They also have a recreational property in the U.S. with a estimated value of C $80k. They don't rent it and want to keep it, so sale is not part of this analysis. They make no private savings in RRSPs and at this stage of their lives dramatic increases in their current investments would require them to take substantial risk. The couple is relying on their defined benefit indexed pensions, but they worry that the pensions may not cover their retirement needs. This video has failed, but we apologize. Please don't hesitate to upload the video
Tap here to see more videos from our team. couple considers pension commuting their friends, but managing money comes with big risks.
Family Finance asked Derek Moran, leader of Smarter Financial Planning Ltd. in Kelowna, B.C. To work with Gus and Jane. To raise cash, they consider commuting Jane Rent, that is, converting income to capital. Their goal is pension income of $120,000 a year before tax. As we will see, they can get that without taking on the risk of converting DB pensions to their own management via commutation.
The pros and cons of commutation Definition benefit pensions are contracts to pay defined sums in future. The money behind the payments belongs to a government entity. It is possible to commute the defined DB pension to the amount of capital needed to generate expected pension income flows for estimated numbers of years. The math is complex: interest rate changes require actuarial work and with some money going into registered plans and some not, there are tax considerations, too. Mortality also enters in the calculation. A DB pension pays for life, which requires a sequence of payments that can be difficult to duplicate with private investments. If they get cash to manage, they may get more out of their pension capital than the DB pensions will pay. However, they carry all risk of gain or loss.
Mouran advises that if you want to leave alone, you should really leave your partner alone. The plans are, after all, professionally managed and will never run out of money. The downside of the plans is that if they build up RRSPs before retirement the payouts will be on top of pension income and perhaps in higher tax brackets. What you can now save on RRSP contributions could be considerably taken back by future taxes. The couple should instead focus on debt. They have only one thing left in their house: $130,000 of what they owe to the bank. They can take $30,000 from $35,000 of existing cash and put it on mortgage, shortening payments by 20 months or less if rates rise when the loans are renewed and paying total interest they will pay. If they keep $1,500 monthly payments, they can have it paid off in about six years, give or take if their mortgage loan is due for renewal in 2025. If they add $74,000 from TFSAs, reducing the balance to $26,000, they could be mortgage free in 18 months. They would be sacrificing tax-free investments to pay off a low interest loan, which is not ideal, but it would make them to zero debt faster.
With the mortgage relegated to history, the $1,500 per month they have been paying would be theirs to keep. Eliminate $200 for life insurance they might not need, add $500 for car replacement and increase present travel expenditure of $1,000 per month to $2,500, and their current monthly spending would drop slightly to about $7,000/month. That is $84,000 per year after tax or an estimated $100,000 before tax if incomes are split. Gus can retire at age 55 in 2015 with an index pension of $64,940 including a $21,160 bridge to 65. Jane will be able to have a $58,500 pension including a $100,500 bridge to 65 but can't collect it until age 55. Neither would be old enough to qualify for benefits of Canada Pension Plan or Old Age Security (the CASP) program. Commutation to achieve the combined pension flows of $123,440 implies a capital value of $4.1 million generating 3 per cent above tax on every year.
If they could get this sum, pay tax due and put the balance in locked-in RSPs, they would each be able to get $48,000 to $49,000 from capital after tax. In a growing number of years, however, it becomes doubtful that the guaranteed-for-life income stream of a DB pension can be replaced, Moran cautions. Rather than commute pensions, they could close the gap by spending some of their $256,000 in RRSPs for 6 years until Jane can draw her pension. Looking ahead, Jane has to wait to 55 to start pension. We assume that a draw of $50,000 per year for six years empties their RRSPs including six years growth. At 65, his bridge will end and OAS and CPP will start flowing. Their income will consist of $91,780 combined base pensions and Jane's $10,500 bridge, his $12,756 estimated PPO retirement and his $7,518 OAS benefit for total income of $122,554.
When both are 65, they will have $91,780 base pensions, no bridges, two OAS benefits of an estimated $12,756 each total $25,512 and two CPP benefits of $7,518 each for total pre-tax income of $132,328 each. That was over $120,000 pre-tax goal. If this income was split by allowing age and pension credit, they would pay tax at an 18 per cent average rate and have $108,500 to spend after tax. That is $9,040 per month, far ahead of present spending of $7,110 per month. With $1,500 monthly mortgage payments repealed, they would have additional income to travel, a new car fund, or donation to good causes. Their retirement is financially sound, however their lack of substantial personal assets are a limitation. Retirement stars: Four retirement stars out of five.