The article “FP Answers: What effect will changing employers have on my investment strategy?” was originally published by Julie Cazzin with Brenda Hiscock, on November 5, 2021 in Financial Post. PHOTO BY GETTY IMAGES/ISTOCKPHOTO FILES.
Wilson’s new job offers a lot more money, but not the same kind of pension. How will this switch affect the asset mix for his investment portfolio going forward?
Q : I am 40 years old and have been employed for the past 10 years by a company that offers a fully-indexed defined-benefit (DB) pension plan. I earn $100,000 a year, but will be leaving this job for one that pays about $30,000 more annually. My wife is a stay-at-home mom to our two kids and also has a small part-time job that brings in about $15,000 annually. Our mortgage will be paid off in 10 years.
I have about $60,000 in registered retirement savings plans (RRSPs) and $50,000 in tax-free savings accounts (TFSAs). My wife has $30,000 in TFSAs, but no RRSPs. The money is all sitting in cash at the moment in online trading accounts. I have sold whatever blue-chip stocks we had in them so I can start from scratch with a new investing strategy. How should we invest this money? What should our saving/investing strategy be going forward and what role does the DB pension play when we are trying to decide our asset mix? We’d like to stick with low fees and something simpler than stock picking. — Wilson and Maureen in Kingston, Ont.
FP Answers: Congratulations on your new job, Wilson. The $30,000 salary increase will result in about $17,000 of after-tax cash flow annually to invest, pay down debt or spend. However, you are leaving a DB pension that may be the equivalent of putting 10 to 20 per cent of your salary into a RRSP, depending on the pension formula.
Upon exiting a DB pension, you can leave it with your employer and collect it in the future. In some cases, pension funds can be transferred into a new DB pension if your new employer has one, or you may have the option to take a lump-sum payment to invest on your own. A lump sum may be partially taxable with a portion eligible to transfer to a locked-in RRSP on a tax-deferred basis. You have been with your employer for 10 years, so the amount could be substantial.
You have not indicated whether your new employer has any pension or RRSP-matching programs in place. If it does, participation in those programs would be a priority to replace your pension and continue building your retirement income.
Your wife does not have a RRSP, but her income is relatively low, so the tax savings may not be that beneficial. She may be in a higher tax bracket in retirement, so you could contribute to a spousal RRSP she owns, where you get the tax deduction and she makes withdrawals in the future. This may allow for more flexibility with retirement income planning, especially if your goal is to retire before age 65. DB pension income can be split with a spouse before age 65, with up to 50 per cent taxable to them, but withdrawals from your RRSP or RRIF would be taxable only to you. That is where a spousal RRSP could help with income splitting.
Your tax rate of 43 per cent is high enough that you should probably aim to maximize RRSP contributions, with extra investment contributions going to your TFSAs. TFSAs are flexible and withdrawals can be used for emergencies, make extra RRSP contributions or make lump-sum mortgage payments. TFSAs can be a good short- or long-term savings option for a family who has maximized their RRSP contributions or has RRSP room, but a low tax bracket.
If your mortgage rate is low, and your risk tolerance is moderate or high, you may be able to earn a higher rate of return by investing in your TFSA than you would get from the interest you save by paying down your mortgage more aggressively. Given your 10-year mortgage repayment time horizon, you could consider using your TFSAs to pay it down if rates were to jump when it comes up for renewal. Your interest-rate risk is low given your modest mortgage balance.
You mention that you have two young children, but do not mention having a registered education savings plan (RESP). The government matches 20 per cent on the first $2,500 contributed annually to a RESP, and the account grows tax deferred. If you have not contributed in the past, you can even catch up by making up to $2,500 of additional contributions each year and still receive the 20-per-cent match, which makes a RESP more appealing than a TFSA for a parent saving for post-secondary costs.
You mention that you recently moved all your investments into cash and want to come up with an investment strategy that is simpler than stock picking.
First, you and Maureen should assess your risk tolerance to find a strategy that works for both of you. A conservative asset mix would be made up of roughly equal amounts of fixed-income funds to equity funds. This type of portfolio mix is usually less volatile than one where equities comprise 80 to 100 per cent, but returns over the long term (20 years or more), while still solid, may not be as big.
Mutual funds can be a simple alternative to stock picking, because they may hold hundreds or thousands of different stocks or bonds. This can reduce or eliminate the need to select and monitor stocks. Additionally, international stock exposure can be challenging to get when buying individual stocks, so mutual funds can make this simpler.
Other key benefits of mutual funds are that they are actively managed, which means individual stocks can be traded by a manager within the mutual funds to help enhance returns, and they offer automatic investment plans, which can be valuable to investors who want to invest a specific amount on a monthly basis, and dividend reinvestment plans (DRIPs), which allow you to use any income generated by the fund to buy additional shares.
The knock on mutual funds, which is often true, is that the fees are high. Fees, which can include a management expense ratio (MER), deferred sales charge (DSC) and other charges, average about two per cent in Canada, but can range from 0.5 to three per cent, depending on the type of mutual fund you pick.
You may also want to consider other low-fee investment options such as exchange-traded funds (ETFs). These often have lower fees, which you pay every time you buy and sell (just like a stock), as well as an MER that can often be less than 0.25 per cent — much lower than mutual funds. Be sure to read an ETF’s prospectus or its summary disclosure document to understand the fees and the holdings of your investment.
If you believe in passive investing, want to keep costs low and need a bit of investing support, robo-advisors may be a good solution. They provide asset allocation oversight, automatic rebalancing and light advice.
If you want to invest on your own, all-in-one or asset-allocation ETFs are another passive, low-cost approach to consider if you are not comfortable selecting and monitoring a handful of ETFs yourself.
An all-in-one ETF is a diversified basket of ETFs, ranging from conservative (usually a 50/50 equity-to-fixed-income mix) to a full 100-per-cent equity allocation. They typically have Canadian, American and international stock exposure, as well as varying levels of bonds depending on your risk tolerance and the specific ETF you select. These would be purchased through a discount brokerage, and do not require any rebalancing.
Wilson, just keep in mind that do-it-yourself (DIY) investing is not for everyone. Investment advisers can help, but you pay for that help through higher fees.
There are definitely options that have low fees and allow you to be more hands off than picking individual stocks. The lowest-fee option is not always the best one, but since every investor is different, you have to find what works best for you.
I encourage you and Maureen to consider your options on your own or with a professional adviser to determine the best course of action for you and to get your cash invested. The advice of a fee-only adviser can also help you get started on the right portfolio investments and help you monitor your portfolio until you feel comfortable doing it yourself.
A priority should be replacing your DB pension accumulation by participating in any retirement program through your new employer or by contributing to your personal RRSP. Beyond that, try to be conscious of how you allocate your salary increase between spending, savings and debt repayment with a long-term strategy that works for both of you.
Brenda Hiscock is a fee-only, advice-only certified financial planner with Objective Financial Partners Inc. in Toronto