Podcast - March 19, 2024
Latest Episode: Unpacking Retirement Savings: A Guide to Navigating Your Future
Ever feel like retirement planning is a maze? In our latest episode of Bare Naked Money, hosts Josh Sheluk and Colin White take you by the hand through the labyrinth of pension plans, group RRSPs, and the pivotal differences between defined benefit and defined contribution plans. With a straightforward approach, they discuss the impact of investment performance, the flexibility of group RRSPs, and the importance of being proactive in your retirement planning. If you’re seeking clarity on how to secure your financial future or simply curious about your retirement savings options, this episode is your compass. Tune in and start making informed decisions for a worry-free retirement.
The transcript is automatically generated
Announcer (00:00):
Welcome to Barenaked Money, the podcast where we stripped down the complex world of finance to its bare essentials. With your hosts, Josh Sheluk and Colin White Portfolio managers with Verecan Capital Management, Inc.
Colin White (00:13):
Welcome to the next thrilling edition of Bare Naked Money. Josh and Colin, back in the saddle here, and we’re going to have an exciting as scintillating a remarkable conversation about pensions.
Josh Sheluk (00:28):
That’s right. That’s right. It’s maybe not the most exciting, I would say, topic as it comes to mind, but I think we have some exciting thoughts about it.
Colin White (00:39):
Well, we’ll do our best to make it interesting, but this is one of those ones that the educational content here I think is quite good. This is a topic that everybody should have at least a rudimentary grasp on. We’ll do our best to make it entertaining. We’ve gone to great lengths to prepare this in the most scintillating way possible, trying to add as much excitement to it as we can, but we’re going to have a conversation about pension plans, group RSVs and the lot, and point out the differences, some common misconceptions and a few tips for how to take advantage of these things when you happen to be in a position where you’re trying to make a decision. Hopefully you’ll find it helpful.
Josh Sheluk (01:16):
Yeah, it seems like the vast majority of people that have some type of employment will encounter one of these at some point in their life, whether a pension plan and the pension plans, we will split in and define what a defined benefit pension plan is versus a defined contribution. So either that is coming across most people’s lives at some point, or the group RSP thing, which is similar but different.
Colin White (01:42):
And part of this is I’m quite excited to see that this is a very required part of being an employer in Canada, that you’re expected to provide one of these because this is important and people need to be paying attention to this. So this is something that is nice to see, be as prolific as it is in Canada, but it is important to be properly earned, understand the differences between your options that are out there. So let’s see if we can help.
Josh Sheluk (02:08):
Yeah, so why don’t you start calling. So I think we’re going to look at three basic categories today of these, let’s call them retirement savings plans. We’re going to look at a defined benefit pension plan. We’re going to talk about a defined contribution pension plan, and we’re going to talk about a group RRSP. Is that fair to bucket them in those three categories?
Colin White (02:27):
Sure. That we can do some comparisons between the three and maybe dispel some of the myths and confusion over them, but sure, absolutely.
Josh Sheluk (02:35):
Sure. So why don’t you start with defined benefit pension plans and give a little bit of an outline for what those are.
Colin White (02:42):
Well, sure. Defined benefit pension plan, and you can recognize this, and this is funny, this is the first thing people have trouble understanding is, well, what do I have? So a defined benefit pension plan has some kind of formula based on your years of service and your wage that ends up calculating what your pension’s going to qualify for. So when people start talking about how many years into the pension you have or your final five years, or they start talking about averaging their income, those are defined benefit plans and they are not as common as they used to be. In fact, very few new defined benefit pension plans have been launched, and there are many employers where the employees that have been there longer may have a defined benefit plan that’s been closed down, and new employees coming in have a different option, and it’s considered a little bit of the gold standard.
(03:35):
I mean, the current defined benefit pension plans tend to be government or very large company defined benefit plans because they are very onerous for all parties involved to keep track of. They’re very difficult, they’re very opaque and they come with some hair on them. And I guess to illustrate that, I can describe a court case that was recently came to fruition in the People’s Republic of Nova Scotia, where an employer, one of the things about defined benefit plans is they get valued and every two or three years they get valued to say, how well funded are they? Because there’s a calculation that can be done to say, you should have X number of money set aside in order to meet these future obligations. And those are done by actuaries and they’re very regimented and they’re very specific. So when a pension gets valued, it gets valued as being either fully funded, not fully funded or overfunded.
