Exploring Pension Options

As my regular readers know, a little more than a month ago my wife and I did the unthinkable for the average Canadian. We both quit our cushy full-time, gold-plated government pension jobs near Edmonton, Alberta. Then we sold and gave away 99 percent of our stuff, packed what was left in four suitcases and a few cardboard boxes, and moved approximately 11,000 km to the other side of the globe.

Our Journey

We are just getting settled in south east Asia as I write. It's taken a little adjustment in many ways. We moved from a comfortable, newly built suburban rowhouse surrounded by lush lawns and large nearby parks to an older—but newly renovated—apartment building in the middle of a large Vietnamese city. I've talked about the benefits of downsizing before, and I have zero regrets cutting our living space down by more than one-third once again.

Naturally we are renting. Renting provides ultimate flexibility and is a great way to make sure you are in control of your living expenses. There are no surprise costs, no maintenance fees, nothing. Just the monthly rent and an electric bill. This time our place is furnished (common for expat homes in our area).

We also getting used to the change in weather. Hot and sticky takes on a whole new meaning in south east Asia. There's little relief at night, early mornings are almost as humid as the day, and the smells of a large, developing tropical city hang in the moist air. I'm nearly accustomed now, but the first few whiffs are memorable.

The city environment is completely different here as well. True, nearly unfettered capitalism abounds! Everywhere you walk people are selling things. Fresh flower stalls. Small convenience groceries. A small food menu with a few tables. Large baskets of fruit on bicycles. Haircuts and shaves. There are hawker stalls on the sidewalks and many first floors of homes are converted into small shops and restaurants. The people here are hustling!

The best part is that it's working! In a country that was unthinkably poor just a couple decades ago, the common sight now is a local riding an imported motorcycle talking on a smartphone with a 4G data connection.

But onto the main point of this post: pension options!

The Math Behind Pension Options

While I still haven't received my pension options, my wife received hers. As promised, I wanted to share the numbers since it is my strong position that nearly everyone is better to cash out your pension than to take the monthly payments for life in our current financial environment.

In our particular plans, if you leave the plan early (more than 5 years of service but less than the "85 Factor" for a full pension) you have the option of taking a pension payout for the commuted value of your share in the plan, or leaving the pension in the plan and taking an estimated future benefit at age 55 or older.

I've adjusted the numbers because of privacy. Although I've shared my net worth for years, our pension payouts have a decent sized impact on our net worth. Also, I am currently building a new site where I will no longer be sharing our net worth every month. Instead, I will share my investment returns and let you guess where we stand.

Estimated Future Pension at 55: $485 per month (average of the different options)

Current Commuted Value: $100,000 ($65,000 in LIRA + $35,000 in cash)

Since we qualify a retirement at age 55 to be an early retirement, we need to assume that the future value of the commuted amount should be 25x our annual estimated future pension income. Because a government pension is theoretically highly secure, I would like to see a 30x multiple to be on the safe side.

To calculate our estimated future value, we need to make a few adjustments for tax. First, we will assume that our pension payment at age 55 within the plan will be taxed at 20 percent. Pensions are not very tax efficient and are taxed as regular income (with some splitting benefits).

Tax Adjusted Pension Benefit: $388 per month

This means the future value of the commuted pension adjusted for tax must exceed $139,680. That is the annualized benefit multiplied by 30.

Next, we need to adjust our commuted value for tax liabilities. I believe this is best done in two steps. First, we should adjust the cash portion right away as this is taxable upon payout. The tax charged for a non-resident is a flat 25 percent.

Tax Adjusted Current Commuted Value: $91,250 ($65,000 LIRA + $26,250 cash)

Next, we need to adjust our future investment returns on the cash portion for ongoing taxes. I will make a safe assumption that taxes will reduce returns on this portion by 1 percent annually. If we assume an inflation adjusted return of 5 percent for a portfolio over 27 years, the tax adjusted return on the cash portion will only be 4 percent annually.

Tax Adjusted Future Commuted Value: $318,363 ($242,675 LIRA + $75,688 cash)

Once again, we will adjust for taxes on the monthly income from the future commuted value. We'll assume the LIRA portion will be taxed at the same 20 percent. The cash portion will be taxed lower at 10 percent (capital gains and dividends will form a large part of the income).

Tax Adjusted Future Monthly Benefit for Commuted Value: $728 ($539 LIRA + $189 cash)

In the end, at an assumed gross inflation-adjusted return of 5 percent annually, you will be nearly twice as well off taking the commuted value and investing it yourself. In fact, if you can generate an inflation-adjusted return exceeding 2 percent per year, you are better off taking the commuted value.

As you can probably guess, my wife and I will be taking our share out of the pension plan and investing the commuted value on our own. First, I believe that I can achieve returns exceeding 2 percent annually after inflation. Second, I like to be in control of my own money.

Pension plans around the developed world are going through increasing pressure. Financial benefits are slowly being cut as current pensioners live far longer than expected and didn't contribute enough in their working years. In effect, many pension plans are the definition of a Ponzi scheme. The public pension system is also facing political pressures. I don't know what's going to happen the next time the world's financial markets get rocked in a 2008-esque moment, but I don't want my financial security subjected to the kind of political atmosphere I think may erupt. Taking the money out of the plan is another form of total risk control.

Comments & Questions

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Please visit my new website and blog for current posts on financial topics. DArends.com

Financial Housekeeping for Moving Abroad

The last couple weeks have been a whirlwind of selling of stuff, packing what's left, moving the packed things, saying "goodbye" to our awesome friends in Edmonton, and traveling. All this to say things have been busy.

