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

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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

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Case study 1

• Sixty-five year old man selecting a pension
  option
• Worried that, if he takes a JS 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 wifes
  ability to handle the investment of a large lump
  sum

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Pension Decisions in Context
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Pension Decisions in Context
Pension Legislation
Pension 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 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
  todays 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

Conclusion Decision influenced by marital status
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Increase rate of return to 7
Assumptions
Projected Asset Values

• 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

Take lump-sum value Take the pension
Assets Variance Assets Variance 000
000 000 000 Reg. Assets 922
201 165 36 Non-Reg. Assets 256 214 679 1
56 Total Assets 1178 415 844 192
Conclusion Investment return is a critical factor
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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

Conclusion Short life expectancy makes lump sum
attractive
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CPP starts at 65
Assumptions
Projected Asset Values

• 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

Take lump-sum value Take the
pension Assets Variance Assets Variance 000
000 000 000 Reg. Assets 705
(16) 129 - Non-Reg. Assets 61 19 546 23 T
otal Assets 766 3 675 23
Conclusion Best start date depends on the
situation
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More RRSP Investments
Assumptions
Projected Asset Values

• 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

Take lump-sum value Take the pension Assets Var
iance Assets Variance 000 000 000
000 Reg. Assets 649 (72) 386 257 Non-Reg.
Assets (72) (114) 201 (322) Total
Assets 577 (186) 587 (65)
Conclusion The investment portfolio has a major
impact
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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???