There are some 13,000 Nortel pensioners that are members of the Nortel Managerial and Non-Negotiated Pension Plan (Reg. 0342048). The settlement of this plan provides members in some provinces with the option of either receiving the default of an annuity or taking the commuted value and converting it into a Life Income Fund (LIF). The references, comments and spreadsheet provided in this post may be of some assistance in making the choice. It is also of use for others who need to compare an annuity against a LIF.
Feedback Requested August 27, 2017
Settlement replies for Nortel were required by the end of January, 2017. There were lots of views of this post before then and I hoped it helped people in making a decision. However, since then this post has been viewed many times. If you are not with Nortel and this post is of some use to you could you send me an email describing what has lead you to this post. If you are with a different company with the same option, I might be able to create a new post that meets your needs. If you are with Nortel, I would also like to know if this is still useful. Please use the email form on the Contact page.
Changes October 4, 2016
The spreadsheet and the post has two new entry variables: Target LIF Payment/Year and LIF Investment Percent. Chart 1 has another line which is the Target LIF and includes inflation. A table of Limits has been added and is the last 2 columns. It is color code and shows what withdrawal limit is used for each age in Chart 1.
Changes October 26, 2016
The spreadsheet originally started at age 60. It appears that some people can take an annuity at age 55. In case others can do the same at an earlier age, the spreadsheet has been changed to start at age 50.
If you are not retired yet, you will be eligible for a deferred pension and not the option of a LIF or Annuity as discussed below. Please see the Nortel Pension Settlement – Deferred Pension post which has a spreadsheet for this case.
Nortel Bankruptcy Background
Nortel declared bankruptcy in 2009 and the pension plans were later placed under an Administrator (Morneau Shepell). As the pension plan was underfunded, the Administrator has been providing monthly payments based on 70% of what pensioners received before the bankruptcy, plus, for Ontario pensioners, any applicable coverage from the Ontario Pension Benefits Guarantee Fund.
The Administrator’s Nortel individualized “options letters” issued during August, 2016, indicates that the approved final funded level has increased to 77.12%. It also includes the final monthly amount of the annuity. If the member is eligible to transfer to a Life Income Fund (LIF), the commuted value of the pension is also included. In this case, the member as two options available: Annuity Settlement or LIF Settlement. For most provinces, there is no inflation option for the Annuity Option. This will erode the buying power of the monthly payments over time.
Since the bankrupty, the Nortel Retirees and former employees Protection Canada (NRPC), which is a volunteer based organization comprised of former Nortel employees worked hard and successfully to represent the former employees at the bankruptcy hearings and with the Administrator, lawyers, and federal and provincial governments to ensure that the members’ interests were protected. One of these successes is that Ontario now permits the conversion of the members’ commuted value to be transferred to a Life Income Fund (LIF).
This post and the spreadsheet hopefully assist you in deciding if a Life Income Fund (LIF) or the annuity is appropriate for your circumstances. Use this as background information only. You should seek professional advice before making a decision.
Life Income Fund (LIF)
A LIF is similar to an Registered Retirement Income Fund (RRIF) in that most investments permitted in a RRIF can be used in a LIF and that there are many financial institutions that can issue a LIF. The minimum withdrawal rates are the same. However, a LIF has a maximum annual withdrawal limit, which is discussed later.
A good source for questions that you may have regarding a LIF in Ontario is provided by the Financial Services Commission of Ontario’s FAQs on New Life Income Funds. The “New LIF” is the one that pertains to Nortel members, so ignore comments about the “Old LIF”.
Annuity Compared to a LIF
An annuity is an agreement with a financial institution for them to provide you with monthly payments based on capital that you provide. They make their calculations based on which type of annuity you choose, your and/or your spouse’s age and their expected rate of return on the capital. Based on the annuity type, they will provide monthly payments until death and for a set number of years depending on the type you have selected. A good description of the types of annuities is given by Canada Life on their Annuities page.
There are many articles on buying an annuity and when it is appropriate. (For example, this one from MoneySense.) However, for this post, you do not have an option of when and were to buy the annuity as a result of the Nortel pension plan settlement. Morneau Shepell will negotiate with insurance companies over the next few years and inform you later who holds your annuity.
A LIF is different in that you or your estate gets to keep whatever capital is left, if any, after death, but you must manage the investments. Note that the minimum and maximum withdrawals can have a major impact on how long the LIF will provide monthly payments (and the amounts) and the amount of capital left. The maximum withdrawal rates change each year and, for most provinces, are designed to reduce the capital to zero at age 90.
