The Pension Series – Part I – The Basics

Following the market correction in 2008 we collectively have realized that pensions are not like diamonds – they don’t last forever.  So how does this effect our retirement and what can we do about it?  This series on pensions is going to explore the following: the basics of a pension, what’s wrong with pensions, some proposed solutions and what’s wrong with the cure.

So let’s look at the basics.  Despite the common belief that the pension has been about the worker the reality was pensions came about as a means to get rid of older, more expensive workers and replace them with cheaper, more productive (in theory) younger workers.  Pensions were for the benefit of the company.  So they created the rules such that few workers would collect benefits and then would die shortly after getting benefits.

Today things are significantly more complex: we have vesting periods, defined benefit, benefit formulas,  define contribution, minimum ages, group RRSP’s, LIRA, employer and employee contributions…and so on.  No wonder people get frustrated with retirement planning, you can get a headache just look at your work pension plan.  So here are some basic terms you need to know.

  • Group RRSP – Technically this isn’t a pension plan at all.  It can often be similar to a defined contribution plan, but pensions are regulated either federally or provincially while a group RRSP is not.  The majority of pensions are provincially regulated making things even more difficult since the rules are not uniform across the country.  The great thing about a group RRSP is since it isn’t a pension it is easier to transfer the money to another account if you are not happy with your investment options or if you want to use the money for an early retirement.
  • Defined Contribution – In this plan the idea is the worker takes the risk of investment lose.  The company often matches your contribution to a set amount and then provides you with investment options.  Once you hit the minimum retirement age you can retire and use the money to live off.  The catch here is there is no guarantee on the part of the employer on how much money you will get, yet on the plus side you can leave more easily with less risk of losing significant amounts of retirement income.  If your investments do well, great.  If they do poor, you have to keep working.  On the plus side for the company there is significantly less risk with these plans since they don’t have to cover short falls from a bad year in the market.  These pensions are much more common than defined benefit.
  • Defined Benefit – Here the risk on investments goes to the company.  Hence you are seeing fewer and fewer of these types of pensions since if the market does poorly the company has to make up the shortfall.  On the plus side for the employee is you get a set benefit, determined by a formula, to replace a certain % of your pre-working income until you die.  It’s easy, no thinking required.  Yet there are downsides to defined benefit plans for an employee: 1) early retirement options are often very limited if they exist at all, 2) if the company goes bankrupt with a significant pension short fall your benefit can be reduced by a lot.  Recently a common reduction has been about 33%.
  • Vesting Period – Often if you work only for a short period of time the company doesn’t want you to walk away with the money it put in your pension.  So if you leave prior to your vesting period you only get your money you put in the pension plan back, not the companies contribution.  After the vesting period you get to keep both even if you leave. Two years is a common vesting period.
  • Lock In Retirement Account (LIRA) or Locked In RRSP – Once you have vested money and you leave that company, you might not be allowed to transfer your pension money into a regular RRSP (it depends how much money there is and where the pension is setup) if not then you could transfer it to a locked in retirement account or Locked In RRSP.  A LIRA is similar to an RRSP but often has some additional restrictions on it that carry over from your pension plan.  Typically there is a minimum age that you have to be prior to taking the money out of the account.
  • Canada Pension Plan (CPP) – People often like to complain about how few people are in a defined benefit pension plan and completely forget about the CPP.  The CPP is about as close as you can get in this country to a near universal defined benefit pension plan, the problem is the payouts are tiny.  Yet we need to give the CPP credit, they made adjustments a long time ago to correct for the problems facing most other pension plans today (Dave will write more on this tomorrow).

Obviously that is just a short overview of some of the terms out there, I could go on for a very long time.  Yet that should be enough for a discussion for the rest of these series.  If you have any ideas to add to this list or expand a definition please leave a comment.

Green Spot: What’s Lighting Up Your Tree?

