Exercising your options helping your clients make pension decisions
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Exercising Your Options- Helping your clients make pension decisions. CIFPS Annual National Conference – May 29, 2006 Patrick Longhurst, CFP, FCIA. Making pension decisions. When to retire. What form of pension. Whether to buy back service. Lump-sum or annuity. When to take CPP/QPP.

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Exercising Your Options- Helping your clients make pension decisions

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Exercising your options helping your clients make pension decisions

Exercising Your Options- Helping your clients make pension decisions

CIFPS Annual National Conference – May 29, 2006

Patrick Longhurst, CFP, FCIA


Making pension decisions

Making pension decisions

When to retire

What form of pension

Whether to buy back service

Lump-sum or annuity

When to take CPP/QPP


The three critical issues

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?


Understanding the implications

  • Benefits payable upon death, disability or termination of employment

  • Tax-sheltered contribution room

  • Other post-retirement benefits

Understanding the implications

  • Many people find pensions confusing!

  • A decision made about a “pure” pensions issue can impact on:


Case study 1

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


Case study 2

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


Case study 3

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


Case study 3 option 1

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.)


What is special about the client

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 :

    • Expectations of longevity

    • Investment expertise and attitudes to risk

    • Earnings expectations

    • Their spousal situation


Case study 4

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


Case study 5

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


Case study 6

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


  • Pension decisions in context

    Other

    Pensions

    Income sharing strategy

    Registered

    Investments

    When to retire

    What form of pension

    Whether to buy back service

    Non-Registered

    Investments

    Lump-sum or annuity

    Attitude to

    risk

    When to take CPP/QPP

    Post-

    Retirement Benefits

    Vision of Retirement

    Spousal

    Assets

    Other Income Sources

    Pension Decisions in Context


    Pension decisions in context1

    Other

    Pensions

    Demographics

    Global Economics

    Income sharing strategy

    Registered

    Investments

    When to retire

    What form of pension

    Whether to buy back service

    Non-Registered

    Investments

    Lump-sum or annuity

    Attitude to risk

    When to take CPP/QPP

    Post-

    Retirement Benefits

    Income Tax Rules

    Vision of Retirement

    Spousal

    Assets

    Other Income Sources

    Pension Decisions in Context

    Pension Legislation

    Pension Legislation


    Case study 7

    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 non-registered assets first”

    • But how about the OAS clawback?


    Case study 8

    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


    Case study 9

    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


    Default assumptions

    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


    Default

    Net rate of return6%

    Life expectancy85

    CPP starts60

    Part-time workNo

    Income needs$44K

    InheritanceNo

    Reg. Investments$100K

    Non-reg. Inv.$300K

    Projected Asset Values

    Take lump-sum valueTake the pension

    AssetsVarianceAssetsVariance

    $’000 $’000 $’000 $’000

    Reg. Assets721-129-

    Non-Reg. Assets42-523-

    Total Assets763-652-

    Default

    Assumptions

    Conclusion

    Decision influenced by marital status


    Increase rate of return to 7

    Net rate of return7%

    Life expectancy85

    CPP starts60

    Part-time workNo

    Income needs$44K

    InheritanceNo

    Reg. Investments$100K

    Non-reg. Inv.$300K

    Increase rate of return to 7%

    Assumptions

    Projected Asset Values

    Take lump-sum valueTake the pension

    Assets Variance Assets Variance

    $’000 $’000 $’000 $’000

    Reg. Assets922 +201165+36

    Non-Reg. Assets256+214679+156

    Total Assets1178+415844+192

    Conclusion

    Investment return is a critical factor


    Life expectancy reduced

    Net rate of return6%

    Life expectancy75

    CPP starts60

    Part-time workNo

    Income needs$44K

    InheritanceNo

    Reg. Investments$100K

    Non-reg. Inv.$300K

    Take lump-sum valueTake the pension

    Assets VarianceAssetsVariance

    $’000 $’000 $’000 $’000

    Reg. Assets952+231170+41

    Non-Reg. Assets40(2)446(77)

    Total Assets992+229616(36)

    Life Expectancy Reduced

    Assumptions

    Projected Asset Values

    Conclusion

    Short life expectancy makes lump sum attractive


    Cpp starts at 65

    Net rate of return6%

    Life expectancy85

    CPP starts65

    Part-time workNo

    Income needs$44K

    InheritanceNo

    Reg. Investments$100K

    Non-reg. Inv.$300K

    CPP starts at 65

    Assumptions

    Projected Asset Values

    Take lump-sum valueTake the pension

    AssetsVarianceAssetsVariance

    $’000 $’000 $’000 $’000

    Reg. Assets705 (16)129-

    Non-Reg. Assets61+19546+23

    Total Assets766+3675+23

    Conclusion

    Best start date depends on the situation


    More rrsp investments

    Net rate of return6%

    Life expectancy85

    CPP starts60

    Part-time workNo

    Income needs$44K

    InheritanceNo

    Reg. Investments$300K

    Non-reg. Inv.$100K

    More RRSP Investments

    Assumptions

    Projected Asset Values

    Take lump-sum valueTake the pension

    AssetsVarianceAssetsVariance

    $’000 $’000 $’000 $’000

    Reg. Assets649(72)386+257

    Non-Reg. Assets(72)(114)201(322)

    Total Assets577(186)587(65)

    Conclusion

    The investment portfolio has a major impact


    For highly paid clients

    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!


    Conclusion

    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


    Questions

    Questions???


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