(04:34):
And because of pension legislation, there are tight rules around what actions are expected. So basically if a pension becomes underfunded, then there can be a requirement on the employer or employees to increase contributions to the plan to get it to be fully funded. And there’s thresholds that they set and the thresholds have changed historically. So the court case that was recently fought in Nova Scotia was over an employer that when they received their valuation, the valuation came in outside of the historic requirement, but inside of the current requirement. So the employer looked at it and said, we’re on side with the current rules, but for the period being measured, they were a little bit offside. So they said, good enough. We are currently, I think it was over 90% funded, so we’re all good. Well, the position that was taken by the union was involved, but also the province was, no, no, no, you have to write a check into the plan to make up for that Division C.
(05:36):
And so they went to court and they fought it. Now the pension plan is currently sitting over 95% funded, which is well within all of the current regulations for funding of a pension plan. So it’s considered very stable right now, but the court finding was no, you have to put an extra 3 million into it right away because it was underfunded in 2016 and 2017. The employer’s going, seriously, we don’t have that laying around that would operationally impact us and cause extreme difficulty, but it doesn’t matter. It’s the rule. So that’s the weakness or one of the weaknesses in the defined benefit pension world because there’s so heavily regulated that even if you assume everybody’s trying to get the proper outcome, the rules and regulations can make it more onerous to comply with and unnecessarily onerous is the complaint against them. So while they seem to have a whole lot of certainty to them as to what you’re going to get out of them in the end, there is a lot of complication to that.
(06:36):
And you do end up in situations where you think you’ve got a defined benefit pension plan, but because of the financial strength of the pension plan or the employer, you don’t. There’s big cases like Nortel in situations like that where people on a pension, all of a sudden their pension gets cut, they don’t have the assets they thought they had. And that’s absolutely tragic. And for people who really, really count on that income and they’ve worked their whole life, I got a pension upset and that’s all they have. That’s super, super impactful and very, very hard on. And it goes to, you really, really want to make a defined benefit pension plan your whole plan. There are those that would argue the government plans, governments are not going to pay pensions otherwise they can put it out, but there’s even limits within governments as to what they can guarantee to the workers. So that was a really long-winded answer and traveled down a long
Josh Sheluk (07:34):
Road. I’m glad you realized that. I’m still here.
Colin White (07:40):
I’ll shut up, Josh. I’m sorry. Did I answer the question?
Josh Sheluk (07:43):
Yeah, and then some. So, but there’s a lot to unpack there. So just to recap some of the key points I think that are really important that people understand. So with a defined benefit pension plan, as you said, your years of service, and there’s some formula that determines based on your years of service and your salary, what you’re going to get out on a monthly basis from the pension planning when you retire. So that’s very important for people to know. So it doesn’t so much matter for you what the investment returns are. You’re not actually directly putting money into an investment pot for you, which is determining your outcomes in retirement. There’s just a set formula based off of, again, years of service and salary. That is how you determine what your benefit is in the future. That’s why they call it again, defined benefit.
(08:34):
I think that’s really important to understand the reason, just tying all this together, money goes into the plan on your behalf, off your paycheck or whatever it is your employer puts it into the plan, then the employer is responsible for investing this money prudently intelligently so that when you retire in 30 years, what they’ve promised you is there for them. That’s where the disconnect sometimes arises. Is this defined benefit. If investment returns that the employer is making don’t get to that defined benefit, then there could be a lack of money there to pay out the employees when they actually retire the retirees. Is that a good sort of recap in a nutshell?
Colin White (09:24):
Yep. No, absolutely. The only piece I would add to that particular piece is the employers also contribute. So there’s two sides of contribution there, and that tends to be a negotiated thing that there’s a split 60, 40, 50 50, but it’s not all the employee’s contribution.
Josh Sheluk (09:39):
Sure, sure. Fair enough. And this is where there’s a risk for the employer because they’re depending on a certain level of investment returns to get the plan to where it needs to be to fund all these benefits in retirement. And if investment returns for a variety of reasons, could just be markets, could be interest rates, could be bad investment decisions on behalf of the employer who is ever managing that pension, if the investment returns don’t get you there, that’s problematic and that’s where it can become very onerous for the sponsor or the employer.
