Exercising Your OptionsHelping your clients make
pension decisions
CIFPS Annual National
Conference – May 29, 2006
Patrick Longhurst, CFP, FCIA
1
Making pension decisions
When to retire
What form of pension
Whether to buy back service
Lump-sum or annuity
When to take CPP/QPP
2
The three critical issues
• Does the client fully understand the implications of
the choices available?
• What is special about him/her that will influence
the decision?
• Have you looked at the overall context in which
the decision should be made?
3
Understanding the implications
• Many people find pensions confusing!
• A decision made about a “pure” pensions
issue can impact on:
Tax-sheltered
contribution
room
4
Benefits payable upon
death, disability or
termination of employment
Other postretirement benefits
Case study 1
• Sixty-five year old man selecting a pension
option
• Worried that, if he takes a J&S option and his
wife dies, he will have to live with it!
• Thinks that a pension guarantee starts from the
date of death
• Thinks that he will lose the guarantee if his
beneficiary dies
5
Case study 2
• A widow of a senior executive who died at age
55 – still in a daze
• Executive was a member of a DB Plan and a
SERP
• Has the choice of a lump-sum or some pension
options
• Does not realize that the lump-sum option
means the end of post-retirement benefits
• Has a physically disabled daughter
6
Case Study 3
• A couple both disabled, with a six year old son
• The father is aged 47 and is more severely
disabled
• He has exhausted his benefits at work and has to
select a pension option
• The family has been given a tight deadline to
select an option and do not understand the
choices available to them
7
Case study 3 – Option 1
Deferred Pension – a monthly pension (not to
commence prior to age 55) will be purchased with
the total of all the contributions remitted into the
Plan. This represents 100% of the Normal
Retirement Benefit. The deferred annuity contract
shall be administered in accordance with the
requirements of the Pension Benefits Standards
Act, 1985. (If chosen, please complete the
enclosed Appointment of Beneficiary.)
8
What is special about the client?
• In general, pension options are designed to be
cost-neutral to the plan sponsor
• On the other hand, the plan member is anything
but average!
• Their decisions will be affected by :
•
•
•
•
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Expectations of longevity
Investment expertise and attitudes to risk
Earnings expectations
Their spousal situation
Case study 4
• Female member is deciding whether to buy
back service in a DB public sector plan
• Male spouse is younger
• She expects a major promotion in two to three
years’ time
• Family has poor longevity
• Some experience at investing
• Expects to retire at age 55
10
Case study 5
• Male member age 49 is trying to decide
whether to join a DB Plan or a DC Plan for
future service
• A model will be provided to help employees
make their choice
• In this case the employee is highly paid and
receives a bonus
• The treatment of bonus is different under the
two options
11
Case study 6
• A pension plan member is extremely sick
• He has to select between:
• A transfer to a LIRA
• A transfer to a successor plan
• A deferred annuity
• His wife is in excellent health
• The member is very concerned about his wife’s
ability to handle the investment of a large lump
sum
12
Pension Decisions in Context
Other
Pensions
Income
sharing
strategy
Registered
Investments
When to retire
What form of pension
Attitude to
risk
Whether to buy back service
Lump-sum or annuity
When to take CPP/QPP
Vision of
Retirement
Other
Income
Sources
13
NonRegistered
Investments
PostRetirement
Benefits
Spousal
Assets
Pension Decisions in Context
Other
Pensions
Income
sharing
strategy
Registered
Investments
When to retire
What form of pension
Attitude to
risk
Whether to buy back service
Lump-sum or annuity
When to take CPP/QPP
Vision of
Retirement
Other
Income
Sources
14
NonRegistered
Investments
PostRetirement
Benefits
Spousal
Assets
Case study 7
• Member of a DC Plan wants to decide when to
start LIF/ LRIF payments
• Plans to retire at 55 – debt free
• Has significant non-registered investments
• Traditional wisdom says “draw down the nonregistered assets first”
• But how about the OAS clawback?
