The cost of retirement certainty

Bruce Sellery says buying back pension benefits can be a wise move as long as you know what you’re giving up for it.

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Question

I am 49 years old and want to retire at age 55. I will have 20 years of service with the government, but because I won’t have 30 years there will be a 25% decrease in my pension. I have an RRSP and a Locked-in Retirement Account (LIRA) from the time I worked earlier in my career and combined they have a market value of about $80K. My question is should I transfer some or all of my RRSP and LIRA to buy back the 10 years missing from my pension? The quote I received is about $280,000 and I could spread this out 10 years into my retirement.

Answer

This $280,000 quote to buyback 10 years on your pension—assuming you are eligible—is an enormous amount of money. But it might make good sense for you for one important reason: Certainty.

A government pension will provide a secure income for the rest of your life. The same cannot be said of investments within an RRSP or LIRA, because both rely on variables that are hard to control: market performance, your psychology and fees.

That being said you will pay a price for certainty and you’re the only one who can determine if it is worth it. “The answer is both and art and a science,” says Adrian Mastracci, a portfolio manager with ?KCM Wealth Management. “But you have to be careful on the details.”

There are a number of factors to include in your analysis. For example:

Real estate: Will you still have a mortgage or other debts upon retirement? If the answer is yes, it will be harder for you to pay off that $280,000 bill than if you were debt free. Also consider the trade-off you could make to downsize your home now, move somewhere cheaper, and use the proceeds to fund the buyback.

Family: Do you have children, and if so do you want to pass along an estate when you die? RRSP assets will transfer, but a pension will not. Do you have a spouse, and if so, how do your plans affect him or her?

Lifestyle: What sort of retirement do you want to have? Your pension will provide you with a steady income, but an RRSP will allow you to have some flexibility to spend lump sums if you choose to. Are you planning a life of gardening and golf? Or do you want to spend chunks of money time travelling around the world?

Longevity: How long do you think you are going to live? I know, I know: It is impossible to determine that, but if you have no current health issues and longevity is in your family, the pension option may make more sense.

Pension health: In your case, the pension comes from government, which is about as secure as you can get. But if you were looking at a buyback in the private sector you’d want to factor in the health of the company and the pension fund as this move really does reduce your diversification.

Restrictions: You’ll want to see if there are any restrictions. “Make sure that the LIRA account can indeed be used to buyback the missing years. You may have to check with its previous pension administration office,” says Mastracci. There may also be tax issues to be factored in, and implications to what you’ll receive in OAS or CPP. There shouldn’t be any tax implications associated with transferring the money from your RRSP or RRIF, but there may be some if you use non-registered funds for the buy back. It would be wise to consult an adviser or tax expert to be certain before you proceed.

Check out multiple scenarios

The math is going to be very helpful in making your decision. I recommend you retain the services of a [fee-only financial planner][insert link on how to find] to take you through the numbers associated with your options. Consider the three scenarios below in particular and calculate how much cash you’ll have coming in under each of them:

Buyback 10 years of service: You’ll have a higher pension bump out of the gate, but it will likely be more than used up in the first 10 years paying the tab on the buyback, which will be about $1,700 per month, assuming you use up the LIRA and RRSP. You will have to check with the pension administrator to make sure their rules allow the money to come from your RRSP or LIRA. You should also confirm with your pension administrator that you are allowed to buyback the years of service you’re missing. The rules vary greatly between pensions; most will only allow buybacks under specific circumstances.

No buyback: If you don’t do the buyback, you’ll have more free cash available and can therefore sock away more into your RRSP each year, reducing your tax bill.

Work five years longer: I’m not advocating this approach, but I think you should have the numbers handy. If you were to work for an additional five years you would have more pension credit, and more money to put towards the buyback. How do those changes affect your cash flow?

As Adrian Mastracci says, a buyback is generally a good idea. But you’ll need to do some more digging to see if it is a good idea for you.

ask@moneysense.ca

2 comments on “The cost of retirement certainty

  1. Work the 5 extra years. Freedom 55 is a pipe dream for most.

    Reply

  2. The catch is, there's no sure fire way to be certain about retirement. The only thing anyone can do is prepare for it as much as they can and as early as possible.

    Reply

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