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Peter and Mary want to retire early. Peter must decide whether to take a monthly payment for life or a lump sum that will be transferred mostly into a locked-in retirement account with the remainder in cash.
Peter and Mary want to retire early. Peter must decide whether to take a monthly payment for life or a lump sum that will be transferred mostly into a locked-in retirement account with the remainder in cash.

FINANCIAL FACELIFT

Perusing the fine print on pensions Add to ...

Peter and Mary are in their mid-50s and earn two incomes. They are wondering whether they can retire at 60.

It helps that their three children have grown up. The two oldest are “off the payroll” and the youngest is expected to become self-supporting after he completes university in three years.

Their retirement dreams aren’t extravagant. The couple plan to sell their house and live six months of the year in their condo (where the youngest child is now living rent-free until university is finished). For the rest of the year, they envisage travelling one to two weeks and spending the remaining time living abroad with Peter’s parents in their house, rent-free.

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Moreover, Peter, a professor since the mid-1980s, has a good defined-benefit pension. His wife, a public school teacher, has a defined-benefit pension but she began teaching only a few years ago.

Peter wants advice on retirement-plan options. His main decision is whether to take a monthly payment for life or a lump sum that will be transferred mostly into a locked-in retirement account (LIRA) with the remainder taken in cash.

Commenting on the couple’s situation is Patrick Longhurst. He is president of Patrick Longhurst Advisory Services Inc., a consultancy that offers advice on pension matters to financial advisers. His analysis was peer reviewed by William Jack, president of William D. Jack & Associates.

What the expert says

“Based on the material provided and some fairly conservative assumptions about the future, Peter and Mary can afford to retire at age 60,” declares Mr. Longhurst. The main reason is that Peter “has been a member of a generous defined-benefit pension plan long enough to be eligible for an unreduced pension at age 60.”

Retiring early also works in this case because many of the couple’s biggest financial obligations will be over. “Notably, all the kids will have flown the nest, the principal residence will be sold, and their debt-free status will be preserved. Peter and Mary also plan to downsize to one car.”

However, “other expenses seem quite modest and should probably be reviewed to ensure they are adequate … . How will Peter and Mary spend the increased amount of time together, and what additional costs might they incur pursuing these activities?”

Peter has to decide “the form in which he takes his registered pension.” If he were 60 years old today, he would have the choice of:

– receiving $5,000 a month (partly inflation indexed) for the rest of his life; 60 per cent would be redirected to his wife if she outlives him;

– a lump sum of more than $1-million, of which over half would be transferred to a LIRA and the rest would be distributed as cash (subject to tax withholding).

According to Mr. Longhurst’s calculations, if Peter were to take the lump sum and live to 85, he would need to earn at least 4 per cent annually on the capital (after expenses and before tax) to match $5,000 a month in payments. If he lived longer, or if Mary outlived him, a higher rate of return would be needed. Some couples may prefer not to take on this investment risk.

Note that when Peter and his wife do reach 60, the choice could look quite different, depending on the level of interest rates. They are now very low, which inflates the value of the lump sum because it’s calculated based on the amount of money needed to generate $5,000 a month in payments. In a few years, rates could be a lot higher and cause the lump sum to be much lower. Thus, it might be better to delay a decision until closer to retiring.

There are other aspects to consider. For example, post-retirement benefits, such as dental and term insurance, could be lost if the lump sum is selected. Also, the monthly payments option removes the risk of outliving one’s pension. However, a lump-sum pension has an estate value that can be passed on to heirs.

Considering that Peter still enjoys his work, he should look into “phased retirement” options. For example, his employer permits working half-time for a couple of years while earning a full pension credit each year.

When they retire, they will have to make several decisions – including whether to take reduced Canada Pension Plan payments as early as 60, and whether to split income from registered pensions and the CPP to reduce taxes. They may want to speak to an adviser at that time who can help them assess the impact of the various options.

CLIENT SITUATION

The people

Peter and Mary, in their mid-50s, with three grown children.

The problem

Deciding whether or not to retire at age 60 and in what form Peter should take his pension.

The plan

Keep maximizing registered plan contributions and carefully review projected retirement expenses. As retirement gets closer, undertake a full analysis of Peter’s pension-plan options.

The payoff

Retiring early at 60 with few worries

Monthly net income

$9,000

Assets

Non-registered savings and investments $123,100; registered savings $220,000; home and condo $385,000; current value of pension plans $18,300 (Mary) and $539,612 (Peter). Total: $1,286,012

Monthly disbursements

Condo fees $200; property tax $485; school taxes $134; property insurance $150; electricity $220; maintenance $100; alcohol and other $65; beauty $100; club memberships $67; dining out $180; entertainment $110; sports and hobbies $65; life insurance $98; car insurance $129; fuel $111; maintenance $158; parking $66; health care $150; groceries $650; clothing and dry cleaning $120; cellphone $90; fixed phone, cable, Internet $95; gifts $200; charitable $65; travel $500; tuition fees $1,370. Total: $5,678

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