Colin White (10:16):
If you’ve got an active company that’s continuing to have new employees be hired, it’s an active business and there’s money flowing into the plan, you can recover because if there’s money going into the plan, you’re less likely going to be cashing out investments to pay out retirement benefits. So it buys you some time as an employer winds up or an employer is reaching the end of, or it’s getting a lot smaller. Again, the plans get a little bit more fragile because they don’t have as much of a timeline to work with. But it’s, again, it’s one of those things that the tragedy is people think this is the whole thing and I’ve got my retirement set on 100% of my pension income, then I’ve got it all spent. I still have a mortgage and I’m giving money to the kids, and then all of a sudden it drops by 10% and it’s the end of the world. So you have to build a little bit of cushion in there because of these plans.
Josh Sheluk (11:09):
And so what we’ve seen is private companies have moved away from defined benefit pension plans because they can be problematic in the sense they don’t want to stress the business by having to potentially put more money into pension plan that they might not have that scenario that you’re talking about. So the majority of defined benefit pension plans today for a new employee would be public entities of some sort. So municipalities, provincial governments, federal governments, quasi government entities. These are more so where we see defined benefit pension plans today. Fair. Yeah,
Colin White (11:46):
No, absolutely. And the frustration with them is on two sides, again, I’ve been around the sun enough, there’s also overfunding mechanisms. There have been times when pension plans have become overfunded and when they’re overfunded, there’s a requirement if you can believe this, to take somebody out of the pension plan to reduce the overfunding, which then makes it weaker when the next downturn happens. And it’s like, well, shit, we were fine. We had left the money there, we would be okay.
Josh Sheluk (12:11):
Now we’re,
Colin White (12:13):
There’s a real frustration to them. So I mean, there are those who say it was like, well, the employers owe that to their employees. Even a well-intentioned employer is going to look at them and go, but there’s better ways for me to get money to my employees. That’s better for all of us. Right.
Josh Sheluk (12:26):
And so ultimately just to again, make sure people understand what a defined benefit pension plan is. The way that I’ve thought about this is kind of like a buffet. What you see is what you get. You can’t go to a buffet and say, well, I want a lobster tail. A lobster tail is not there on the buffet. You don’t get that right. So they very clearly lay out what you’re getting. You come to the buffet, you pay your 30 bucks and you get all that that’s there on the buffet,
Colin White (12:46):
And you can eat at nine o’clock or 12 o’clock. You can’t eat at nine 30 and you can’t eat at 1230. You can eat at nine o’clock or you can eat at 12 o’clock. Right.
Josh Sheluk (12:54):
Okay. Good stuff. So contrast that with a defined contribution pension plan, then what’s the difference there?
Colin White (13:02):
I almost want to call this the worst of all worlds. It’s under the Pension Act. So it has some fairly stringent requirements on it, but it’s more about the money that goes in. You can see it, you can see how much money is in your account and in some cases you can make choices as to how it’s invested, but it’s transparent At any moment in time, you can understand where you stand now, being in a pension plan, there are restrictions on taking it out. So I guess said it’s kind of the worst of both worlds. It still has some pension restrictions on it, and those pension restrictions are designed to be paternalistic so that you can’t blow it all in RV the first year you retire, because again, the government doesn’t want you doing that because now you’re going to be a problem that they’re going to have to support.
(13:48):
So they put restrictions on them as far as how the money can come out. They’re not particularly onerous, but it makes it behave a lot like a defined benefit plan as far as longevity, it’s just designed to pay out over your lifetime. The advantage to it is that it’s there, you can see it year over year. You can sometimes adjust your investments as you get close to your retirement so that it’s more lined up with your particular situation. And there’s some more flexibility on taking it because a defined contribution plan typically would go into a locked in RSP or a lift, and there’s more control over how the income comes out within a range when the income comes out within a range. So it does add some flexibility for sure, and gets away from that valuation calculation that we’ve described as being fairly burdensome on all parties involved. So it’s kind of the middle ground, and honestly, I don’t see a whole lot in that realm now because again, it’s a halfway to the third option that we’re going to talk about.
Josh Sheluk (14:47):
So just to again, take a step back. So defined contribution, what is defined as how much money is going into these savings plans, what you get out of the savings plan when you retire depends on the actual performance of those investments. So just like any investment account, you can see what goes in. You can track the performance on a day-to-day or month to month or year to year basis, and 30 years from now when you retire, the amount that has grown to determines how much you may be able to pull out of that pension plan over the course of your life. So define benefit again, just to recap, you’ve worked here for X number of years and made a salary of Y. You’re going to have a $3,000 a month payout when you retire. Defined contribution doesn’t really matter how long you’ve worked here for or how much you’ve made when you retire, your pension plans worth $300,000, take from it kind of what you will with some limitations, but this is how much you have to live on the rest of your life. So it’s kind of the risks are transferred in some ways. So the risk of the market return lies with the pensioner, not the company. And the risk of living too long or outliving your savings, again, lives with the pensioner, not with the company. Whereas those two things on a defined benefit pension plan live with the employer.
