What’s the right retirement asset mix if you have a DB pension?

Q: When calculating your asset mix can you include a pension as part of your bond/cash holdings in a portfolio with a 60% equity, 20% bond and 20% cash mix? If you had a pension that was paying $50,000 a year this would be equal to a million dollar GIC at 5%.

—B. McLeod

A: Hi B. McLeod. Thanks for the question.

To begin, I am going to operate under the assumption that you have a defined benefit pension which guarantees you $50,000 per year.

If you are trying to determine the risk portfolio of your cumulative holdings then I would suggest that yes, it would be appropriate to put your Defined Benefit pension plan into a risk category that has the same risk profile as a highly rated corporate or government bond.

Continuing under the assumption that you have a defined benefit pension plan that will pay you $50,000 per year until you pass away I would say that your pension plan is more similar to a life annuity rather than a GIC since a GIC comes to term whereas an annuity pays until death, but if you are trying to put a value on the holding of your pension plan I would say that yes, it is fair to count it as a million dollar GIC at 5%. (A life annuity is an insurance product in which the annuitant receives a series of future payments for his/her lifetime after retirement. The annuitant has to pay a predetermined payment or a series of regular payments till he/she is working.)

It sounds to me like you are attempting to allocate your portfolio by asset class and determining where your defined benefit pension plan will fit into this portfolio. If this is the case I would suggest considering what your cash needs in the future will be and adjust the volatility of your holdings accordingly, for example:

Let’s assume that you are receiving $50,000 per year from your pension and are spending all of that, then one year you decide you want to go on a trip that will cost you $20,000. It doesn’t make sense to have to cut your lifestyle expense by $12,000 so you can go on a trip when you have other money saved up, but, if you are invested solely in equities and the market is in a dip you will be liquidating $12,000 at a loss, potentially a large one.

Therefore, I would strongly suggest having some of your money in a low-risk class in your portfolio to allow you to draw on that money when needed without having to sell at a loss. This could potentially be your TFSA as this would be interest income, which is the least tax-preferred form of income and therefore it would make sense to put this type of income in your TFSA anyways.

Andrew Fox is a certified financial planner with Fox Wealth Mangement in Calgary.

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