# Why My “Gold-Plated” Government Pension Sucks

That's right. The pension plans that every socialist drools over and the right-wing anarcho-capitalists love to hate are really not an outsized deal.

Mediocre returns, high administration costs, bad investment strategies, political dabbling, I don't know... but when I do the math the numbers tell the same story over and over. I would be much better off investing on my own in a matching contribution-based plan than contributing to my supposedly gold-plated, defined-benefit government pension plan.

## How Government Pensions Work

Government pension plans—or at least the ones that the media world tell you are so brutally unfair—are defined-benefit plans. You and your employer pay into the plan according to advanced calculations. Regardless of how the investments contained within the plan perform, you get a guaranteed pension benefit that's based on a percentage of your working income and your years of service under the pension plan.

Periodically, government pension authorities evaluate the sustainability of their pension plan and set contribution rates. These rates fall into two main categories: 1) a certain rate for employees and employers up to the CPP contribution limit [called YMPE - Yearly Maximum Pensionable Earnings], and 2) a higher rate for employees and employers above the YMPE limit.

The CPP limit—or YMPE—is factored into the calculation because once you turn 65, your pension benefits will be lowered according to your estimated CPP payments. For example if the plan calculates you will earn \$1,000 a month from CPP, they will reduce your monthly pension benefit by about \$1,000.

In my pension, one can retire and collect a benefit as early as 55 years old as long as they meet the "85 factor" (Age + Years of service >/= 85). This means you would have to start your career contributing to the pension plan at 25 years old to get the full benefit at 55 years old.

## My Future Pension Estimate

Under the current rules, my pension benefit calculation goes like this: Average of Best 5 Years Salary x 2% x Years of Service = Best Annual Benefit.

At age 65 this is changed to a two part calculation for the CPP adjustment: (YMPE x 1.4% x Years of Service) + (Balance of Salary x 2% x Years of Service) = Total Pension Plan Benefit.

Assuming my salary goes up with inflation (it has been lower than inflation for the past decade now), at age 55 I will get a taxable benefit worth about \$53,000 in today's dollars. After paying taxes at 19%, my net income will be around \$42,900 if I retire in Alberta.

At age 65 when I get CPP, the pension benefit will be adjusted down to \$23,219 + \$20,560 for a total taxable benefit of \$43,679 in today's dollars. I should note once I start collecting my pension the benefit only increases each year by 60% of the posted inflation rate so over time my real purchasing power goes down. Also, when I die my wife only gets 66% of the total benefit for the rest of her life. Our estate gets zilch when we both die.

Not bad at first glance considering I earn around \$85,000 a year before a bit of overtime (overtime/extra pay is not included in the pension calculation). However, I should point out the benefit is fully taxable as regular income and I have zero control over my income mix, tax saving strategies, or coordinating my withdrawals with my actual expenses.

## What If I Invested Myself?

The contribution rates to my pension are pretty high. About \$420 biweekly comes directly from my salary plus \$455 biweekly from my employer. That's a total adjusted contribution of \$875 bi-weekly.

If I invested through Questrade according to a Growth Portfolio—which should return 6% annually after inflation over the long term—after 31 years my portion of contributions would be worth about \$970,000 and my employer's contributions would be about \$1,050,000 for a total value of a bit more than \$2,000,000.

Following my 25x Rule (which gives me more than 92% chance of success when retiring at 55 years old), I would be able to withdraw \$80,000 in my first year of retirement and adjust up each following year at the full rate of inflation. Plus I get no clawback at 65 years old for CPP. My wife would still get the full amount when I die. When we both die, our estate would get the total value of the portfolio which is very likely to be worth more than \$2 million.

With a self-directed portfolio, I also am able to tax-optimize my withdrawals. Drawing some fully taxable income from RRSPs, tax advantaged Canadian dividend income from my Cash/Margin Account, tax advantaged capital gains income from my Cash/Margin Account, and non-declarable income from my TFSA, I could realistically pay a blended tax rate of 16% (or less) for a net income of \$67,300.

## Outcome

Although my pension is pretty much guaranteed, it certainly isn't as lucrative as many believe it to be. To me a 92% guarantee with full adjustment for inflation, no CPP clawback, and a remaining balance for my estate is about as valuable as the 99% guarantee the government pension gives with only 60% inflation adjustment.

Using the same contribution rates in a self-managed, low-fee, index based Growth Portfolio, I would realistically be able to achieve almost 60% higher net income in retirement.

If the pension plan was able to follow the 25X Rule, the total value of my pension at age 55 should be \$1.325 million (\$53,000 x 25). The administrators should be able to achieve that with total biweekly contribution of \$600 over 31 years instead of the current \$875. It's almost certain that anyone contributing to a defined-benefit pension plan today is subsidizing the under-funded pension payments enjoyed by current retirees of those plans.

I realize it's definitely a controversial topic, especially considering many Canadians are about as financially literate as my fluffy and ever-so-cute pooch. "Guaranteed pensions" courtesy of the government is probably a decent deal for the average Canadian who would fall apart financially if their interest expenses went up a few hundred bucks a month.

I for one would not be upset if "the swamp was drained" and my fallaciously esteemed government pension was changed to a contribution based indexing plan open to all working Canadians. One can only dream.

Despite the large contributions I make to my government pension plan, which ultimately shrink my paycheque, I don't add my pension value in our Net Worth Updates. I feel it would throw off our true accomplishment: building a great investment portfolio out of what's left of our paycheques after taxes and those massive contributions.