I think most people are realizing that those season LED (SLED) lights are a lot better than the old school Christmas lights for either your house or your tree.  I personally like the SLED’s since I’ve managed to step on a bulb and not break it.  Proving to me they were going to last a very long time if they can handle that kind of abuse (not to mention they are rated to last 10 times as long).  They also use 90% less power, so in terms of saving money these bulbs should be an obvious replacement for the old ones.

Yet when people say 90% less power that still doesn’t help most of us convert it to cash.  Well my power company was nice enough to send a flier in my last bill that broke out exactly how much savings there is for a 100 foot string of lights on for five hours a day for a 31 day month.  Assuming a cost at 10.22 cents/kWh for your power the cost to run different lights for a month are as follows:

  • SLED $0.22/month
  • Mini-regular lights $3.17/month
  • Small standard bulbs (outdoor) $7.92/month
  • Standard Outdoor bulbs $11.08/month

So if you have just replacing a 100 feet of outdoor lights and another 100 feet of indoor mini lights you could potentially save $13.81 on your first power bill.  WOW, talk about short payback periods.  The savings get even better if you leave them on longer than five hours a day or you take advantage of one of those seasonal exchanges that most power companies run where they will give you a rebate on a SLED set if you turn in your old set of lights.

So consider investing in SLED’s this year for your tree and house.  You can keep the seaon bright and your power bill lower to free up money for those important things like eggnog, treats and all the other holiday cheer.

Book Review: What Colour is Your Parachute for Retirement

Ok, in all fairness I will say this in advance.  I’ve never read What Colour is Your Parachute? so I can’t make any comparisons to it or say how similar or not this book is the original.  Yet I can say is, What Colour is Your Parachute for Retirement, should be mandatory reading for anyone planning their retirement.  Yes the book is that good.

Now first off the book isn’t so much on the money side of retirement.  It does touch on that, but from a US point of view.  So that section isn’t too useful to any Canadian.  Yet everything else in the book is really about lifestyle planning or how exactly do you want to live in retirement?  And that is the essential part that you should read in this book since most people don’t put any where near enough time in planning their lifestyle.

In this book it says retirement is really based on three things: your prosperity, your happiness and your health to having a good retirement.  From there it breaks things down further to examine each part of your life that will contribute to having those three things in the following seven categories:

  1. Relationships – Basically while working you usually automatically find friends where you work, but once you stop you have to in make an effort to find new ones.
  2. Psychological Strengths – Forget balancing yourself at this age, play to your strengths.  What are you good at and that you like to do?
  3. Biological Practices – A little work on your diet and exercise program can go a long way to living a better retirement.
  4. Medical Uses – Again a bit more US based in discussing insurance, but does bring up a valid point.  Do you like traditional medical care or do you also want to use some alternative treatments? Do you have a condition that requires you to live near specific services?
  5. Financial Pillars – The money side of the equation (notice it’s only one small part of the plan).
  6. Geophysical – What do you do and where do you want to do it?  Do you want to plan two phases to your retirement: an active phase in a fun location and then passive phase later on closer to family?
  7. Ways to Live – The broad brush strokes of your life that you want.  Are you a artistic type, hermit, entrepreneur, social butterfly… you get the idea.

So by addressing all of these issues now and planning for them you can really create your ideal retirement.  What is really useful in the book is that it has lots of questions and exercises for you to work on to help you determine what parts make up your ideal retirement.  It forces you to consider what do you want from your retirement and what do you need?

I even found the exercises useful to flush out my planning a bit more.  Yes I might change my mind a bit as I get older, but at least I’m thinking about how exactly I want to live now since how much money you need really does flow from that.  It’s not the other way around, so yes start saving for your retirement, but also start thinking: what have I always wanted to do?  Don’t just daydream, you also have to plan out things a bit.  Afterall when you are filling up decades of time it’s good to have a plan.

So how about you, what do you want to do in retirement?  I’ve determined I have a mountain of reading to work on and I want to keep writing and perhaps do more in the publishing side.  I also want to travel a bit, but mostly I’m a home body type of person.