How to Decide between an Annuity and a LIF
As you will see in the example below and when you use the spreadsheet provided, the decision basically comes down to whether
1) you want a constant steady stream of monthly payments from an annuity and no capital at the end (but possibly guaranteed payments for a fixed period, depending on the annuity type) or,
2) you are willing to accept a more volatile stream of payments and the need to manage the LIF investments to obtain the rate of return desired without depleting the capital too soon. However, once the LIF capital is gone, the monthly payments stop, even if you are still alive.
Using the example discussed below, a few criteria are provided later that can be used to decide if the LIF is a good option for you.
The LIF Withdrawal Rates
The LIF minimum withdrawal rate is set by the Government of Canada and is the same as for the RRIF which was changed in 2015. These rates are age dependent so that each year you have an increased rate. Here are two links to view these rates: RRIF minimum withdrawal rate (item 3) and RRIF Minimum Payout – 2015 Rates.
The LIF maximum withdrawal rates change each year as well as being age dependent. The formula used has been difficult to track down, but the methodology and the 2016 rates are presented on a webpage by the Government of Canada, Office of the Superintendent of Financial Institutions (Life Income Fund FAQs, question 1, item 2). It uses the previous year’s November 30th CANSIM rate. (These can be found at the Statistics Canada website for CANSIM B14013. Enter B14013 into the search, click on the v122487 series and then select the dates to include November of the last year and then the Retrieve now button. For Nov. 2015 it was 2.17%.)
It appears that each province that has LIFs has its own maximum withdrawal rates, which are close to, but not the same as the Federal ones above. For example, the Financial Services Commission of Ontario’s L200-415 pdf has higher values for all ages. A useful link that has all provinces is the Kudsia Leith Sanchez website at klsfinancial.ca, which is used for the 2016 rates shown on the spreadsheet. For subsequent years, at the beginning of the year, go to any of the above references and copy and paste the year’s values into the spreadsheet.
As you will be able to see on the spreadsheet, the spread between the minimum (which you must withdraw) and the maximum (which you cannot exceed) is not very much (the maximum is only about .6 to .8 more than the minimum when the person is in the 70s), so there is not a lot of flexibility to increase or decrease the payments depending on your circumstances.
Comparing an Open-Market Annuity
If the commuted value could be invested in an annuity on the open-market, what could you expect? While you will need to deal directly with the insurance companies of your choice to get competitive rates, there is a very good reference to get you started. It is a Globe and Mail page that provides monthly payments that selected insurance companies offer for annuities. Just click on the entry that fits your circumstances. The data given on the spreadsheet uses this website’s page. (You can also view other investments, so it is a good reference for other investments.)
Why should you care about getting a quote for an annuity when you cannot use the commuted value to buy one? The reason is that it provides a check as to how good (or bad) the annuity option is compared to an open-marked annuity. The Administrator should be able to use the large number of people that it has to find annuities for to negotiate with the insurance companies for a better result that a single person.
Present Value of the Annuity Payments
A reasonable question is whether the Commuted Value is a fair amount. As indicated in the section below, calculating the value is complex and details have not been provided by the Administrator. However, there is another way to determine if it seems fair. To do this, you only need to determine what interest rate it takes, for your life expectancy, to have a present value for the yearly annuity payments that match the Commuted Value. The spreadsheet provides an area where you can change the years and the interest rate.
Commuted Value Calculation
As indicated in the Statement of Benefits for Nortel pension plan, for members that are eligible to receive a Commuted Value, the Administrator used standards provided by the Canadian Institute of Actuaries. The actual values used for mortality and the pension’s value are not included in the Benefits statement, so it is not possible to comment on how the calculation was done or whether it is fair. Also the impact of the 3.10% interest that was added to the adjusted commuted value is unknown.
However, if you are interested, here is the link to the referenced “Section 3500 of the Canadian Institute of Actuaries’ Standards of Practice – Practice Specific Standards for Pension Plans“. This contains all of the 3000 – Pension Plan practices, so scroll down to page 3031 to get to section 3500. The mortality rates used are given in section 3530 and refer to UP-94. The interest rates calculations are specified in section 3540 and use three CANSIM tables with specified weighting depending on the year. UP-94 (The 1994 Uninsured Pensioner Mortality Table – Society of Actuaries) is a well used table by actuaries but is from 1994 and was developed for the USA.
