# What is the Investment Return used to calculate Commuted Value?



## Eric (Oct 20, 2009)

I have the spreadsheet to calculate Commuted Value of a pension, however I wonder what is the "official" Investment Return that should be used. 

I presume an employer cannot just use his own estimate. I would think that there is some official value that employers must use. Right?

Is there a web site that give the current official value?


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## Eric (Oct 20, 2009)

I have found the answer to my question. It is now 3.7% for the first 10 years and 5.2% after that.

http://www.leong-associates.com/links.php?c=1

Has anyone seen a CV calculator that can use two rates? I realize that using something like 4.2% is probably a good approximation.

I wonder if annuities are also using the same rate or should one shop around.


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## MoneyGal (Apr 24, 2009)

1. Don't use a blended rate. Do PV calculations using the "correct" rate for two periods. However, note that the second period - after the first 10 years - is random. How are you going to choose a period? 

2. Note that the CV rates you cited are for non-indexed pensions. 

3. Annuity rates are not calculated based on anything to do with pensions. There are lots of places to find current annuity quotes. Take a look at Cannex.


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## Eric (Oct 20, 2009)

MoneyGal said:


> 1. Don't use a blended rate. Do PV calculations using the "correct" rate for two periods. However, note that the second period - after the first 10 years - is random. How are you going to choose a period?


I think CV calculators include a life expectancy of 83 for a man.



MoneyGal said:


> 2. Note that the CV rates you cited are for non-indexed pensions.


Good point. Do you have a reference for rates that include various levels of indexing?

I wonder if the impact on the CV is significant - a CV could be invested to provide some protection against inflation. I presume the non-indexed rates I quoted would give a minimum CV. 



MoneyGal said:


> 3. Annuity rates are not calculated based on anything to do with pensions. There are lots of places to find current annuity quotes. Take a look at Cannex.


Thanks for the reference. I have not studied it yet, but I thought that I would be able to find an annuity that, with my CV, would match my present benefits. Am I optimistic?


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## MoneyGal (Apr 24, 2009)

(I know I am not responding to each of your questions here.)

It is very important that you understand the limitations of using a "life expectancy" number in making your calculations. The number you've given sounds like Canadian life expectancy at birth for a man. However, there are two main problems with using this number:

1. It isn't valid for a male at retirement age. Life expectancy increases as we age. What you need is not the static life expectancy at birth, but the life expectancy for a healthy male, at your expected retirement age. This number *increases* with each year of life (until very advanced ages). 

More useful still is a calculation of the probability of survival of a healthy male, at your expected retirement age, over a defined period. You will find it is much greater than you think. (And when I get to work I can provide more on this.)

2. It doesn't cover off any probabilities other than that you will live to that exact age, and then die. 

What you need, as noted above, is a probability array that describes your chance of being alive at the end of a series of periods. And then you need to get that number down to a rate you are comfortable with (i.e., I have now found a scenario where my survival probability over this period of time is less than 5%) -- keeping in mind that you never have to deal with this issue as a pensioner, and that you can't undo the CV decision if you get it wrong.


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## MoneyGal (Apr 24, 2009)

On indexing: I highly recommend, if you are going to be creating scenarios like this, that you learn how to use a financial calculator or the finance add-ins in Excel. That will allow you to determine PV for various sums for various periods and various indexing assumptions.


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## MoneyGal (Apr 24, 2009)

OK. Using mortality tables from the U.S. Society of Actuaries for healthy adults ages 50 and over, I get the result that a healthy male, aged 55, has a 39% chance of living to 83 -- and a 22% chance of living to 88, and a 16% chance of living to 90, etc. 

Using these same input values, a healthy male aged 60 has a 41% chance of living to age 83, and a 23% chance of living to 88. 

Disclaimer: I'm not an actuary.


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## Eric (Oct 20, 2009)

MoneyGal said:


> On indexing: I highly recommend, if you are going to be creating scenarios like this, that you learn how to use a financial calculator or the finance add-ins in Excel. That will allow you to determine PV for various sums for various periods and various indexing assumptions.


Yes. I have been using some ready made spreadsheets but they do not have the flexibility I really need. I should roll-up my sleeve and make my own. I used to do a lot of that.

I am a Nortel pensioner so I am expecting to be offered a CV in the coming weeks - 31% reduced I am afraid. I would like to know the order of magnitude of what I should expect.

When I retired, I choose to take the pension rather than the CV. I am still glad I did, because we had a few market crashes since then and my investment style was not safe enough.

Now, I will be faced with the same decision. I think, I should not take an annuity now. However, my father lived to 92 and I am in much better health than he was at my age. We have good longevity genes, unfortunately. So, eventually, I might buy an annuity for peace of mind.

I must say also that I am not good at safe investments. I just sold a lot of my bond ETFs, worrying about rate rising. I bought some RRBonds ETF's (XRB) (lousy rates but better than cash) and some High Yield funds (PHN). I am siting on 15% cash not knowing what to do with it.


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## MoneyGal (Apr 24, 2009)

The question you are facing is that of optimal product allocation in retirement - not asset allocation. 

Given that you do not need to annuitize everything in your portfolio, what is the right mix for you?

Take a look at this article for some thoughts. 

My recommendation would be to work with a FA who specializes in retirement income analytics -- the kinds of questions posed and answered in the article.


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## Eric (Oct 20, 2009)

MoneyGal said:


> OK. Using mortality tables from the U.S. Society of Actuaries for healthy adults ages 50 and over, I get the result that a healthy male, aged 55, has a 39% chance of living to 83 -- and a 22% chance of living to 88, and a 16% chance of living to 90, etc.
> 
> Using these same input values, a healthy male aged 60 has a 41% chance of living to age 83, and a 23% chance of living to 88.
> 
> Disclaimer: I'm not an actuary.


Thank you for the info. I appreciate the time you take to dig this information out. I am 66, so I presume that they will use a life expectancy of much more than 83. This is good news.

With the low rates, the indexing and the bigger life expectancy, I think I will get over the $400k limit, despite the 31% Nortel drop. This will complicate my decision. I wonder if I can put $400k in a locked-in plan and the rest in an annuity - I don't think I can do that. The limit on the contribution to a locked-in plan is strange. Why do they care?


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## MoneyGal (Apr 24, 2009)

Same tables: 

a healthy 66 year old male has an 18% chance (rounded) of living to 90, and a 6% chance of living to 95. 

As I said earlier, these figures will change (increase, to a point) with each year of life lived. 

The limits on locked-in plans are related to tax issues.


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## Saniokca (Sep 5, 2009)

Eric said:


> Thank you for the info. I appreciate the time you take to dig this information out. I am 66, so I presume that they will use a life expectancy of much more than 83. This is good news.
> 
> With the low rates, the indexing and the bigger life expectancy, I think I will get over the $400k limit, despite the 31% Nortel drop. This will complicate my decision. I wonder if I can put $400k in a locked-in plan and the rest in an annuity - I don't think I can do that. The limit on the contribution to a locked-in plan is strange. Why do they care?


As the person above said this - it's taxes. The government wants it's share. And it's is pretty much for the same reason as having a limit on RRSP contributions... Unfortunatelly for you, the excess will be fully taxed.


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