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## 11 Replies to “Why My “Gold-Plated” Government Pension Sucks”

1. Saskacthewstachian says:

I would have to very much agree with you, I have run these same numbers for my wife and the results come out the same. It’s a provincial plan not federal but the basics are the same. At age 55 she can get \$51,200 for life. If the contributions were invested myself between now and then it would be \$1,063k so (42.5k/yr) the big difference comes as the estate. Yes you get slightly more per year (8.7k/yr) from the pension but not enough to make up for the over \$1M estate that will be lost upon passing.

The numbers get MUCH worse when considering early retirement as well due to the % penalties applied for each year before the rule of 80 is reached.

Thanks for the post, just stumbled here from the MMM forum and it’s great so far!

2. Mr. Rich Moose says:

Thanks for the comment and kind words! Sorry for the delay in approving your post, I have strict comment moderation settings on new posters to prevent spam.

I’m guessing your wife’s plan has lower contribution rates? I feel my contribution rates are outrageously high.

3. I too came over from the MMM forum. Nice blog! I particularly like the layout. It’s easy on the eyes and not at all cluttered.

-TheGrimSqueaker

4. Saskacthewstachian says:

The contributions are quite high, although I don’t really have anything to compare them to. They are 8.7% of earnings if < YMPE then ratchet up to 10.7% of earnings after YMPE. The employer puts in 9.07% and 11.98% respectively.

5. Fire_at_45 says:

This post is topical for me. I opted out of my ex wife’s DB plan for a lot of the same reasons. If I invest the money myself I do much better than the plan (assuming fairly modest returns) and I can pass the money down.

I’m also in a locked in plan through work very similar to yours. I plan to call to see if they offer buyouts if you leave. That way if I ER I can take control of the investment.

6. Mr. Rich Moose says:

Does your wife’s employer offer a matching RRSP plan instead?

I can’t opt out in my plan if I wanted to, but it makes sense to contribute because of the employer contributions. I can take a lump-sum value out of the plan when I end my employment. However, that lump-sum is not necessarily based on total contributions. Instead, they take the actuarial value of the pension at the time so current interest rates are the big factor.

With the super low interest rates we have now, it makes financial sense for most people to take the money out of the pension plan — if they can invest it properly at a low cost. Given most people’s investing acumen it’s not something I would recommend for many.

7. carla says:

So, do you plan to take the cash rather than the pension?If so, do you think there is an optimal age for this? I also have a DB pension with the federal public service. I can take a great pension at 55, or a small one at 50 due to a hefty penalty. If i leave before 50 I can take the cash as a transfer value. The only problem I see with the cash as a portion of it cant be put into an RRSP and I will be forced to pay 50% tax on it. I hate that I would lose half of that portion. Also my health and dental insurance continues with a pension, but i’d have to find my own insurance if i took the cash. Not sure if this would be an issue if we had any health issues at that time.

8. Mr. Rich Moose says:

I think this depends on the circumstances. Right now, with current low interest rates used to value the pension, many pensions are better off to be taken in cash. With government pensions that I fully indexed to inflation (many are only partial or capped), I would use the 30x Rule to make this choice. If the commuted value of the pension is more than 30x higher than the expected annual payout after your tax hit, take the payout. Other pensions I would value at 25x as they are less certain or eroded by inflation over time.
A pension payout is separated into two categories. The first portion MUST be transferred to a Locked in Retirement Account / L-RRSP and this payment does not affect your RRSP room. The second portion (known as excess value/amount) is paid in cash and would be taxed. You can fill your RRSP room with this payment.
There are tricks to mitigate the tax issue. You can retire in January so your payout is not added onto a normal year of income, or you can build up RRSP room in anticipation of the payout. Done right your taxes on the Excess Amount of the payout should be around 30% max.
Also, once out of a pension plan, your taxes in retirement are much easier to control. You can shift your income to dividends and capital gains, split this income, and achieve substantially lower tax rates in most cases.
The health/dental plan is a different issue and depends on the value you want to place on it. Does your spouse have a plan? How much would a private plan cost? What are your realistic anticipated health costs? Could they be partially covered by other government benefits (seniors etc)? In Canada most people really overkill health care concerns. Unlike our neighbours, all emergency and non-elective procedures are 100% covered by provincial health care. The only real concern is dental and drugs. Dental can be done super-cheap while on vacay in Mexico, so that really just leaves drugs.

9. Mr. Rich Moose says:

In answer to your first questions, yes I plan to take the payout if the value to income ratio stays similar to what it is right now. It would actually be quite lucrative for me over time.
I don’t really see the choice as age based. To me it’s strict math and probability of success over time. If the math tells me I’m better off to take the payout in say 85%+ of all scenarios, I’ll take the payout every time. But I do have a high risk tolerance; some people do not so they might only be comfortable taking the payout if their 99% likely to be better off that way. Many others are so risk averse they will never take the payout no matter what the math says.

10. Thanks for this I’m in the same boat. I’m planing on retiring in my mid 30s (could retire now at 28 but I would like to be fat fire) I work for island health and have a db pension that is really bad mathematically so I will take the pay out as a LIRA and retire in January so minimize takes paid on the cash portion. It’s amazing to see how many nurses I work with that are so financially illiterate. I didn’t inherit any money all I did was learn about money when I was 18 and I am now able to retire only 10 years later while still going on vacations every year (infact I write this as I’m currently on a cruise to Alaska 🙂 thanks for the blog very insightful and well laid out you are the mrmoneymustache of Canada

11. Daren (Editor) says:

Thanks Matt and congratulations on seeing the light young! Financial illiteracy is an epidemic. It might even be worse for public workers who spend every dime of their net paycheques (and more in some cases) because they know they have a pension coming.

Comments are closed