How to plan your retirement
DO YOU KNOW What pension plans cost you—and what you get? Which of the thirty major systems is best for you? How to cash in on new tax benefits? IT CAN COST YOU THOUSANDS IF YOU DON’T
J. J. BROWN
Sooner or later almost everyone who reads this article will have to live on retirement income. Some will be forced to subsist in squalor and near starvation on government old-age pensions alone. Some will live frugally on company pension plans, government annuities, or other superannuation schemes. Some, the lucky or provident ones, will be able to live it up as usual after retirement, drawing income from a variety of well-chosen investments.
Today, do-it-yourself pension planning is more important than ever before. This is because parliament has recently passed an amendment to the Income Tax Act giving individuals certain tax benefits previously enjoyed only by employees of companies having a group retirement plan. You can now put ten percent of your income or a maximum of $2,500 a year into an approved individual pension pian, and deduct the amount paid before calculating your income tax.
This sounds like a gift to you from the tax collector, and in one sense it is. But you should realize that it is also a heaven-sent opportunity for insurance salesmen and investment dealers to load you up with pension schemes that fail to fit your needs, or cost more than you can afford.
Pension planning is difficult for an individual because there are at least thirty major classes of plans for accumulating the capital and your pension upon retirement depends on which system you choose. It also depends on how much you have paid in each year, and how old you were when you started. If we take even hundreds of dollars from one to 25 as the possible annual premiums, and settle for 40 starting ages from 20 to 65, the number of different plans possible is 30,000. This is why you won’t learn all there is to know about retirement plans and how they affect you from reading a magazine article. But, if you get your feet down off the couch and read what follows carefully, you will know the advantages and disadvantages of the various plans offered and be in a position to make a reasonably intelligent choice between them.
Here are the main questions asked about pensions, together with some more or less simplified answers:
Q. What kind of pension does everyone have to buy?
A. The government old-age pension, which goes to everyone at seventy. At the moment it pays $660 a year. We pay for this through two percent tax (maximum $60) on our net income each year. While all Canadians get this pension as a matter of right, it is not enough for mere subsistence even today, and it does not begin until seventy. Q. I work for a large corporation. Am I covered by a pension?
A. Probably. Many Canadian companies, especially the larger ones, have pension plans which function as a sort of fringe benefit received by employees in addition to their salaries. This is open to both hourly-paid and white-collar workers. According to the latest figures, nearly seventy percent of Canadian industrial employees are covered by some sort of company pension plan. But of course industrial workers make up only a small part of the total Canadian labor force. While exact figures are difficult to come by, it looks as if about one person in every five in the labor force is covered by company pension plans.
Q. What kinds of company retirement plans are there?
A. There are two kinds: contributory and non-contributory. In contributory plans the employee and the employer together pay the cost of the pension. The common system is to have the employee pay four percent of his salary each year and the employer pay the balance of the premium cost. This balance is small when you are young, large when you are old.
In non-contributory plans the employer pays all costs, but the amount of the final pension is normally much smaller.
Q. How much will I get from government plus company plans when I retire?
A. You won't be rich. Even under a fairly generous contributory retirement plan, the amount of pension is not large. For example, a man earning $3,000 a year would retire after thirty years with the company on a pension of $144 a month. Here’s a table of various income brackets, showing the total income from old-age pension plus a generous company pension that might be expected by an employee who retires at sixty-five after thirty years’ service:
Q. What can I do if this amount seems too small?
A. You can join an individual plan in addition to the company and government plans. If you are a member of a non-contributory plan, you can put ten percent of your earned income (up to a maximum of $1,500) into an individual plan; if you are already a member of a contributory plan, you can contribute the difference between your present payment and ten percent of income up to $1,500 as before.
Q. I own my own business. What retirement plan can I buy?
A. You can join one of the individual registered plans offered by professional and trade associations, insurance and trust companies, investment-counsel firms, and certain mutual funds.
Q. What are the advantages of joining any plan?
A. The basic advantage of saving through a registered plan is that it provides a measure of tax relief. The immediate tax saving, if maximum amounts are contributed to an approved plan, would be about $95 if your earned income is $5,000; $240 if your earned income is $10,000; and $1,100 if your earned income is $25,000. The tax saving will be larger or smaller depending on the number of your dependents and on whether you are married or single.
A second advantage of a registered plan is that you enjoy the moral support of the insurance company or trust company in carrying out the plan. As individuals we are weak and find saving difficult. When we tie ourselves up by a contract with a big institution, we can rely on the company for a measure of moral support.
Q. What are the disadvantages of joining any plan?
A. The basic disadvantage is that the capital you accumulate is locked in. both before and after retirement. Under existing legislation, once you have put money into an approved plan it must stay there until you retire. You can’t even use it as collateral for a bank loan. On the other hand, this “locked-in” feature may not always be a disadvantage, since the money may be protected from unwise investment decisions on the part of either you or your advisers.
