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.

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RM Portfolios Update: July 2019

Welcome to the July update for the different portfolios which I track here at The Rich Moose blog.

I use Canadian-listed ETFs where possible for the models I share to keep the tracking, purchasing, and selling easy for Canadian readers. However, because they are not available in Canada, I use U.S.-listed 3x Leveraged ETFs and track returns in U.S. dollars for the Dual Momentum strategy and some of the Leveraged Barbell Portfolios.

See the list of my favourite Canadian ETFs on this page.

Vanguard All-in-One Portfolio ETFs

These Vanguard ETFs hold multiple assets inside a single ETF. It's nearly a perfect solution for investors who want to buy just one ETF and hold it forever without worrying about re-balancing, tax trigger issues, and excessive costs. Read my post reviewing these products to get an idea of how they are designed.

While I personally believe there are better ways to invest when you have a larger investment account, these Vanguard Portfolio ETFs are great for newer investors, people who don't want to spend any time thinking about their investing process, and investors who want to minimize costs that would otherwise use a "robo-advisor" or a similar, more expensive passive investment approach.

Here are the monthly and past 12-month returns of these portfolio products (NAV data) for July 2019.

Vanguard Growth ETF (VGRO.TO)
July:  +0.60 percent
12-Month:  +3.81 percent

Vanguard Balanced ETF (VBAL.TO)
July:  +0.51 percent
12-Month:  +4.78 percent

Vanguard Conservative ETF (VCNS.TO)
July:  +0.42 percent
12-Month:  +5.76 percent

The decision between choosing the Growth ETF, Balanced ETF, or Conservative ETF depends on your tolerance for risk and your investment time-line. The Growth ETF should have the highest returns and highest draw-downs over time while the Conservative ETF will show lower returns with more stability. The Balanced ETF is a middle-of-the-road option.

12-Month Dual Momentum Strategy

Dual Momentum is a strict, rules-based investing approach which uses an easy performance evaluation to decide your investment holding for the next month. Most months the holding will stay the same; trades occur fewer than two times per year on average.

By evaluating just once each month, you can reduce the negative effects of market noise and spend very little time managing your investments.

I use Dual Momentum in my own personal portfolio. Looking at the history, I think Dual Momentum investors have a good opportunity to have market beating performance with lower drawdowns.

The Dual Momentum strategy—as tested by Gary Antonacci of Optimal Momentum—has shown fantastic results over complete market cycles. Read his website, book, and research papers to get a full understanding of how the strategy works.

In my model, I evaluate the holding each month based on the 12-month gross performance of the MSCI USA Index, the MSCI ACWI ex-USA Index, and the annualized past return of 3-month U.S. Treasury bills.

Each month I will share the model signal as either U.S Stocks, International Stocks, or Bonds. Read the linked posts to understand the investment options and other questions related to these signals. The signals and returns are calculated in U.S. dollars.

See how the Dual Momentum portfolio would have performed compared to a buy-and-hold index portfolio over the past 5 decades by visiting the Portfolios page.

Index 12 Month Performance: -3.26 percent
Index July Performance: +1.54 percent
Current recommendation:  U.S. Stocks

Leveraged Barbell Portfolios

The Leveraged Portfolio strategy uses a unique mix of short-term bonds and leveraged stock ETFs to achieve growth while limiting downside risks. It's essentially a barbell strategy where all the risk and growth is contained in a small portion of the entire portfolio.

Although I add a trend factor into the analysis for my personal portfolio, the strategy I use in my non-registered account works very similar to this Leveraged Barbell Portfolio.

If you choose to implement the strategy, make sure you treat each account as a whole portfolio. Do not put bonds in one account and leveraged stock ETFs in another account!

Leveraged portfolios are re-balanced just once per year. For this reason, I will always track the Year-to-Date returns only. Longer term returns can be seen on the Model Portfolios page.

Canadian-listed ETFs (2x Leverage Stock ETFs)

HSU.TO (50%) & XSB.TO (50%): +20.53 percent
HSU.TO (30%) & XSB.TO (70%): +13.37 percent

U.S.-listed ETFs (3x Leverage Stock ETFs)

UPRO (40%) & BSV (60%): +26.96 percent
UPRO (30%) & BSV (70%): +21.09 percent

These allocations are just a few examples of how Leveraged Portfolios can work. Leveraged ETFs amplify positive and negative returns so they should always be paired with low-risk assets to meet your personal risk tolerance. In a non-registered account, you might use margin debt to purchase your stock index ETF for somewhat better tracking.

Comments & Questions

All comments are moderated before being posted for public viewing. Please don't send in multiple comments if yours doesn't appear right away. It can take up to 24 hours before comments are posted.

Comments containing links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.