Exercising Your Options- Helping your clients make pension decisions

1. Exercising Your Options- Helping your clients make pension decisions CIFPS Annual National Conference – May 29, 2006 Patrick Longhurst, CFP, FCIA

2. Making pension decisions When to retire What form of pension Whether to buy back service Lump-sum or annuity When to take CPP/QPP

3. 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?

4. 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:

5. 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

6. 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

7. 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

8. 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.)

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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

15. 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?

16. 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

17. 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

18. 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

19. 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 valueTake the pension Assets Variance Assets Variance $’000 $’000 $’000 $’000 Reg. Assets721 - 129 - Non-Reg. Assets 42 - 523 - Total Assets 763 - 652 - Default Assumptions Conclusion Decision influenced by marital status

20. 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 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 +201 165 +36 Non-Reg. Assets 256 +214 679 +156 Total Assets 1178 +415 844 +192 Conclusion Investment return is a critical factor

21. 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 valueTake the pension Assets Variance Assets Variance $’000 $’000 $’000 $’000 Reg. Assets952 +231 170 +41 Non-Reg. Assets 40 (2) 446 (77) Total Assets 992 +229 616 (36) Life Expectancy Reduced Assumptions Projected Asset Values Conclusion Short life expectancy makes lump sum attractive

22. 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 CPP starts at 65 Assumptions Projected Asset Values Take lump-sum valueTake the pension Assets Variance Assets Variance $’000 $’000 $’000 $’000 Reg. Assets705 (16) 129 - Non-Reg. Assets 61 +19 546 +23 Total Assets 766 +3 675 +23 Conclusion Best start date depends on the situation

23. 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 More RRSP Investments Assumptions Projected Asset Values Take lump-sum valueTake the pension Assets Variance Assets Variance $’000 $’000 $’000 $’000 Reg. Assets649 (72) 386 +257 Non-Reg. Assets (72) (114) 201 (322) Total Assets 577 (186) 587 (65) Conclusion The investment portfolio has a major impact

24. 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!

25. 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

26. Questions???