Author Topic: Early retirement language and communted pension benefits etc.  (Read 5349 times)

vwDavid

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I need a little linguistic help.

Scenario. DW and I are both MMM and contemplating early retirement very soon (hopefully before the age of 40).
I do not have pension benefits from my employer. We are in canada and have to manage our own RRSP.
My wife has pension benefits as she is a staff person at a university. My wife is age 38 and has 10 years of service at this university. Below is a cut and paste from her pension benefits handbook.

I am trying to figure out the value of her pension to us if she terminated her employment early and how to best maximize the outcome. I am not familiar with the language and need a little bit of help to translate it to something understandable.

Benefits on Termination Prior to Retirement
If your employment is terminated for reasons other
than death or retirement you may elect to:

(i)
Receive a deferred retirement benefit
upon
receipt of application
after age 55.
 
The pension payable at age 65 is
equal to the
retirement benefit which has accrued to
your credit up to your date of termination.
Deferred vested benefits will be indexed at 3% per year
from age 45 or your
age at date of termination, whichever is later,
to your pension commencement date or age 65, whichever is earlier, or

(ii)
Transfer the value of your retirement
benefits (the commuted value) to an RRSP or
to another registered pension plan.
Pension benefits earned after January 1,
1993 are subject to locking-in legislation.

If you elect the deferred retirement benefit, you may
commence the pension as early as age 55. However, the
pension will be reduced for early retirement. The pension
at the early commencement date will be actuarially
equivalent to the pension payable at age 65.


Can someone help me put some numbers to a scenario so I can numerically visualize this legal lingo?

Thanks


arebelspy

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Re: Early retirement language and communted pension benefits etc.
« Reply #1 on: July 03, 2013, 12:33:05 PM »
Have you gone to talk with the administrator of the pension plan?  They will be able to guide and direct you much more clearly (and likely tell you stuff that may not be included there).
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vwDavid

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Re: Early retirement language and communted pension benefits etc.
« Reply #2 on: July 03, 2013, 02:09:52 PM »
No, I have done that yet. I mostly prefer to try to do the leg work myself, however I suppose I will have to.

I now understand some of the lingo and I guess what it comes down to is a comparison of the commuted value vs. deferred benefits both of which will be a calculated value with some actuarial magic involved that one can not necessarily do oneself. It appears that most defined benefit pensions involve a calculation using the years of service as a multiplier of the payout so that 10 y/s vs 35 y/s will pay out dramatically different amount whether deferred or not and this seems reasonable of course.

There exists very little discussion of early employment termination and how it affects the employees pension benefits. I guess I will have to lift the phone...

arebelspy

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Re: Early retirement language and communted pension benefits etc.
« Reply #3 on: July 03, 2013, 02:22:00 PM »
There exists very little discussion of early employment termination and how it affects the employees pension benefits. I guess I will have to lift the phone...

It's because so many plans are different.

I have a spreadsheet I made for mine that shows 11 different scenarios with various combination of options (purchasing years of service, retiring early at various ages with penalties, etc.) and allows me to input various rate of return and inflation assumptions and graphs the results to see various breakeven points.

There are just too many variables to be able to discuss, and they vary so much between plan providers.

Just about the only question that can easily be discussed (and one that often is on forums like E-R.org) is: take lump sum, or keep pension? (And again, it depends on the details, but the most common answer is to price a SPIA you could buy with the lump sum and compare it to the pension.)

Also suspect that most here, being a younger crowd, won't have pensions.  More common among older folk, like the E-R.org group.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
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pom

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Re: Early retirement language and communted pension benefits etc.
« Reply #4 on: July 04, 2013, 03:58:33 AM »
I would need some info. Do you have the "retirement benefit which has accrued" or at least the accrual formula? Typical formula is 1.5% or 2% of final average pay per year of service. Average pay is usually defined as average of last 3 or 5 years.

So lets say it is 2% per year of service and she earns 30 000.

