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.
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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