Even after you reach retirement age the money must be used in just one way — to buy an immediate annuity at the rates in force at that time. If you want to spend the money some other way, for example on buying a small business to provide you with a new interest during retirement, the money will have to come from another source.
A second major disadvantage is that the income-tax benefit is not clear gain; you are merely exchanging one tax benefit for another. To the extent that you place your savings in an approved retirement plan, you can't put your money into other investments that carry tax benefits. For example, you are entitled to deduct from your income for tax purposes ten to twenty percent depletion allowance on wasting assets, such as oil wells or mines; and in addition, twenty percent of the net dividends received from Canadian companies. Together, these privileges make dividends tax-free in many cases. These benefits are lost when you join any registered plan.
Perhaps more important, you lose the specifically Canadian advantage of tax-free capital gains. Here, if you are a prudent investor or a lucky speculator, and buy stocks for a thousand dollars which you later sell for ten thousand, it is possible to build up an estate undiminished by taxes. Once gained, this money can be employed any way you see fit. You can retire on it, paying tax only on the income portion and drawing on tax-free capital for the balance.
Q. There seem to be more disadvantages than advantages to joining a registered plan. Is this true?
A. No. It merely takes longer to write out the disadvantages, because they are more complicated.
How much weight you give to these various advantages and disadvantages depends on your personal circumstances and your goals. If you are an industrial worker or a professional man, you may find it simpler to turn over to someone
IF YOU HAVE EARNED AN AVERAGE EACH YEAR OF: $2000 3000 4000 S000 8000 12000
YOUR MONTHLY RETIREMENT INCOME WOULD BE:
from government old-age pension (after age 70) $55 55 55 55 55 55
from your company pension plan (after age 65) $96 144 192 240 408 590
TOTAL (after age 70) $151 199 247 295 463 645 else all the headaches of managing your retirement fund. If, on the other hand, you are in the investment business, you can probably earn more with your money than could any approved plan. Take for example a man aged forty, married, with two children, earning $10,000 a year. If he puts a thousand dollars a year into an approved plan, he can earn a tax saving of $240, or, he can pay his normal income tax and end up with $760 for private investment. Here is what happens to his money over twenty-five years:
TWO CHOICES FOR A
($1,000 a year earns an average of 5%)
THEN THE TOTAL SAVED IS: End of 1st year $1,000 5th 5,526
PRIVATE INVESTMENT ($760 a year earns 10% combined capital appreciation & interest)
THEN THE TOTAL SAVED IS: End of 1st year $760
AT AGE 65
Total Accumulated Savings
This amount must be used to buy an immediate annuity of $325 a month. Therefore the tax on the $3,900-a-year income is $218.00. This man has no free capital on which to draw.
Total Accumulated Savings
This amount can be invested in such a way as to generate an annual income of $3.000. Tax on this income is $75.
This man can draw on capital to the extent of another $3,000 a year, without undue risk.
Can you sleep at night if you take.risks? Risk is inescapable,
no matter what retirement plan you choose.
Q. How much docs it cost to join a plan?
A. There are two costs involved when you join any registered retirement plan. The major cost is the savings you put aside each year to remain a member of the plan. The money you lock away in a savings plan in order to enjoy a tax benefit must come from somewhere. If you do not have a regular savings plan now, you will have to finance the pension plan out of spending money. If you earn ten thousand dollars a year and contribute a thousand dollars to a registered retirement plan, you enjoy an income-tax saving of $240. Hence the net amount of extra cash required is only $760. But if you are not already saving $760 a year, joining any plan will force you to raise this amount. This may be a hardship. However, many people are already saving through share purchase, annuity, and other investment plans. You should investigate the possibility of converting your present savings plan to a form under which it will qualify for tax relief.
continued on page 57
How to plan your retirement continued from page 29
Managing money is a skill. When you need it you have to pay for it — but find out how much
The second item of cost in any plan is the cost of administration and management. Money management is a skill, like legal service, and when you need it you have to pay for it. In addition, trustees and insurance companies have fixed operating costs which must be covered. The fee charged for these services is normally small in relation to the amount of money at stake. Hence you should not allow your decision to be swayed by small differences in charges. On the other hand, you should calculate how much of your savings will eventually come back to you, and how much will be swallowed up in costs of administration.
Q. If I decide to join, what individual plans are available?
A. There are a variety of plans now being offered by various companies. There are two major types of investment programs: trusteed plans and insured
plans. Under the first, the trustee says, in effect, “I will manage your money with all possible prudence and skill, and return it to you, with interest, at your retirement date. But I do not guarantee that you will receive any particular amount.” Under the insured plan the company signs a definite contract with you, promising to pay a specified sum at your retirement date.
Q. What are the usual features of insured plans?
A. In return for a fixed payment every year until you retire, insured plans guarantee you a fixed monthly income after retirement. Such plans are sold by lifeinsurance companies, by the department of labour in Ottawa and by the Province of Alberta. When buying them you do what any sensible person does when he buys a car. That is, you shop around until you find the greatest protection for the lowest premium.