A new Canadian mortality table has been developed over the past few years and is called CPM2014. The Administrator probably did not use the Canadian table but it would be a good question to ask. There are lots of web pages that can be found for either table by searching the internet. Here are two links that might be of interest: Retire Happy – New Mortality Table for Defined Benefit Pension Plans and Morneau Shepell – CIA final mortality tables released.
Your life expectancy, from today, factors into all of the annuity and commuted value calculations. Now that your pension is being rolled over into an Annuity, the Administrator and the eventual issuer of the annuity, has to determine if the final monthly payments can be guaranteed and still make a profit.
Life expectancy is the average age to which one might be expected to live. That is, there is a probability for each age before the life expectancy age that a person will die as well as a probability for each age after that the person will still be alive.
Statistics Canada provides access to life expectancy and probability data (plus much more) on Table 053-0003, Elements of the life table, Canada, provinces and territories. Using the Add/Remove data tab, I was able to obtain, for 2010-2012, data for ages 65 to 95 of the Life Expectancy and Probability of survival between ages for all of Canada and both sexes. These values are included in the spreadsheet. You can change any of the selection criteria to select, for example, a province or a specific sex.
There are sites that offer life expectancy for an individual where you enter specific criteria. For example the one by Sun Life Financial has a few criteria while the Canadian Business one has many more. Each provides slightly different results, but they are all within a few years of each other.
Based on your family history, your present heath and other factors, you can assess whether these generalized life expectancies apply to you. Also keep in mind that these are the average for a large population so you may decide that another age applies to you. For example, the annuity is appealing when you expect to live longer than the average life expectancy and the LIF, if it provides adequate income, may appeal for the other situation. Try the spreadsheet with different values to see what happens to the LIF withdrawals and remaining capital.
Range of Returns for LIF
Determining the interest or rate of return you might need on a LIF to provide the same yearly payment that the Annuity Settlement Option offers is one of the key aspects of the spreadsheet. You can enter different rates to see what effect it has using the charts provided.
However, you must be realistic as to what you can expect and not use too high a rate. For example, the best you can obtain today for a 5-year Guaranteed Investment Certificate (GIC) is 2.3%.
The stock market’s long-term return is 8.5% but the volatility is very high. One very good post to read before deciding to commit your “pension” to the stock market is by the Canadian Couch Potato: What are Normal Stock Market Returns? Another is by Retire Happy: What rate of return can you expect from the stock market? In both of these posts the argument is made that year to year returns can range from a negative to a positive double-digit.
You must remember, that the pension you are receiving (and will receive with the Annuity Option) is for your lifetime (and, if originally chosen, at 60% for your surviving spouse). If you presently rely on it for a significant portion of your income, then you must carefully consider if the risk of a higher return for a LIF is worth jeopardizing your future.
Click on Download Spreadsheet and open it so that you can follow along with the example below and then customize it to your circumstances. It is an Excelspreadsheet which requires the Excel application. If you do not have it, try the online version which is free, but requires that you create an account and then upload the file. Other application will probably open the file, but the charts do not always work. When opened for the first time, the spreadsheet has data for the example. As you enter your own data into the outlined cells, some other cells will automatically change and the charts will be updated, as indicated below.
The spreadsheet consists of a section for entering data (in the upper half of the window, numbered 1 to 21), two charts, a table of Limits and tables below the charts that are used for the charts . Only enter data into the cells that are outlined.
Hovering the cursor over any line on a chart will show a comment that describes the Series, the Age and the Value. Alternatively, scroll the window down to see the tables that are used for the charts. They are in bold in the first few columns.
Entering Data and Charts
Data entry is divided into 5 areas. Each area and a description of each numbered line are given below. Values shown in the charts are for the following fictitious example: $900 annuity monthly payments, $100K commuted value, 65 year old male living in Ontario, 8% LIF interest, 8.41% present value interest, $483.34 open-market annuity for a couple with joint coverage and 10-year guarantee.
The charts will change when values are entered into specific cells as mentioned below. The x-axis (Age) starts at your current age and goes to 100. This axis only changes when what you enter into line #5 (Age When Option Starts) changes. The earliest age is 50.
This chart shows the LIF Withdrawals as a solid thick black line.The Annuity payments provided by the Annuity option as a straight red line. The Target LIF Payment/Year is a dashed orange line. Both the red and orange lines will show through the black line when the payments/withdrawals are the same. The Open-Market annuity is a dashed blue line and it normally lies well below the Annuity option’s red line.
Because one of the features of a LIF is that the capital can be turned over to the estate upon death, the dashed green line, which uses the right vertical axis shows how much capital is left at each Year-End. For the example, capital is gone by age 92 (and so are the LIF payments).
