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, 2006Patrick Longhurst, CFP, FCIA

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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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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?

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Understanding the implications

• Many people find pensions confusing!• A decision made about a “pure” pensions

issue can impact on:

Tax-sheltered contribution

room

Benefits payable upon death, disability or

termination of employment

Other post-retirement benefits

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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

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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

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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

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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.)

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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

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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

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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

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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

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When to retire



Lump-sum or annuity


Income sharing strategy

OtherPensions

RegisteredInvestment

s

Non-RegisteredInvestment

s

Post-Retirement

Benefits

SpousalAssets

Other Income Sources

Vision of Retirement

Attitude to risk

Pension Decisions in Context

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Pension Decisions in Context

Pension Leg

islationWhen to retire



Lump-sum or annuity


Income sharing strategy

OtherPensions

RegisteredInvestment

s

Non-RegisteredInvestment

s

Post-Retirement

Benefits

SpousalAssets

Other Income Sources

Vision of Retirement

Attitude to risk

Global Economics

Inco

me

Tax

Rule

s

Demog

raphic

sPension Legislation

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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?

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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

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Case study 9

A Pension plan member aged 60, retiring in 2006, living in Ontario

The QuestionTake 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

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 Take the pension

Assets Variance Assets Variance

$’000 $’000 $’000 $’000

Reg. Assets 721 - 129 -

Non-Reg. Assets 42 - 523 -

Total Assets 763 - 652 -

ConclusionDecision influenced by marital status

Assumptions

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Increase rate of return to 7%


Life expectancy 85

CPP starts 60

Part-time work No

Income needs $44K

Inheritance No


Non-reg. Inv. $300K

Projected Asset Values

Take lump-sum value Take the pension


$’000 $’000 $’000 $’000

Reg. Assets 922 +201 165 +36

Non-Reg. Assets 256 +214 679 +156

Total Assets 1178 +415 844 +192

ConclusionInvestment return is a critical factor

Assumptions

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Life Expectancy Reduced


Life expectancy 75

CPP starts 60

Part-time work No

Income needs $44K

Inheritance No


Non-reg. Inv. $300K




$’000 $’000 $’000 $’000

Reg. Assets 952 +231 170 +41

Non-Reg. Assets 40 (2) 446 (77)

Total Assets 992 +229 616 (36)

ConclusionShort life expectancy makes lump sum attractive

Assumptions

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CPP starts at 65


Life expectancy 85

CPP starts 65

Part-time work No

Income needs $44K

Inheritance No


Non-reg. Inv. $300K




$’000 $’000 $’000 $’000

Reg. Assets 705 (16) 129 -

Non-Reg. Assets 61 +19 546 +23

Total Assets 766 +3 675 +23

ConclusionBest start date depends on the situation

Assumptions

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More RRSP Investments


Life expectancy 85

CPP starts 60

Part-time work No

Income needs $44K

Inheritance No


Non-reg. Inv. $100K




$’000 $’000 $’000 $’000

Reg. Assets 649 (72) 386 +257

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

Total Assets 577 (186) 587 (65)

ConclusionThe investment portfolio has a major impact

Assumptions

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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!

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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

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Questions???

Documents

Exercising Your Options- Helping your clients make pension decisions