Her choice will be:

- get a pension of 30 000 x 2% x 10 years x 1.03^20 (adjustment from 45 to 65) = 10 800 a year starting at age 65. Note that assuming an average of 3% inflation between 38 and 65, that would be worth about 4900 a year in term of purchasing power.

- get a pension starting at age 55. Typically the amount received is about 50%-60% of the age 65 amount, it will depend on the interest rate environment when she reaches age 55. This is the "fair amount" for them to pay considering that she will receive 10 extra payments and receive them much earlier than if she waits until age 65.

- get a lump sum that can be transfered to a locked-in RRSP (it means that will not be able to withdraw anything until a certain age, that varies by province.

Note that I haven't worked in Canada for more than 15 years so don't take this as gospel, your pension administrator will have more precise numbers.

Let me know if there is any sentence that are not clear and you would like for me to expand on.

Posthumane

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Re: Early retirement language and communted pension benefits etc.
« Reply #5 on: July 04, 2013, 08:44:28 AM »
What pom has said is very similar to how my pension plan works as well. Basically, since you are quitting before the normal retirement age range (55-65) you have the option of getting your regular pension payments when you reach that age ("deferred payment"). You won't be working and paying into the plan, so your payment amount won't go up substantially, but it will be adjusted to inflation over that time. In your case that increase will be 3% per year starting at age 45, until whenever you decide to take the pension. My plan has a 5% penalty per year for taking the pension before age 65, so if I were to take it at 55 I would only get 50% of my regular amount.

The second option they give you is you take the equivalent current value of your pension as a lump sum and transfer it to your RRSP. How this is calculated varies from place to place but you should be able to get that number from your pension statement if you get one, or from HR. One caveat with this option though: What you and your employer paid into your pension plan was deducted from your RRSP contribution room (using the pension amount box on your tax forms) and so you can transfer that amount to an RRSP tax free even if you have no contribution room left. However, the value of the pension has likely grown substantially over what you actually contributed, so your transfer amount will be more than what was deducted from your contribution room previously. If you don't have enough contribution room left to make up for the difference, you may have to pay income tax on part of the transferred amount. Also, it would all have to go into a special RRSP called a Locked In Retirement Account (LIRA).

arebelspy

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Re: Early retirement language and communted pension benefits etc.
« Reply #6 on: July 04, 2013, 09:45:08 AM »
Mine is not adjusted to inflation during the "gap" years - it stays the same in nominal dollars, so when I finally take it it starts up at the same salary when I left (significantly less then in terms of real dollars due to inflation).  It is eventually COLA'd after I start taking it, yes, but off that base (original) amount.

Mine, however, is not Canadian, so I'd be more inclined to think yours is like the above ones, however it's still best to call.  Making major life decisions hoping your case is similar to others would be silly.  :)
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
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vwDavid

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Re: Early retirement language and communted pension benefits etc.
« Reply #7 on: July 04, 2013, 11:59:41 AM »
Hi guys, thanks for giving me a little help on this.

Here is the pension calculation:

Quote
For service on and after January 1,1990
1.7% of your average annual basic salary
over 60 consecutive months of your highest
earnings multiplied by the number of your
years of credited service at the University
from January 1, 1990
Less:
0.5% of your average maximum pensionable
earnings under the Canada Pension Plan
(YMPE) multiplied by your years of credited
service at the University since January 1,
1990.

and here is an example which I'll borrow the YMPE stuff from
Quote
An example of how your pension at Normal Retirement Age will be calculated
John Doe became a member of the Pension Plan July 1, 1981 when he was 35 years of age and remained employed by the University until his retirement 30 years later July 1, 2011. His average annual earnings during his highest five consecutive years was $55,000, and his average maximum pensionable earnings under the Canada Pension Plan (YMPE) when he retired was $48,533. Mrs. Doe is three years younger. His pension is calculated as follows:
.0213 of $55,000 x 8.5 yrs.
Less CPP adjustment
.0063 x $48,533 x 8.5 years
$9,957.75
$2,598.94
$7,358.81
Plus
.017 x $55,000 x 21.5 years
$20,102.50
Less CPP adjustment
.005 x $48,533 x 21.5 years
$5,217.30
$14,885.20
Annual Pension (subject to annual cost of living adjustments) if 50% survivor benefit is elected:
$7,358.81 + $14,885.20 = $22,244.01
The pension will be paid in monthly installments. This amount is payable to John Doe for his lifetime and if his wife survives him, she will receive a pension for her remaining lifetime equal to 50% of John Doe’s pension. If John Doe is not married, or his wife dies before he retires, his pension will cease with the payment made on the first day of the month in which his death occurs. In both cases, the pension is increased each year to a maximum of 3% in accordance with changes in the Consumer Price Index.
In addition to the pension calculated above, and any payments arising from voluntary contributions, John Doe can apply for Canada Pension Plan benefits and Old Age Security benefits.