In the last two columns is a table of Ages and Limits. This shows which limit is used for each age on Chart 1. It will show either Max, for a Maximum withdrawal in red, Min for a Minimum withdrawal in yellow or Target in green for withdrawal that is the same as the Target LIF Payment/Year (including inflation). Adjust the Target amount in #6 to see what happens to the dashed orange Target LIF line, the black LIF Withdrawal line and the Table of Limits entries.
This chart has 3 lines that provide an indication of the StatsCan data on life expectancy. The lines change whenever the sex changes and the current age changes. The purple line shows the life expectancy as an age. Just move along the x-axis to your present age and then up to the purple line to see your life expectancy. Hovering over the purple line and moving along it will show the data points. Stop at your current age to see your life expectancy. To see the life expectancy as a number of years from your current age, use the orange line and the right axis.
As mentioned above, life expectancy is an average, so that there is a probability of death for each future year. This is shown in the dark blue line. Moving along it will show the percent for each future year.
A) Annuity Option
Annuity Monthly Payment (#1) – Enter the monthly payment that will be provided. On the Nortel Statements of Benefit, this is the Final Monthly Amount. When an amount is changed, the red Annuity Option line in Chart 1 will also change.
Annuity Option Yearly Payment (#2) – This is calculated automatically from the monthly payment of #1.
Inflation Percent (#3) – Enter the Inflation rate as a percent that the annuity is to increase each year. Most provinces do not permit an increase. The red Annuity Option line in Chart 1 change. Please enter only positive values as there is no check for a negative.
B) Life Income Fund (LIF) Option
Commuted Value (#4) – Enter the commuted value that will be provided. On the Nortel Statements of Benefit, this is the Commuted Value of Pension. When changed, there is no change to either chart.
Target LIF Payment/Year (#5) – Enter whatever value you want to receive from the LIF as a yearly amount. By default it is linked to the value in #2 (Annuity Option Yearly Payment). If it is too low, the Minimum LIF withdrawal will automatically be used. If it is too high, the Maximum LIF withdrawal will automatically be used. Examine the two columns along the right side of the window to see what Limit is used. Once changed, the solid black LIF Withdrawal, the dashed orange Target LIF and the dashed green Year-End Capital lines on Chart 1 will change as will the Limit column.
Age When Option Starts (#6) – Enter your current age, or your age when the option starts, if different. Once changed, the solid black LIF Withdrawal and the dashed green Year-End Capital lines on Chart 1 will change. Also the purple Life Expectancy Year on Chart 2 will change. While any age can be entered, only ages 50 to 99 will produce charts.
LIF Investment Interest rate (#7) – Enter the interest rate you expect to obtain with your LIF investments. The lowest rate will probably be a 2% to 3% GIC rate and the highest will probably be a 5% to 8% stock market return. Once entered, the LIF Withdrawal and the Year-End Capital lines will change on Chart 1. Notice that for the example, the LIF Withdrawal does not reach the Annuity Option Payment until age 80 and the drops off after age 88. Clearly, a LIF for the example does not come close to matching the Annuity. This is due to the maximum withdrawal restrictions and the low Commuted Value. Try a few values to see what happens for your circumstances. For the example, at 9% the LIF Withdrawal starts at $8K and rises to the annuity value by age 76 and stays there to over 100 years of age. There will still be a small amount a capital left at 100. However, even an 8% return is not reasonable to expect during retirement when capital preservation should be a key criteria for investing. The risk of not getting the return desired and having to withdraw from capital should keep most people awake at night.
LIF Inflation Percent (#8) – Enter the inflation rate you want to be considered for the remainder of the LIF. The dashed orange Target LIF line will change. A 1% inflation is used for the example. The LIF Withdrawal may change depending on what withdrawal choice has been selected.
Select the Province (#9) – This is set initially to “1) AB,NB,NL,IN,SK”. If your province is not one of these, when the cursor enters the outlined cell, a small drop-down menu appears to the right of the cell. Select the other set of provinces (“2) BC,MB,NS,QC”). The remaining “Federal” value does not apply to Nortel members. There will be a slight change to the Chart 1 lines in later years due to the lower maximum withdrawal rates.
Select the Withdrawal Choice (#10) – This is set initially to “1) Closest Possible“. It will select a withdrawal the gets as close as possible to the Annuity Option Yearly Payment of #2 while ensuring that the Minimum and Maximum withdrawal limits are not violated. When the cursor enters the outlined cell, a small drop-down menu appears to the right of the cell. Try the other 2 choices (“2) Maximum” and “3) Minimum“) and observe the affects on Chart 1. Choose the one that best suit your circumstances.