The premium rates and the income to be paid after retirement are fixed by contract now. If the present inflationary trend continues, all pensions paid in fixed dollar amounts are likely to prove inadequate when paid. On the other hand, if we enter a period of deflation, their buying power may be more than adequate. Nobody knows what the value of the dollar will be ten years from now.
With an ordinary annuity, you will lose money if you make the mistake of dying soon after the payments begin at sixty-five. To correct this, most people buy an annuity with a guarantee. Under the guaranteed plan you get a promise that the annuity will be paid for 10, 15 or 20 years, whether you live or not. A variation of this is the last-survivor annuity, by which the annuity is paid as long as either you or your wife continues to live. Both the guaranteed and the lastsurvivor type cost more money to buy, but they are useful in many cases.
Q. What kinds of trusteed plans can I buy?
A. There are four main ways of accumulating pension funds under trusteed plans. They differ in the degree of risk and in their expected earnings.
1. The guaranteed plan: Under this plan the interest rate allowed is guaranteed, not to retirement date, but for a shorter period such as five years. At the end of that period a new interest rate will be set depending on business conditions at that time. In addition, the principle sum itself is guaranteed, that is, your fund will get back exactly the same number of dollars you put in, plus the interest earned over the period.
2. Fixed-income plan: Your money is put into a portfolio containing government and municipal bonds or industrial bonds or mortgages, or a mixture of all four. Since bond and mortgage interest is a fixed charge, it is possible to predict accurately what the income will be. The principal is not guaranteed, but is relatively safe.
3. Equity plan: Your money is put into equities (common and preferred shares) of going corporations. You actually become a part owner of the companies. This is highly enjoyable when times are good and the particular companies you buy are making money. If this happens, money put into a good equity plan will grow much faster than any other. But common stocks are notoriously subject to sinking spells. If business is bad and companies are losing money, an equity plan will do worse than the others.
4. Balanced plan: In these your money is put into a mixture of fixed-income securities such as bonds, and equities or common stocks. The goal of these balanced plans is to achieve a measure of safety and certain income through the bonds, and, at the same time, have a chance of increasing capital through successful investment in common stocks.
Q. What do I need to know to plan my retirement?
A. A good pension plan is an individual thing, created specifically to suit the needs of one person. In order to get a plan that suits your needs and pocketbook, you will first have to answer some questions. These, in order of increasing difficulty, are:
1. How old are you? If you are young, trusteed plans, and especially those containing common stocks, may appeal because the long-term trend of the Canadian economy seems
to be up. If you are nearing retirement age, the certainty of the insured plan may have more appeal.
2. How much do you earn? The more you earn, the more risk you can afford.
3. How many dependents have you now?
4. How many dependents will you have
later? Make an intelligent guess.
5. What will be your earnings pattern over your working life? Some professions like medicine and the law show earnings that begin late and modestly, but climb to high levels and last past seventy. Other occupations have high earnings early in life but drop off rapidly. This obviously makes a difference in the kind of pension plan needed.
6. What kind of person are you? This
is the most difficult question of all, since most of us don’t know much about ourselves. For example:
What is your taste in risks? Some people can’t sleep nights if they take risks. But risk is inescapable, no matter what you do with your money. So you have the choice between risks that show and risks that don’t show.
If you lose, do you prefer to lose money prudently, in a way that is acceptable to solid citizens, or to lose it in a speculative way? If you prefer to lose your money prudently you will favor a trusteed plan that is guaranteed, or an insured plan.
How do you feel about inflation? The kinds of risk you assume in a pension plan depend on your views about inflation. People who bought annuities in the thirties using dollars worth 100 cents are unhappy today when they are being paid off in dollars worth 30 cents. But maybe in the next two decades the pendulum will swing the other way.
Q. In any plan, what determines how much I get at retirement?
A. The income you will have to live on after retirement depends on three factors: the number of years you have contributed to your retirement fund, the amount in dollars you contributed each year, and the rate of return on the capital invested. To maximize the first factor you should start building up a retirement fund at the earliest possible age. To improve the second factor you should put aside from current income as much as you can conveniently spare, without actually impairing your present living standards for benefits that may be mythical. The importance of the third factor is shown in the following table.
IF YOU PUT ASIDE A THOUSAND DOLLARS A YEAR FOR TWENTY-FIVE YEARS, AND
If your investment plan earned (capital appreciation plus interest) an average of
the total at age 65 would be
amount would buy an annuity of
This shows that good investment management is vital to your savings fund.
The choice of a retirement plan that is suitable for you, like many other financial decisions, is complicated by emotional factors that are to a large extent beyond your control. But by studying the various plans available, and then choosing the one that is closest to your individual needs, you can maximize benefits and avoid major pitfalls, -jf