and

Quote
Indexing
Your retirement benefits will be adjusted each year after
retirement proportionate to changes in the Consumer
Price Index. However there is a limitation that the
pension may not increase by more than 3.0% from one
year to the next.

So, if my wife quit after 11 years service and deferred her pension to age 65 I am thinking the yearly benefit would be:

0.017 X $50,000 (est.) X 10 X 1.03^20 = 15351.95 / year or about 1279 per month at age 65.

Assuming a life expectancy of 85 years this could be a $307000 benefit (not including indexing during retirement)

Now, perhaps she draws pension early at age 55

Quote
Early Retirement Benefits
Provided you are 55 or older, you may early retire under
the following provisions:
If you are age 60 or older and have at least 10
years of credited service, there is no
reduction.
If you are between age 55 and 60 and have at
least 10 years of credited service, your
pension will be reduced by 5% per year for
each year the early retirement date is below
age 60
. However, if the total of your age plus
credited service equals 80 or more (“magic
80”), the 5% per year reduction is waived.
If you are between age 55 and 60 and have
less than 10 years of credited service, your
pension will be reduced by 5% per year for
each year the early retirement date is below
age 65.
If you are between age 60 and 65 and have
less than 10 years of credited service, your
pension will be reduced by 5% per year for
each year required to reach age 65 or to
reach 10 years of credited service, whichever
is less.

So I think this is correct:

0.017 X $50,000 (est.) X 10 X 1.03^10 X 0.75 = 8567.47 / year or about 713.96 per month at age 55.

With an estimated life span to age 85 (30 more years) the pension benefit would be $257,024 (not including indexing during retirement)

SO, now it appears I would need to address the option of determining the commuted value for some sort of comparison to take place. Thanks for helping me learn this guys.


vwDavid

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Re: Early retirement language and communted pension benefits etc.
« Reply #8 on: July 04, 2013, 12:03:51 PM »
oops, I forgot to do the CPP subtraction in both cases... anyway, it was a start.

Thanks

arebelspy

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Re: Early retirement language and communted pension benefits etc.
« Reply #9 on: July 04, 2013, 01:16:30 PM »
Does your pension company not help at all with this?

Mine literally will schedule you an appointment and sit down and run the numbers with you (and then, traditionally, they'll go over other options if they exist, like taking the pension early, purchasing years of service, taking a lump sum, etc.)

I can totally understand your wanting to calculate it yourself (if nothing else but to go into the meeting armed with a rough idea of what it should look like), but it seems that you just don't want to meet with them for some reason, so are determined to figure it out yourself instead and hope that it's right.  Hope I'm misinterpreting that.  :)

Anyways, the math looks right except I'm not sure why you're multiplying by 10 instead of 11.

Also you'll want to calculate the option of retiring at 55 versus 60 based on various return scenarios.  Getting the guaranteed 5% per year boost is decent, but it'll likely depend on the interest rate environment at the time.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
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pom

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Re: Early retirement language and communted pension benefits etc.
« Reply #10 on: July 05, 2013, 03:27:32 AM »

Hi David, a few points

1. As you mention, you need to reduce this by the CPP offset

2. The way that the benefit are reduced for people retiring at 55 and the way that they are reduced for someone that left and want to commence his payment at 55 are usually calculated differently (companies tend to give more to early retirees than to defered members). There is probably a paragraph that address the issue.