C) Life Expectancy from StatsCan Table
Sex (#11) – This is initially set to Male. To change, place the cursor into the outlined cell, and select Female from the small drop-down menu appears to the right of the cell. Females have a longer life expectancy that males and the values of #12 and #13 as well as the lines on Chart 2 will change.
Life Expectancy in Years (#12) – This is calculated automatically when an age is entered on #6 using a column below the charts.
D) Present Value of the Annuity Payments
Annuity Option Yearly Payment (#14) – This is #2 and filled in automatically.
Life Expectancy in Years (#15) – This is the same as #12 and filled in automatically. If you want a different value based on your circumstances, enter any value you want, especially if you can obtain the value used by the Nortel Administrator.
Present Value Interest Rate (#16) – Enter a percent into this cell and watch the Calculated Present Value (PV) (#17). Keep changing the rate until the PV comes close to the Commuted Value of #4. This will then indicate the interest the Administrator is likely using to obtain the Commuted Value for your life expectancy. Increase the rate to decrease the PV and, conversely, decrease the rate to increase the PV.
Calculated Present Value (#17) – This uses the standard Excel PV formula to calculate the Present Value from the yearly payments (#14), years (#15) and interest rate (#16). Compare this to the Commuted Value (#4) and change the interest rate or year to get as close to it as possible. This does not appear on any charts.
Annuity Terms and Type (#18) – This is provided to record what was selected for the open-market annuity. It can be kept blank, if desired.
Payment per Month/$100K (#19) – Use the link provided in the post to obtain an estimate and enter it here. If it is possible to buy and annuity and not a LIF, get a quote from an insurance company and enter the amount.
Yearly for Commuted Value (#20) – This is calculated automatically and is the dashed blue Open-Market Annuity line on Chart 1.
Open-Market Inflation % (#21) – Enter the Inflation rate as a percent that the open-market annuity is to increase each year. The dashed blue Open-Market Annuity line on Chart 1 will change. Please enter only positive values as there is no check for a negative.
Conclusion for the Example
The example was for a fictitious person but a number of conclusions can be drawn. Use the points given below to evaluate your own circumstances:
What is the risk in using the LIF Investment Interest Rate? – Very high as it is 8% and probably not realistic.
Does the LIF provide the same yearly income as the Annuity Option? – NO, except for a few years. This is from the LIF withdrawal line of Chart 1.
When does the LIF payment/capital go to zero? – At age 92 which is 8 years past the average life expectancy. This is from the Year-End Capital line of Chart 1. Life expectancy is #13.
What is the probability of being alive when LIF = 0? – There is still a 14.7% probability of being alive at 92. This is from the Probability line of Chart 2 and the same column below the charts.
What is the result when a GIC rate is used? – Using a 2.3%, LIF payments are only 60% of the Annuity yearly payments falling to 40%. LIF capital and payments are gone at age 89 which is 5 years past the life expectancy but there is a 29.9% probability of being alive then.
Should the Annuity Option be taken? – YES, because the safe (low interest) LIF is not good enough and the high interest rate is too risky and still does not give an equivalent years payment.
The Nortel bankruptcy and the resulting reduction of pension and loss of other benefits has caused a change to many people’s financial situation.
As a result of extensive work by the NRPC, the LIF option for Ontario is available, but it appears that the Commuted Value is much too low for many people to take this option.
A few years ago I developed a lifetime finances planner that helped me and others to deal with these types of situations. It helped my family decide what needed to change when the pension reduction started. The planner can be downloaded and tried (with data entry restrictions) as a demo for 31 days. For details see FinanceBase-Lifetime Finances and follow other links to for more information and to download the application.
Lifetime Finances uses your assets, income & expenses during your lifetime to project whether you will outlive your money. It can be used at any age and provides a yearly cash flow (income less expenses, including taxes) from now to 45 years after retirement. It is especially useful it you are retired because it helps you decide what you can spend any how long your assets will last and still leave an inheritance, if you want. It also includes setting the transfer of assets on death to the surviving spouse. If desired, changes can be made in any year. You can do what-if analysis and save different scenarios.
Lifetime Finances also contains an Account manager to help keep track of your assets and liabilities and generate reports such as gross and net worth. The Accounts are linked to the planner so that at any time desired any scenario can be retrieved and updated. As your circumstances change, you can use the planner and accounts at any time to check how your financial plans need to change to adapt.