Even though I have a pension, I still buy bonds.

Bonds are boring and safe. Boring and safe can be good.

bonds-screen-918x516
The boring but essential investment.

I’m pretty freaking lucky to be part of defined benefit pension plan, one of those things that used to exist much more broadly 30 years ago.

How it works is that my employer takes small chunks out of my pay check each month before tax and puts it into the pension fund. Then based my years of service and a pre-set formula, I have a guaranteed income in retirement. If my salary stalled for the rest of my career, I could still retire with a full pension for life by 57 with an annual inflation-adjusted retirement income of over $50,000.

Pretty damn lucky right? If I wanted, I could basically blow all my take home pay on the pleasures my money could afford me and do just fine in retirement, but I don’t because: 1) Principally, the world manufactures too much garbage to begin with, so why add to the pile? and 2) I still have other things to save for, like travel, possibly early retirement, and homeownership.

Which leads me to the topic of this article: bonds. That fixed income investment vehicle that gets razzed on for its historical subpar returns. In fact, a practice for many defined benefit pension fund holders is to treat their contributions as the fixed income portion of their portfolio. This approach allows them to take on more risk in the market with their savings by going with a 100% equity portfolio in the hopes of higher long term returns. Pedal to the metal, as they say.

But even then as a pension holder, I still think there is a place for bonds in my portfolio. Like $25,000 worth in my RRSP eventually, to be precise.

So with a guaranteed pension, why bonds at all?

Let’s imagine a scenario: Person A and Person B both have jobs with pensions. The year is 2006 and both are saving for a house. Person A, understanding that the pension is their nest egg, invests aggressively into 100% equities and has a return of 8% year over year. Person B, knowing that he/she can also take on more risk than a traditional 60% stock / 40% bond portfolio, holds an 80/20 equity and bond allocation with a return of 6% year over year.

As they both approach down payment time, the 2008 crash occurs.

Housing prices drop 34%, making it a perfect buy low opportunity for both people. Except Person A now has a portfolio worth 50% of what it was in 2006. Person B is still pretty upset since his/her equities have also lost 50% of their value, but notices their bonds haven’t been affected as much. In fact, they’re doing just fine.

Person A with the dwindled portfolio misses the buying opportunity.

Person B sells his/her bond funds and gets the house.

forclosed
Housing prices crashed in 2008, making it a perfect buying opportunity.

This is the essence of why it’s recommended that almost all people hold bonds or GICs: to provide some stability in the event of a market crash. Bonds especially, tend to act inversely with market crashes since investors flee riskier assets in favour of safer vehicles. As Canadian Couch Potato describes it, bonds are like the underappreciated defencemen of your hockey team.

For younger pension fund holders looking to make big purchases in the next 5-8 years, recall you can’t touch any of your pension contributions unless you: a) are fired, b) quit your job or c) retire.

So sure, you might have a gigantic nest egg waiting for you at the end of your career, but good luck actually having any cash in hand to spend when you need it. Bonds provide the fixed income safety net you need, pension holder or not.

So why $25,000 of bonds in an RRSP?

RRSP are fickle things and since it’s all pre-tax dollars: once you chuck your money in, you can’t take it out without taking a tax hit. Ideally, you’re withdrawing when you’re retired and in a lower tax bracket.

The only time you would want to withdraw ahead of that is for the Lifelong Learning Plan (LLP) or Home Buyers’ Plan (HBP). Both permit a withdrawal of up to $25,000 for school or home ownership with no tax implications as long as you pay it back within 15 years. It’s basically an interest free loan to yourself.

The RRSP is where my bonds live – low risk investments that I can sell in an instant and withdraw for the HBP to buy that house in the event of a market crash. Of course, $25,000 won’t be enough for the 20% down payment many of us strive for, but would be enough for a 5% down payment on a $500,000 property.

Lastly, I’m not holding any fixed income vehicles in non-registered accounts since interest income is taxed at my marginal rate. In fact, across TFSAs and non-registered accounts, I’m going pedal to the metal and holding primarily dividend paying stocks and index funds for the prospect of higher returns.

In conclusion…

For a guy like me, with all the warning signs in our Canadian housing market and consumer indebtedness, I want to be Person B. Ready to go. Ready to spend. Ready to get the house.

The worst that can happen? I take my 3-4% return on my bond fund and call it day. But at least I can sleep at night.

ADDENDUM:
With a pension, what happens if you wind up in a higher tax bracket upon retirement?

A very realistic scenario for pension holders.

The answer is yes: I’d actually pay more tax than if I hadn’t contributed to my RRSP at all. But that’s a risk I’m willing to take and I’m confident that I can hit the 33.89% marginal tax rate eventually.

The significance of that marginal rate? Chances are my pension distributions would not come close to that income range ($84,404-$87,559), so my strategy has been a combination of a) still contributing but deferring my RRSP deductions until that marginal rate is achieved, b) still letting my investments grow tax free, and c) claiming smaller incremental deductions in the years I do owe tax so my tax bill is close to zero.

Another option down the road is to start drawing down my RRSP at 65 but income split those withdrawals with my spouse. Big assumption here is that my spouse would have a lower income. This would probably be the case if she was also retired and had no defined benefit pension to draw on.

Or finally, the blue sky dream: early retirement. If I’m living frugally on only $30,000 a year, drawing down my RRSP is not a big deal since I’m already in a lower tax bracket.

Want to learn more about investing? Check out these posts:

  1. A Guide to Dollar-Cost Averaging
  2. When Index Investing, I Skip the TSX
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Author: stretchingeverydollar

Millennial trying to retire by 40. Because why not?

3 thoughts on “Even though I have a pension, I still buy bonds.”

  1. I have a DB pension also, but I have zero bonds in my RRSP. I treat my pension as my big bond. I figure my company is big enough that it won’t fail (but I’m sure Sears employees said the same thing).

    The one place I do hold some bonds is my TFSA, but I only have that there so I can allocate to other investments if they ever go on “sale.”

    Liked by 1 person

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