We took a 10 day trip to visit our friends in Toronto. I've never been there before and it has a lot to offer. If you haven't been, go visit Niagara Falls (the Canadian side)! We also took in a Blue Jays game (where they stomped all over the Orioles), visited Barrie and the Flying Monkeys Brewery, and enjoyed the South Asia Festival.

While I admit Toronto is a cool city to visit, the traffic and sprawl are quite insane. Our friends were sharing prices for houses, semis, and condos in different areas of the city. My god, I don't know why anyone would ever buy there. It's a ticket to financial destruction! Not to mention poking your eyeballs out driving in endless gridlock traffic day-in and day-out. If you want to buy a house and enjoy your life with much shorter commutes, move to Calgary or Edmonton folks!

Currently we are in B.C. visiting family and friends on the west coast (where house prices and financial madness are no better than GTA). We go to B.C. twice a year on average, so this will be the less touristy part of our trip. In about a week we will be flying out of YVR en-route to Hanoi.

Daily Banking

Some of the things I've been working on between the traveling and busyness is arranging our banking accounts for our move. A few months ago I opened up a Tangerine account and shifted most of our banking to the orange folks. (I was with an Alberta credit union before.) Since Tangerine is all online and fees are low, we will be keeping this account when we are overseas.

I must say I've been very impressed with Tangerine—especially considering they are owned by a big bank (Scotia) and I otherwise try stay away from the oligarchs. Customer service over the phone has been great, the app is clean and a pleasure to use, and the process of setting up our bill payments and deposits is easy. If you are banking with the big guys and are paying monthly fees, you should seriously consider switching. If you do, a free way to say thanks to me is by using my Orange Key: 55884598S1. We will both get around $50 from Tangerine as a thank you. (You have to use the Orange Key in the sign-up process.) As an aside, thanks to everyone who used my Questrade referral code! It has paid several hundred dollars so far, helping cover the costs of webhosting this blog.

I've also opened up a Borderless account with Transferwise. This is another awesome application that will allow me to move money across linked accounts (including Tangerine) and change currencies for extremely low fees. I was hoping to get a Mastercard debit card from Transferwise sometime this year, but it seems they have quietly put that program on hold in Canada.

I anticipate my wife will be opening a local account in Vietnam for local spending (a portion of her salary is paid in Vietnamese dong). Whether or not we can move Vietnamese dong out of the country (via Transferwise), or another compatible currency like Euros or British pounds remains to be seen. I know there are problems with U.S. dollar transfers.

Investment Accounts

As I've mentioned in prior posts, my wife and I will become tax residents in Vietnam effective on the date we land in Hanoi. This is based on the Vietnam tax code and their tax agreement with Canada.

Our RRSPs look like they won't be a problem. We can continue to invest within our RRSP accounts (including Locked-in RRSPs/LIRAs) as we always have without any additional tax repercussions. Questrade allows full access for expats and non-residents. We won't make any new contributions to our RRSPs though; there won't be any income earned in Canada which we can deduct the contributions against. With no new contributions for a while, I don't need to worry about currency changes; in the coming weeks I will switch these over to U.S. dollar accounts.

Our pensions will be partly moved into LIRAs and partly paid out (the excess portion). Neither my wife nor I have received our pension packages yet, so I don't know what their impact will be on our new worth. However, I anticipate it will be relatively substantial and I will not be leaving the money in the pension plans.

The payout will be made to us as foreign residents so it will be subject to a flat 25 percent tax. This might seem high, but it is important to remember that we contributed in the 30.5 and 36 percent tax brackets. Even if we remained residents in Canada, the excess portion would be taxed as regular income less any RRSP contributions we made. It is highly likely that the payout would be taxed at rates higher than 25 percent.

Unfortunately Vietnam doesn't recognize TFSAs as being tax free. I'm not sure if or when we would return to Canada as residents, so at the end of the month I will be moving money out of our TFSAs and into our regular investment account. This means we will be shifting more money from investing in Dual Momentum towards trend investing.

I'm looking forward to this move as it will play a key part in improving our overall capital efficiency. In our regular investment account I would love to get to 90 percent bonds (mostly short-term). I'm not precisely sure how this will look as I'm trying to find the best ways to allocate capital with tools like options and futures. But I do believe it will be doable while being tax efficient.

Taxes

In order to legally leave Canada, we will be paying a sizeable tax bill. All of our assets will be deemed disposed on the day we leave and taxed at their current fair value. This means some capital gains taxes will be owing. But I suppose that's the price to pay for moving to a much lower tax jurisdiction where our taxes should be much lower going forward. Pay now, save a lot more later.

As mentioned above, we'll also be paying taxes on pension payouts. This would happen inevitably with quitting our jobs, but the costs will add up nonetheless. With RRSPs, time will be on our side. We can keep them indefinitely and let them grow, or withdraw them at a 25 percent tax at any time once we are out of Canada. For now I'll keep them in place, mindful that any gains are effectively subject to a 25 percent tax while I make up my mind.

Taxes in Vietnam will be much lower than in Canada. Particularly on investment income and returns. Using UCITS funds (mainly listed in London), we can buy bond funds and have a low 15 percent withholding tax on interest income while also eliminating estate tax exposure. In Vietnam our tax rate on the interest income will be just 5 percent. The only other investment tax we need to worry about is effectively a sell-side transaction tax of 0.1 percent on equities and publicly traded instruments.

Comments & Questions

This is an archived post and all comments are disabled for management efficiency. You can email me for direct questions.

Please visit my new website and blog for current posts on financial topics. DArends.com