By Jonathan Chevreau National Post Friday, June 6, 2003

Opportunistic few play on investor fear

With corporate pension plan woes in the news every day, current and near retirees may well feel insecure.

But if you're in public service pension plans, funding issues are less critical. "Whether we like it or not, we taxpayers are on the hook for those promises and there's nothing we can do about it," says Bruce Cohen, co-author of The Pension Puzzle.

A bigger threat to your government pension may be opportunistic financial advisors who are taking advantage of pension paranoia to urge members to cash out of their plans to take a flyer on some dubious alternatives.

Canada's third-largest defined benefit pension plan -- the Ontario Municipal Employee Retirement System -- has issued just such a warning to its 325,000 members and 900 employers .

On its Web site, OMERS warns some financial planners are advertising seminars which imply they are sponsored or presented by OMERS. That's not the case. "OMERS is encouraging its members to consult an independent financial adviser, and compare their OMERS benefit with what they may get by transferring their pension out of the plan."

OMERs spokeswoman Jane Courtemanche said the warning was issued after it discovered a Niagara Region financial planning firm posted bulletins in the workplace of various OMERS employers.

Courtemanche did not accuse the firm of doing anything unethical. "From his point of view it makes sense to target our members. He was pitching a diversified portfolio with multiple managers to reduce risk. We're just saying be careful. Doing it on your own can increase costs and there are many advantages to a defined benefit plan."

Actuary Malcolm Hamilton says the Ontario Teachers' pension plan had the same problem, although it reduced its exposure through recent amendments.

"Deciding to forgo a fully indexed lifetime pension in exchange for a sum of money that you must invest on your own is a big decision. For some, such as those with a short life expectancy, it is an easy decision. For most, it is not."

Hamilton says plan members will have difficulty finding objective advisors because "many advisors don't know much about pension plans and many have a vested interest in people cashing out."

Typically, portfolios are reinvested in mutual funds sold with a deferred sales charge (DSC). The salesman gets a 5% commission on the portfolio value plus ongoing annual trailer fees of 0.5 to 1%.

A typical commuted value on a teacher's pension plan might be $600,000, generating an instant $30,000 commission.

Teachers' spokeswoman Lee Fullerton says "opportunistic" financial advisors targeted the plan at the top of the bull market in 1998-1999. She knows of one case where a teacher invested the lion's share of his pension proceeds in Nortel Networks when it sold above $100 a share.

Fullerton uses the word "unscrupulous" to describe the practice of certain financial planners who "lured people to what they thought was a presentation by our pension plan. Then they presented only half the information necessary to make a good decision."

However, she adds, there were many good financial planners who consistently told clients the switch was not in their best interest. "Many called me and said this is ridiculous. They're getting bad advice."

The biggest drawback is you must quit your job to get access to the pension value. A second, as in the Nortel case, is reinvestment risk. A third is the higher cost of investment management: typical mutual funds have annual management expense ratios of 2.5%, compared with just 0.3% for the OMERS plan.

Finally, there may be tax consequences. Only a portion of the commuted value can be tax-sheltered once it comes out of the plan. For a 55-year-old with a pension valued at $600,000, only $360,000 is tax-sheltered, Fullerton says. The remaining $240,000 is fully taxable at the top marginal tax rate: meaning an instant income tax hit of $110,000 for top-bracket Ontario residents.

Vancouver pension consultant Greg Hurst thinks OMERS could have done a better job in its warning. He takes issue with flat statements like "an OMERS pension is not affected by investment market turbulence." While there may be less risk, it's not true that there is no risk to defined benefit plans, Hurst says.

Certainly, financial planners are capitalizing on the pension fear. The Financial Planning Standards Council (FPSC) yesterday issued a press release with the provocative headline "Pension Plans in Peril? Is your retirement safe?" In it, advisor James Kraemer says future retirees should not rely "too heavily on only one element for your financial future."

Vancouver advisor Adrian Mastracci of KCM Wealth Management warns many pension decisions are not reversible -- both at the outset, when deciding whether to join, or near the end when pension values are transferred to registered accounts or to new employers.

Perhaps the biggest potential hazard is taking on extra risk to chase promised or implied higher returns. It's not uncommon for salespeople to use "illustrations" based on stock markets averaging 10% to 11% annual returns over the long term. Those returns are based on index returns, which contain no fees. Second, past returns are no guarantee of future results. "I'd be skeptical about any alternative plan that assumed more than 6%," Cohen says.

Financial planner and author Jim Otar says projections are " far too optimistic 85% of the time" because advisors have a poor understanding of retirement mathematics. The "vast majority of members of a defined pension plan should leave their pension where it is."

NOTE: The information provided above is intended for general informational purposes only. It does not constitute advice for anyone's specific situation. Everyone should always first consult directly with their advisors to determine the appropriateness of any information contained above before taking any action. KCM Wealth Management Inc. assumes no responsibility for any loss or damage arising from the use of, or reliance upon the above information.