be worth $600,000 and will generate approximately $30,000 a year of income at age 60.”

The outcome: The renegotiated mortgage saved the couple $11,000 in interest, and provides them with an extra $900 a month in cash flow. “They came to me just before the economic meltdown,” Mr. Cooper says. “From the way we restructured the portfolio — 50% bonds, 50% equities — they didn’t take too big a hit. The bonds made good money; when the market hit bottom, they were up 5%. The equities fell in value about 18%, which put the couple’s net worth down only 13% at the worst of the crisis.

“It just proves the power of having a fixed income portion of your portfolio.”

———

PROJECTED PORTFOLIO:

At age 60 they should have the following:

ASSETS

Home $493,000

LIRA $539,000

RRSPs $285,000

Non-Registered investments $71,000

LIABILITIES

Line of Credit $80,000

INCOME

CPP $14,000/yr.

RRIF $14,250/yr.

LIF $36,545/yr.

Non-Reg $3,550/yr.

TOTAL INCOME

$68,345

AFTER TAX

$58,224

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