Colin White (16:10):
But I would like to highlight one of the real big advantages of a defined contribution plan because again, there’s limitation of you assume the risk, but you also gain the flexibility. Sure. So I’ve gone through situations where client retires, that’s it. They’re done. We start pulling money out, and two years in it’s like, well, shit, I’m bored. Can I go back to work? And in those situations, you can stop the income out of the pension or that account and therefore not experience the taxation that would experience by working and drawing a pension at the same time so that the flexibility that comes with a defined contribution plan is sometimes undervalued. And a lot of it depends on your path. But I love flexibility from a planning perspective. And I think that’s one thing that gets undervalued by people. You may think you want to retire, talk to me two or three years. In fact, go talk to somebody who’s retired in the last two or three years, do a temperature check, see how they’re doing. People’s lives don’t go in a straight line.
Josh Sheluk (17:11):
So flexibility is a big one for sure. So not only can you do have some control over the flexibility of when the timing of payments are, but also the amount to some extent, how much you pull out when. So you could front load it if you want. You could kind of back load it if you want. It doesn’t have to be the same amount month after month throughout your entire 20, 30 years of retirement, which is a big thing. It’s a big thing for sure.
Colin White (17:33):
And you can change your mind. You can change your mind. You have one plan now next year you can change the plan to look in within boundaries so you could change the plan.
Josh Sheluk (17:41):
Yeah. Okay, good. So yeah, the analogy here is it’s more like you’re bringing your own ingredients to the Cookoff, right? And there’s maybe you have a pantry, you have a pantry to choose from, and you can choose the different ingredients that you want. And so the end result of your meal is going to be a lot more determinant by your cooking skills as an individual. So you have, again, set pantry and you kind of have to cook the meat yourself, although you’ll get some assistance along the way by the employer on this one for sure.
Colin White (18:16):
Absolutely.
Josh Sheluk (18:17):
Okay. So Roland right along here, then you have before we move on, I think it’s really important to emphasize the employer doesn’t really have a whole lot of risk with a defined contribution pension plan. There’s no risk that they have to put more into a plan because the market hasn’t performed as well as it has, and there’s no possibility that they get to take money out of the plan because the market’s performed better than expected. So that’s why employers have gravitated more towards this side of things where they’re not bearing the risk of the market underperforming where their expectations are.
Colin White (18:50):
Well, some of that risk is also on the current employees because one of the determinations that can be made is that contributions have to increase. So if the pension plan is underfunded, they can go back and say everybody’s got to put more money in the employees and employer, so then the employees that are still working are paying for the deficit for the employees that are already retired. So again, it just transfers the risk. The risk is more malleable, if you will, in a defined benefit situation compared to a defined contribution.
Josh Sheluk (19:20):
Right. So lastly, we have what we’d call a group, RSPA group, RRSP also. And so how does this, this is more similar to defined contribution pension plan, but how does it differ from that?
Colin White (19:33):
The wild west? Maybe you can do whatever crosses your mind. So the group RSPs are the most transferable, understandable. It’s basically just an RSP that your employer normally would put money into. So instead of matching money into a defined contribution plan or making a contribution to a defined benefit plan, they set aside money, and typically it’s done in a matching fashion. The employee contributes 3%, the employer matches at 3%. It goes into an RSP account for your own use, calling it a group RSP, it’s going to come off your paycheck. And the advantage to that is that it reduces your withholding tax right away. So instead of making a big RSP contribution and getting a big tax refund, you make the same RSV contribution and you just have a little bit less tax taken off your paycheck throughout the year. Now for those of you who treat your tax refund as a forced savings program, okay, this isn’t going to work for you putting a big contribution and you’re not going to get a refund.
(20:33):
And people get sad about that, but if you think about it, the government has your money all year and they’re not paying you interest when they give it back to you. So it’s a pretty shitty savings account. So the group RSP is very efficient from reducing your taxes as you go compared to the other way of getting a big refund at the end of the year, and you can invest it in any investment that’s allowed in an RRSP, which is pretty much anything that crosses your mind and you have infinite flexibility of what to do with that. If you again want to cash the whole thing out your first year of retirement to buy that RV and pay the tax, there’s nothing standing between you and bad decisions. You can do whatever you want. A lot of group RSVs will allow you to make additional contributions over and above which your employers matching. You want to put more into the plan? Sure, go ahead. It’s still bound by RSP contribution limits for sure, but it is the ultimate flexibility and very easy to move from one institution to another or one employer to another as you go.
