A common question among professionals, such as teachers or Provincial employees, is whether they should buy back their pensions or not.
Take the case of Jason and Carol Anne. One is a teacher and the other works for the Federal Government. Both have strong pension plans but Carol Anne has the ability to buy back five years of hers. The cost is more than $30,000. She wonders if she is better off investing the money into a RRSP.
At 48 years of age, the answer is simple. Carol Anne is better off buying back the pension. The simple reason is that her pension plan is indexed. This means that when she retires, her pension plan payments will increase every year for the rest of her life. This can be a significant gain and can offset inflationary costs during retirement. Her investments would have to provide a reasonable rate of return, like her pension plan, and increase every year during retirement in order for this to be the more attractive option. When you crunch the numbers, in most cases it is difficult to beat an indexed pension.
Carol Anne’s next question is where she should come up with the money she needs to buy back the pensions. She has $15,000 cash, should she borrow the rest? I suggest we do a tax-free transfer from her existing RRSP, which has $50,000 in it. She can use $30,000 from her RRSP, keep the $15,000 cash, and not worry about borrowing costs or payments; or she can use part cash and part RRSP. It does depend on her income and her current tax situation. After some simple income tax planning, she decides to use $20,000 of her RRSP and $10,000 cash to buy back her pension. She then keeps the remaining $5,000 cash as emergency funds, providing a feeling of comfort. Now Carol Anne and Jason will have a more secure retirement.
What you do speaks so loud that I cannot hear what you say. – Ralph Waldo Emerson
Leadership is practiced not so much in words as in attitude and in actions. – Harold S. Geneen
Published with permission from Grant Hicks