Retiring by 55, Can it be Done?

The risks and advantages of leaving the classroom early

by Ray Hoger | Chair, Pension and Financial Wellness Committee

Well, here I go again. This article is not for anyone currently drawing a pension. It is aimed at our friends and colleagues who are thinking about leaving our pension plan at 54.99 years of age and drawing out the commuted value[1] of their pension.

There are certainly times when this would be a great idea. For instance, in the sad case where an individual has been given a short time to live due to illness or other negative circumstances. These instances, I think, are probably far and few between. Another cause for doing this might be that you have some investment expertise yourself. Many practicing teachers that I have spoken to are convinced that they, or someone they know, can do a better job of investing the funds and achieve a better return that the Alberta Teachers’ Retirement Fund (ATRF).

First, a few definitions. Our ATRF pension is a Defined Benefit (DB) pension plan. All contributions (both from us and the province) are invested with a view to providing a lifetime retirement benefit based on a formula using years of service and our five-year average pensionable earnings (see ATRF website) for the specific formula). A Defined Contribution (DC) pension collects funds from both employee and employer, then typically you must select (from a list of options provided by the fund) where to invest your funds. Upon retirement it becomes the retiree’s responsibility to invest their accumulated funds and to manage their withdrawals to provide themselves a retirement income. In effect, the “I’ll take the commuted value of my teacher pension and invest on my own” is like a teacher changing their DB pension into a DC pension.

In a study by the National Institute on Retirement Security, recorded in an article titled Still a Better Bang for the Buck (2014), researchers compared a DB and DC pension plan using a uniform set of demographic and economic assumptions. The results were quite stunning. “For a given level of retirement income, a typical individually directed DC plan costs 91 percent more—almost twice as much—as a typical DB plan.” The typical DB plan has several advantages over the DC plan. First, a longer investment time horizon allows the plan to invest in assets that an individual simply can’t consider. Second, the sheer size of a major DB plan allows for lower fees with professional management and other risks pooling such as longevity, inflation, investment returns, etc.

When someone chooses to receive the commuted value of a pension, the funds received are placed into a tax-sheltered Locked-In Retirement Account (LIRA). Think of the RRSP and LIRA as cousins with similar rules. However, each province has differing rules for LIRAs. In Alberta you can access LIRA funds anytime after age 50 using a Life Income Fund (LIF) or through purchasing a life annuity. At age 50 or older you can unlock up to fifty percent of the funds in your LIRA. Remember, you will pay tax on this withdrawal. Any amount withdrawn over $15,000 will have a thirty percent tax withholding at source. Your actual tax paid will of course depend on any other taxable income you may have in the year of your withdrawals.

And in many cases, the commuted value of your pension might exceed the Income Tax Maximum Transfer Value, and therefore the allowable amount would be transferred from your pension plan to a tax-sheltered LIRA, but the excess portion of the commuted value would have to be paid as a taxable cash payment, subject to the same thirty percent tax withholding at source. These tax amounts paid upfront are reducing the funds that you have left available to invest and to provide your future retirement income.

If you have followed all this so far and still think withdrawing the commuted value is the way to go, the next question would be: How much will you receive? ATRF provides an estimate of the commuted value for each teacher (until age 55 since members are not eligible after age 55). Look at your annual statement for a general idea. Keep in mind that the commuted value changes monthly as the Bank of Canada interest rates and inflation rates change and will be different for every single teacher (years of pensionable service, salary, age, and assumptions about your expected life span as well as possible inflation rates). And also remember that you have to terminate your teaching contract and apply for a termination benefit before age 55 to be eligible for a commuted value. Terminating your teaching contract earlier than your expected retirement date also means you won’t accrue additional pensionable service that you could have accrued otherwise toward your lifetime pension if you had continued teaching.

Now it’s time for some hypothetical number crunching. According to the ATRF’s 2022 annual report, the average teacher retires at age 60 with twenty-five years of pensionable service. Using the ATRF pension formula, that would lead to an annual pension of just over $38,500 (assuming average earnings of $95,000 and average YMPE of $60,000). If you were that average teacher but left at age 55 with five fewer years of pensionable service, your annual pension would be just a bit over $30,800 minus a 20% reduction for starting the pension ten years short of the 85 factor (2 percent per year x 10 years) since you will be receiving your pension for 10 years more. All ATRF pensions are guaranteed; market fluctuations (severe, moderate or simple), periods of significant inflation, business failures, all have no impact on your pension. And it’s paid for your lifetime, with annual adjustments to partially cover inflation.

Can you beat the pension? Can you invest funds from the commuted value to generate a guaranteed annual income of $30,000 or so for the next 25 or so years? Can you guarantee this annual amount will increase by seventy percent of the annual inflation rate (our

Cost-of-Living Adjustment) each and every year of your retirement? Remember, you are balancing solid guarantees against feelings and promises. If you are 55, those feelings or promises may need to extend out twenty-eight years for men and thirty-one years for women, or even longer if you are very healthy and very lucky! And teachers are on average living longer than the general Canadian population.

Think carefully before you “cut and run”. Remember, you need to beat professional management, worry more, and pay more for the privilege of going your way. At the very least, make sure you have consulted with an unbiased financial advisor.

Another useful source of information is ATRF – contact their Pension Counsellors and visit their website, including more specifically the page on Removing Your Funds from the Plan that outlines some of the elements to consider before withdrawing the commuted value.

I would like to thank Julie Joyal, FSA, FCIA, ATRF's Vice President, Pension Services, for her assistance in reviewing, clarifying, and refining the material presented here.

ATRF defines commuted value as “The lump sum of money that needs to be set aside today, at current market interest rates, to provide your future pension payments. This lump sum represents the present value of the future monthly pension income you would otherwise receive from the pension plan for your lifetime upon retirement. The lower the current interest rates, the higher the commuted value will be, because it is assumed that the amount today will earn less over your lifetime. Conversely, the higher the current interest rates, the lower the commuted value.[1]