Josh Sheluk (21:35):
So just like a defined contribution plan, you put money in your employer matches a certain amount. The risk is with you as the investor with how the market performs, how your investment performs over time. You get to withdraw money from this RRSP presumably in retirement or really whenever you want, but presumably in retirement, and you have investment options that are made on your behalf. The difference here is that with a defined contribution pension plan, you typically have fewer investment options, and with a defined contribution plan, you typically have less flexibility in terms of the amounts and the timing of your withdrawals. You still have quite a bit of flexibility with a defined contribution pension plan, but you have more flexibility still with the group RSP in a nutshell. Good. Yep.
Colin White (22:28):
Yeah, no, absolutely. Absolutely.
Josh Sheluk (22:30):
Alright, so just continuing on with the analogy, this is like you’re still cooking the meal, but you have the full grocery store to pick from. So you don’t have just a small pantry, you have the full grocery store to pick from.
Colin White (22:42):
You could be as silly as you want to be
Josh Sheluk (22:46):
And just like a defined contribution plan here as well. The risk is not born by the employer. So if market returns, investment returns, if your portfolio doesn’t perform well as well as you’d expect, that’s not up to them. That’s up to you.
Colin White (23:05):
Well, yeah. And then that’s one of the weaknesses with the group RP market because oftentimes group RSPs are kind of thrown out. You tick a bunch of boxes, you end up in investments maybe with not all the guidance in the world, and that can be a little bit dangerous depending on how the plan is constructed. So even I’ve got clients to bring it into me, their RSP statements and say, Hey, what should I do? And we kind of go through it with them and give them some support and making decisions. Again, if your employer’s matching it’s free money, my professional expert opinion is take free money. So whatever they’re matching, and you would be gobsmacked by the number of people who don’t take the free money. If somebody’s offering to match money, give them the money, let them match it because good. But to understand what the options are and make sure that you’re not investing in the first Bitcoin ETF or some other cock baby scheme because those can be in those plants in theory. Now most responsible employers don’t let that happen, but there is enough rope there to hang yourself with. So if working with an advisor, absolutely go to your advisor. There shouldn’t be an advisor on the planet that’s going to begrudge you taking free money and they should give you a little bit of guidance on how to make decisions that are right for you. And once you leave the employer, then it’s going to be 100% your account to go get advice on and do what you see fit.
Josh Sheluk (24:24):
Yeah. So the pension plan options are a bit more guided and protected, almost protecting people from themselves and protecting them from not only lack of knowledge, but perhaps behavioral challenges or issues when it comes to investing as well.
Colin White (24:42):
Yeah, you want to get metaphysical about it. I mean, you have the completely guided, protected, you can’t be trusted to make decisions on your own. We’re going to make sure you have enough money to keep yourself warm and eat approach, which is the defined benefit plans. We’re taking all the decision making away from you. We’re going to make it very, very tight, very, very stringent, what you can and cannot do. Then there’s the middle ground. It’s like we trust you a little bit, but not all the way. So we’re going to put guardrails on it so you can’t really get completely in the ditch. And then there’s the RSP, it’s like, Hey, you’re on your own, go nuts, whatever you want. And they have the downsides associated with that. Something that’s very, very protective is going to not be very flexible and not be able to react to circumstances well, because honestly in that scenario, they don’t trust you to make good decisions.
(25:28):
They don’t want to give you the ability to make decisions. So they’re taking all your decision making away from you saying, do you want to eat at nine or nine 30? Those are your two choices. You can’t choose to eat later in the day you have nine or nine 30 because we don’t trust you to make the decision to eat at a proper time. So that end of the spectrum, and it comes with all of the negative associated, so people argue about once better than the other and all the it and honestly, they all are just a different flavor and some rely on individuals to make better decisions. The burden of having an RSP is that you do have an obligation to pay attention to it every so often and your decisions count the pension plans you don’t, or sorry, defined benefit plan. You don’t have the burden of decision making other than do I eat at nine or nine 30? That’s the only decision you have to make.