0.017 X $50,000 (est.) X 10 X 1.03^10 X 0.75 = 8567.47 / year or about 713.96 per month at age 55.


This is probably not the right formula.


3. It appears that the 3% is not guaranteed, the percentage to use is the lowest of inflation and 3%.

4. As far as value goes, I would not necessarily just multiply by the number of years left to live. The question is what is the amount of money that you would need now to replace this benefit. Using 15x or 20x the amount is a decent rough approximation of its value at retirement (under the 4% rule it would be worth a factor of 25x but in the case of an annuity, it is reduced or eliminated upon death so it is less valuable).

arebelspy

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Re: Early retirement language and communted pension benefits etc.
« Reply #11 on: July 05, 2013, 08:14:07 AM »
All great points pom!

4. As far as value goes, I would not necessarily just multiply by the number of years left to live. The question is what is the amount of money that you would need now to replace this benefit. Using 15x or 20x the amount is a decent rough approximation of its value at retirement (under the 4% rule it would be worth a factor of 25x but in the case of an annuity, it is reduced or eliminated upon death so it is less valuable).

Absolutely agree with the first two sentences (the third goes off, and then explains why it's wrong in the parenthetical comment, so definitely don't just multiply by a number to guess its value).  Price a single premium immediate annuity (SPIA) and see what it'd cost to get that same benefit.

The biggest problem is the COLA - most SPIAs nowadays aren't COLA'd, the ones that are are rare and a lot more expensive.

Alternatively you can do a time value of money calculation based on the inflows of money and an assumption of your longevity.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
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pom

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Re: Early retirement language and communted pension benefits etc.
« Reply #12 on: July 05, 2013, 09:41:38 AM »
Yes, it is really hard indeed to get a quote for an immediate annuity with COLA.

Vanguard sells those and a few years ago they had an online quote system where you just entered your age/gender/annuity amount ... and got an instant quote.  I haven't been able to find it so I assume that they not longer support the tool; they still sell those annuities though.

For non-COLA adjusted annuities, I found this site:

http://www.incomesolutions.com/


Debbie M

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Re: Early retirement language and communted pension benefits etc.
« Reply #13 on: July 05, 2013, 07:12:28 PM »
I haven't read all the comments, but one thing to keep in mind is that the pension rules can change.  Dramatically.  For example, the rules for my pension used to be that you need to be at least 65 with 5 years of experience OR you need 30 years of experience, OR you need age + experience to equal at least 80.  Then you get 2.3% of the average of your top three annual salaries per year of service.

Now I think you need to have at least 10 years of service AND you need to be at least 62 AND you need your age + experience to equal at least 80.  Then you get 2.3% of the average of your top five salaries per year of service.  (Not totally sure about the current situation because I was grandfathered.)

The first change I saw grandfathered everyone within five years of retiring, the second change I saw grandfathered everyone within three years of retiring, and the third quite huge change grandfathered everyone with at least five years of experience.  It sounds like DW is not likely to be within grandfathering range for quite some time.

**

Another factor to take into consideration is diversification.  Even if DW's pension invests the money in the same kinds of things you do, they have a pretty good guarantee which can be backed by current employees and maybe taxpayers.

**

Assuming the benefit amount is based partly on DW's salary, that amount will lose value with inflation over the years in a way that your investments probably won't.  However, your description makes it sound like they try to make up for that with a 3% index, in which case you can try to guess whether inflation will be above or below 3% over the next couple of decades.  Or maybe that indexing only starts once she starts collecting; you might want to ask.

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So far as I understand it, most annuities suck.  You'd think that because THEY can assume that you'll live to the average age that people live to, but YOU have to assume that you'll live to be quite old, that they can risk doling out a higher amount per month than you could.  However, their fees are so gigantic that they actually do much worse than giving you 4%.  Also, they can go out of business.  I would much prefer to have a pension or to invest on my own than to deal with annuities the way they are today, and I'm extremely risk averse.