15
Case study 8
• In 2005 the methodology for calculating commuted
values was changed
• At the same time interest rates are at historically
low levels
• Plan members who terminate membership in their
fifties may find that their commuted values exceed
the ITA maximum transfer values
• This may not have been clearly communicated to
them
16
Case study 9
A Pension plan member aged 60, retiring in
2006, living in Ontario
The Question
Take a pension of $40,000 per year payable for
life and guaranteed for ten years,
OR
Take a lump-sum transfer to a Locked-in
Retirement Annuity(LIRA) of $460,000
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Default Assumptions
• Investments in Canadian Balanced mutual funds
earning 6% net of expenses
• Life expectancy of age 85
• CPP benefit starts at age 60
• No income after retirement
• After-tax expenses estimated at $44,000 in today’s
dollars
• Inflation assumption of 3% per year
• Registered investment of $100,000 in an RRSP
• Non-registered investments of $300,000
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Default
Assumptions
Net rate of return
6%
Life expectancy
85
CPP starts
60
Part-time work
No
Income needs
$44K
Inheritance
No
Reg. Investments $100K
Non-reg. Inv.
$300K
Projected Asset Values
Take lump-sum value
Assets
Variance
$’000
$’000
Reg. Assets
721
Non-Reg. Assets 42
Total Assets
763
-
Take the pension
Assets Variance
$’000
$’000
129
523
652
Conclusion
Decision influenced by marital status
19
-
Increase rate of return to 7%
Assumptions
Net rate of return
7%
Life expectancy
85
CPP starts
60
Part-time work
No
Income needs
$44K
Inheritance
No
Reg. Investments $100K
Non-reg. Inv.
$300K
Projected Asset Values
Take lump-sum value
Assets
Variance
$’000
$’000
Reg. Assets
922
Non-Reg. Assets 256
Total Assets
1178
+201
+214
+415
Take the pension
Assets Variance
$’000
$’000
165
679
844
+36
+156
+192
Conclusion
Investment return is a critical factor
20
Life Expectancy Reduced
Assumptions
Projected Asset Values
Net rate of return
6%
Life expectancy
75
CPP starts
60
Part-time work
No
Income needs
$44K
Inheritance
No
Reg. Investments $100K
Non-reg. Inv.
$300K
Take lump-sum value
Assets
Variance
$’000
$’000
Reg. Assets
Non-Reg. Assets
Total Assets
952
40
992
+231
(2)
+229
Take the pension
Assets Variance
$’000
$’000
170
446
616
+41
(77)
(36)
Conclusion
Short life expectancy makes lump sum attractive
21
CPP starts at 65
Assumptions
Net rate of return
6%
Life expectancy
85
CPP starts
65
Part-time work
No
Income needs
$44K
Inheritance
No
Reg. Investments $100K
Non-reg. Inv.
$300K
Projected Asset Values
Take lump-sum value Take the pension
Assets Variance
Assets Variance
$’000
$’000
$’000
$’000
Reg. Assets
Non-Reg. Assets
Total Assets
705
61
766
(16)
+19
+3
129
546
675
Conclusion
Best start date depends on the situation
22
+23
+23
More RRSP Investments
Assumptions
Net rate of return
6%
Life expectancy
85
CPP starts
60
Part-time work
No
Income needs
$44K
Inheritance
No
Reg. Investments $300K
Non-reg. Inv.
$100K
Projected Asset Values
Take lump-sum value
Assets Variance
$’000
$’000
Reg. Assets
Non-Reg. Assets
Total Assets
649
(72)
577
(72)
(114)
(186)
Take the pension
Assets Variance
$’000
$’000
386
201
587
Conclusion
The investment portfolio has a major impact
23
+257
(322)
(65)
For highly paid clients
• Pensions may exceed the maximums permitted by
the CRA
• This means they probably belong to a
Supplemental Executive Retirement Plan (SERP)
• This may be funded or unfunded
• This only makes the three step process more
complicated for you as an advisor!
24
Conclusion
• By providing a conceptual framework for clients
who have pension decisions to make
• You give them peace of mind at decision time
• You reduce the risk of subsequent regrets
• You help to establish an ongoing relationship
25
Questions???
26