Josh Sheluk (26:21):
Yeah. So that leads to interesting question for me. Do you think in your experience has one or the other led to better savings outcomes, let’s say 35 today hypothetically and I have an option between these two, you’ve had the experience of working with people through their life cycles more than I have. Do you find that one person is better off into a defined benefit plan than a defined contribution? Or is there not really any consistent conclusions to draw from that?
Colin White (26:53):
No, there’s no simple answer to that. So it would come down to a couple of things. Number one is the individual, how disciplined are they comfortable are making decisions because sometimes just the burden of making decisions is too much. The burden of making decisions just is overwhelming and they don’t like it and it causes anxiety. So you have a behavioral aspect to it for sure. But if the behavioral aspect is okay and you have somebody who can handle the responsibility of making decisions, life doesn’t go in a straight line. So I always have a bias towards flexibility and I trust and people are going to use that for good. It could be a very extreme event where there’s a health event of some description and your financial situation dramatically changes. If you’re living off of a defined benefit pension plan, there’s not a whole lot financially you may be able to change, but if your money is sitting in a well structured RSP portfolio, we can dramatically change how we’re dealing with the tax planning and the money and estate planning and all the rest of it. So I personally have a bias towards flexibility properly used. It can dramatically improve the outcome, but I also am smart enough and wise enough to realize that that comes with a burden decision making that not everybody’s wired for and not everybody’s comfortable with. And at the end of the day, math is math. Math and math would tell you that having flexibility is way better, but behavioral issues are also real too, and that can overwhelm the math and make it not matter.
Josh Sheluk (28:29):
So follow up question. I forgot what I was going to ask.
Colin White (28:36):
It’ll come back. I’ll jump in right here because there’s one tangential conversation that goes on and it’s indexing. One of the things about a defined benefit plan is that there is a notional head fake towards indexing. Say it’s a notional head fake. Normally it’s written in there as like indexing is going to be plus or minus 2% of the blah blah. The average of this, the average other thing when possible kind of stuff. I have not seen in recent memory a pension plan that says we were absolutely going to index this pension at the CPI every year. That doesn’t exist. So people, again, in effort to simplify and those who get attracted to the simplification of the formula and say, oh, it’s indexed, I’m fine. The word index may be somewhere in the documentation, but it may not be as concrete as you think. It’s, and the examples that I’ve seen in provincial pension plans is that the pension plan when they do the evaluation is when they make the determination as to whether or not they’re going to provide indexing right now, which is truly horrifying to somebody who is thrown over all the decision making to the beast, and the beast becomes nebulous on what it’s going to do.
(29:55):
So people reading the word index, read the words around that, because I haven’t seen a pension plan that in black and white guarantees 100% indexation to the CPI on an annual basis. I haven’t seen that. There’s always a formula, there’s a cap, and it’s one of the things that a pension plan can and sometimes must change if they enter a period of being underfunded. So one of the actions that the pension administrator can take is to say, our funding level is now at 83%. We’re below the 85% threshold. Here are the following actions we’re going to take to get this properly funded, and this is one of the actions they can take. So if you’re going to retire early retirement at 50 or 55 on a defined benefit plan, and you’ve bet all of your life on that, oh dude, seriously have a shock absorber, have a bit of a plan that this may not last 40 years fully indexed to CPI because there’s a really good chance that that’s not the experience you’re going to have and you are going to have to rely on yourself a little bit. So there’s a real danger in completely abdicating all the decision making and all the responsibility in a defined benefit situation because again, many people go, I don’t need RSPs. I’ve got mentioned, dude, are you sure? Let’s read the fine print.
Josh Sheluk (31:15):
Yeah, you’re relying a lot on that pension sponsor and if it’s the government of Canada, it’s probably a pretty reliable pension sponsor. But if it’s Nortel Networks or Sears Canada or the other company that you’re talking about, maybe not all of them are as robust or have the fallbacks to tax at 35 million population if they have a shortfall on something.
Colin White (31:37):
Well, and again, even the government plans, the indexation is actually off of one of the provincial plans was looking at recently. That’s
Josh Sheluk (31:44):
Not problem. It’s not one for one necessarily. Yeah,
Colin White (31:47):
Yeah, exactly. So I mean there’s even uncertainty there. So again, I’m not a doomsayer. I’m not saying that they’re going out of business or all the rest of it, but I just caution people on how much they rely on it. But similarly to how you and I have both cautioned people who real estate investing over the last few years, it’s not that it’s bad, it’s just it’s not the one answer to all the questions.
