August 10, 2020 | Surprise!

Arthur’s a typical teacher. Owns a house but not much more. “My wife has an investment portfolio but it isn’t a lot,” he says. “To be honest, my pay has been used to pay off bills and the mortgage over the decade we have been married while she was on maternity leave for our two kids. We both have TFSAs but I just recently started investing in it. I have so much room I don’t think I will ever be able to max it out.”

Well, teach wrote me because the big 5-0 looms, they want to retire within a decade and wonder how they can prepare.

“We are not willing to go into debt – read as dip into our home equity – to borrow for investments as the next 2 – 3 years will likely be volatile with people learning to live with the virus and its impacts on our health and the economy.

“I know your advice will be sound, and I trust that you will give me an answer that will most likely lead to a conversation that I don’t want to have.”

So why are they typical teachers? Simple. So many people with DB pensions (defined benefit) truly believe they can skate through life spending all their take-home pay, saving nothing in a retirement fund, and living happily ever after. Of the countless classroom people I’ve encountered over the years, few have financial reserves. All of their trust, plus the rest of their lives, has been placed in the hands of a faceless pension administrator.

But teachers have great holidays. The locals in Cancun and Varadero are so grateful.

So what can go wrong?

First, pension incomes are way less fulsome than most people understand. For example in Ontario a long 30-year teacher career landing you in the $85,000-per-year position would result in a pension of about $50,000. That’s pre-tax, of course, and it’s a lot better than many people enjoy. But this represents a 41% drop in income. So the question is simple: if you made $85,000 a year and saved nothing, how do you live on $35,000 less?

Some people think being retired means spending little, staying home knitting scarves and counting the cars driving by. But, since 65 is the new 45, people at this age are active and alive. Travel, hobbies, toys, entertainment, renos – it all costs big. In fact a lot of folks end up spending more in retirement than when sitting in the workplace all day. Fail to budget carefully for a fixed-income life and you might end up selling dope or parking buggies at Walmart (equally distasteful).

Second, leaving your entire financial future in the hands of others is, well, a leap of faith in this altered world.

Here’s an example.

Four days after the virus whacked financial markets, driving equities into the quickest bear market on record and crashing interest rates, regulators in Ottawa panicked. On March 27th, this letter was sent to the administrators of DB pension plans across Canada:

As a result of the COVID-19 crisis, OSFI has made adjustments to its policies to protect the interests of pension plan members and beneficiaries and to allow administrators of federally regulated private pension plans to focus their efforts on addressing the many challenges posed by this crisis, including its impact on financial markets.

Transfers and annuity purchases are being prohibited at this time to protect the benefits of plan members and beneficiaries, given that current financial market conditions have negatively affected the funded status of pension plans. The payment of pensions to retirees and other beneficiaries is not impacted by the freeze on portability transfers and annuity purchases. We will review this temporary measure in the coming months as we continue to monitor the impact of this crisis on defined benefit pension plans.

While this stunning directive did not reduce payments being made to former teachers (and civil servants), it immediately froze the commuting of pension assets to those planning on taking a lump-sum amount for retirement. As we’ve yammered about in the past on this blog, liberating pension money so you can control it, manage the tax exposure and pass it on to your family is generally an excellent idea. So imagine the impact of this outta-the-blue stunner to those who’d planned on such a move.

(The directive was reviewed again in May, recognizing the over-reaction. Now  those within 10 years of retirement age may partially commute their pensions – if allowed by a specific plan. Big relief for many people.)

Here’s the key point: when you don’t control your own financial future, be prepared for surprises. Public sector DB pensions have been the envy of society for decades, but when a temporary bout of stock market willies cases this reaction, anything can happen:

The effect of the COVID-19 pandemic on the financial and economic environment has resulted in market volatility. This has made the impact on the solvency ratios of defined benefit pension plans difficult to gauge, and the Superintendent came to the view that transfers or annuity purchases from defined benefit pension plans could impair their solvency.

So, Arthur, here’s what you don’t want to hear: having almost all of your personal financial wealth in one asset (your house), with no Plan B for income and no mechanism in place to supplement cash flow during two or three decades of retirement is a gamble. You should spend every day fixing that. Do a monthly budget to chop spending and funnel enough into savings to at least max out both TFSAs. In retirement, cash flow from these plans will not count as income and further erode CPP and OAS payments – unlike RRSP money.

Invest the TFSA funds into equity-based growth assets. Ignore market volatility, the virus or your own tepid emotions. The world will come out of it pandemic phase in a blaze of growth, and you should take advantage of it. Tapping into some of the home equity is far from a bad idea. Loans are ridiculously cheap, interest is 100% deductible from taxable income (for non-registered investment accounts) and you need only service that debt. Repay it when you cash in the assets you financed.

Now do a realistic plan for after work. If you save nothing now, you’ll probably want to replace your full income. A $40,000 annual shortfall, for example, means you need about $600,000 working for you in a balanced portfolio. You have ten years to get there. Stop reading. Start doing.

Garth Turner August 10th, 2020

Posted In: The Greater Fool

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