Josh Sheluk (32:08):
Right, right. Now remember I was going to ask before, so have you seen more recently, have you seen people make employment decisions with the pension plan or retirement savings options being at the forefront of their decisions? Or is this way down the list? For most people,
Colin White (32:31):
It changes. It’s in the equation depending on the age of the employee. So most people working with business owners, I’ve this conversation with business owners that have fantastic employees, and by the time they hit age 40, if I’m not offering them a retirement plan, I’m going to lose them across the street for less money to get into a retirement plan, even if it’s just a group RSP, because your age affects how you look at these things. So there’s two ways An employer can use a retirement benefit package. They can do it to entice somebody new in job market where you’re trying to bring in new talent and you’re trying to bring in the experienced talent in the older, and you’re putting together a package for them, then you can use a generous retirement matching package to bring people on board. That’s one method, that’s one strategy that some business owners in some markets need to do that you need to come to the table upfront with your guns blazing.
(33:33):
You have to have a really comprehensive benefits and retirement package to get people through the door. It’s part of the competition. There’s another group of people who they bring people on and the longer they stay with them, the more valuable they get and you’re looking to entice them to stay. So in those situations, they maybe are a little light for the first year or two on their retirement matching, but then it progresses pretty quickly so that the employees now sit there going, well, if I stay here for another year, I want to get another 2% into my R rsp, and that’s a big deal. So they’re enticing the loyalty. So it can absolutely, depending on the industry and the age of worker that you’re trying to attract to keep, can absolutely be a very effective tool and it can have a disproportionate effect. You give somebody a 1% raise, maybe that’s not motivating. You match 1% in their RSP, you’re looking after my retirement. So you’re looking for
Josh Sheluk (34:31):
That psychological effect.
Colin White (34:32):
You’re looking for that, and it’s real. It’s absolutely real. You’re looking for received value of what you’re offering, and again, as an employer, you can get into, okay, we’re going to contract with a firm that’s going to provide a bunch of planning support to our clients, to our employees. So we’re going to, instead of taking it out of the box solution from one of the major insurance companies, we’re going to contract to the company that can actually provide some advice to our employees. I mean, it’s an old expression, Mr. Client, would you not agree that a financially secure and stable employee is a more productive employee? That’s the sales pitch I’m reading from a sales pitch I was given a long time ago, but that’s actually honest. There is a correlation between the financial stability of an employee and the reliability of an employee. So the stakes are pretty big.
Josh Sheluk (35:20):
And I would say if you get longer in a career with a defined benefit pension plan, that becomes a hard thing to leave at some point. People seem to have, well, I’m 30 years into this, I only have to go another five years and then I get a full pension. It’s a hard thing to break, right?
Colin White (35:36):
Well, fuck is a full pension. I mean, it’s something else. If people pick a retirement date based on a formula, it’s like you realize that every year you work, you get another, whatever the formula is, 1.4 or 2% of your wage every year you work. So I’m going to work for five more years. Well, your pension goes up a year for now too, and they get caught. It’s like, oh, I have to hit this finish line. Really, I guess plus or minus 150 bucks a month worth another year of torture. So again, people get caught in that. And the other thing that we need to point out is with defined benefit plans, there is something called a community value. So there can be an opportunity that, okay, listen, I didn’t make it to age 50 with this employer, but I contributed to this and the employer contributed to this pension plan for 20 or 25 years and I’m going to another employer, or I’m just leaving that employer.
(36:26):
What sometimes can be put on the table, not all the time is the commuted value, but the commuted value is the calculation of the net present value of the future pension obligation. So there’s a black box, they stick a piece of paper, one side, the put paper out the other side, and the number comes out and it’s really, really opaque and it can be affected by the funding level of the pension. It can be affected by all kinds of things. Current interest rates are a big deal. So it’s a calculation that’s done periodically, but you can put yourself in a position where they say, you know what? We are going to buy from you the future obligation that we have to pay you X number of dollars starting at your age 65. The present value of that is $400,000. Here you go. So there’s different ways you can avail yourself of that, if at least leaving the employer for sure.
(37:17):
And some employers will offer commuted value. Some won’t be on certain thresholds, like if you’re over age 55 or there’s different parameters. They don’t necessarily have to offer you a commuted value, but it is something that’s out there and can be done. And that’s something that you really do need to get some advice on to make sure that that value is a fair. What you want to do is do the math to say, okay, if I took this money and made some reasonable assumptions, could the sum of money and my estimation pay that money in the future? Is this a reasonable sum of money given those future payments? That’s the math that we could do and say, yeah, you know what? We’ll come back and say, as long as we average a five or 6% rate of return, it’s reasonable to expect this pot of money can provide the income you’re looking at. Then you say, alright, that’s not an outlandish assumption. Great. And for that, you get all of the flexibility that comes with getting out of a defined benefit plan and having the sum of money to manage.
Josh Sheluk (38:13):
Yeah. Do you think we’ve highlighted longevity risk enough with this conversation? Maybe not. That’s
Colin White (38:21):
A whole other podcast.
Josh Sheluk (38:22):
It could be, but I think it’s worth mentioning briefly here, with a defined benefit pension plan, you get a set amount of money for the remainder of your life. That could be three, it could be 30 years. It’s the same amount of money, maybe adjusted for inflation for that period of time. Again, assuming that the pension plan doesn’t go under or whatever, and that’s a risk that you take if you have a defined contribution or an RSP, that’s a risk that you take separately on your own. You need to fund your lifestyle for the remainder of your life through your savings and through intelligent investment decisions. And so that’s another risk that’s maybe not discussed as much. We focus so much on market risk, we think less about the longevity risk thing, but it is certainly a risk when you don’t have that defined benefit plan in place.
Colin White (39:19):
It’s also an opportunity you could decide to live a more vibrant lifestyle for the first 10 years of retirement and spend money on travel and then scale back. You’re living expenses later on the same pile of money.
Josh Sheluk (39:31):
There’s pros and cons to it for sure, because what happens if you die after three years? Well, there might be a survivor benefit there of some sort, but you’re going to be a lot less well off, or your estate would be a lot less well off than it would be if you had your full chunk of money and you decided to kick the bucket at 68.
Colin White (39:50):
Yeah. Well, listen, there’s a huge back and forth with this and overarchingly, what I hope people get from this is they get out of the camps of one’s better than the other. They’re all just different ways of managing the risks. They all have upsides and downsides. So in your own personal situation, take a look at the options that are available to you. Maximize those options. Don’t think you’d be better off if you happen to be in a different situation and had a different option in front of you, because again, it really depends on how life plays out.
Josh Sheluk (40:20):
Yeah. Any final thoughts? Anything we didn’t talk about? Anything I didn’t ask?
Colin White (40:26):
A little longevity risk that you brought up at the end actually is an interesting one because again, the scientists are telling us the first person to live to be 150 years old has already been born. So you start putting that lens on. You go, Ooh, okay, are we using the right math? Do we really want to burn the rocket early and not leave much for later?
Josh Sheluk (40:46):
If I retired 65, that’s a long stretch of time. Right?
Colin White (40:50):
Well, and again, we’ve talked about this, where you go back in history to where retirement came from. Retirement age is set longer beyond life expectancy. So if you made it to retirement, yay, you one of the few that made it there. Congratulations. And now it’s something we’re counting on. Many retirements are going 30 years plus. Wait. So over a third of your life, you’re going to just sit home and live off your investments. That takes different math. We might not be accepting that math. That’s another great podcast. We should do
Josh Sheluk (41:22):
Good. Plug for next time, talk about how we can live to 120 and still finance our retirements.
Colin White (41:29):
There we go.
Josh Sheluk (41:30):
All right. Looking forward to that one, Colin.
Colin White (41:32):
Thanks. Talk to you soon.
Kathryn Toope (41:35):
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Please note the information provided in this podcast is for general information purposes only. It is not intended as financial investment, legal, tax, accounting, or other professional advice. Our discussions are not a solicitation to buy or sell any securities or to make any specific investments. Any decisions based on information contained in this podcast are the sole responsibility of the listener. We strongly advise consulting with a professional financial advisor before making any financial decisions. Listeners should be aware that investing involves risks and that past performance is not indicative of future results. Bare Naked Money is produced by Raan Capital Management, Inc. A licensed portfolio management company in Canada. We operate under the regulatory framework established by the Provincial Securities Commissions in the provinces within which we operate. The views expressed in the podcast are our own and do not necessarily reflect the official policy or position of any regulatory authority. Remember, at Rakin Capital Management Inc, we focus on aligning our goals with yours, prioritizing integrity and transparency. For more information about us and our services, please visit our website. Thank you for listening and let’s continue to challenge the norms of the financial services industry together.
