copyright © 2008 pearson education canada 6-1 defined-contribution pension plans the reverse of...

Copyright © 2008 Pearson Education Canada 6-1

Defined-contribution Pension Plans The reverse of defined-benefit plans

Contribution is known up-front The ultimate benefits are unknown

Upon retirement an annuity is purchased With the combined contributions and interest

No maximum pension as with defined benefit plans

You take all of the investment risk!


Vesting Rights Number of years contributing to plan

To receive future pension To receive employer’s contributions

Leaving job before getting vesting rights Loss of pension Refund

Employee’s contributions Interest on contributions


Option When Changing Jobs Leave funds in the pension plan

Deferred pension at retirement Transfer pension credits to new

employer Transfer to a “locked-in RRSP” - LIRA Transfer funds to insurance company

To purchase a deferred annuity


Survivor Benefits Surviving spouse may be eligible

Partial pension E.G. 60%


Indexation Adjusted for inflation Reflects changes in CPI


An Unreduced Pension May Be Based Upon Specified age - normal retirement age

E.G. NRA age 65 Years of service

E.G. 30 years of service regardless of age A qualifying factor

Combination of age and years of service E.G. QF of 80, if within 10 years of NRA


Example of Unreduced Early Retirement Pension

Harold joined a pension plan when he was 31 years old. The plan has a NRA of 60 with a qualifying factor of 85. Harold will be eligible for an unreduced retirement pension at age 58.


Harold

582

85312

factor qualifying plan thejoining of age


Registered Retirement Savings Plans RRSP’s Trust set up in accordance with the

income tax act To hold certain assets intended for

retirement Not a type of investment

Investment vehicle Tax shelter

Defer tax on current earned income Defer tax on the investment income


RRSP’s Annual contribution limit

18% of earned income $19,000 in 2007

Examples of types of investments Deposits of money Stocks traded on stock exchange Government and corporate bonds,

bonds No foreign content limit


Types of RRSP’s Basic RRSP Self-directed RRSP Group RRSP


Basic RRSP Established by the issuer to hold

specific investments GIC’s Compound CSB’s Many mutual funds


Self-directed RRSP Established by the taxpayer to

hold virtually any eligible investment Common stocks Mortgages Regular CSB’s Some mutual funds


Group RRSP Variation on basic RRSP’s

Sponsored by union, employer, or professional association

Tend to offer limited choice of investments


Maturity Options

RRSP’s must be deregistered Before the end of the year in which you turn 69

Possible options: Remove funds from the tax shelter and pay

income tax Purchase a single-payment life annuity Purchase a fixed-term annuity Set up a registered retirement income fund

(RRIF) Set up a life income fund (LIF) Set up a segregated fund


The Annuity Principle A pool of funds used to generate

an income for life Protects against the risk of outliving

one’s financial resources


The Life Insurance Principle Pooling of funds

To cover the risk of premature death of person with dependants


Benefits of Buying an Annuity Provided fixed, guaranteed income

for life Eliminates concerns about

handling investments


Disadvantages of Buying an Annuity Capital is used

No estate left for heirs Income not protected against

inflation With most annuities

Cannot manage own investments No guarantee of receiving as much

as was paid in


Characteristics of Annuities Accumulation and liquidation

period Method of paying Starting liquidation period Number of lives covered Refund features


Accumulation Period Period during which payments

made to annuity fund Installment payments Lump sum payments

Must be completed before the liquidation period starts


Liquidation Period Period during which payments

received from the annuity fund Deferred payments Immediate payments


Life Annuities Investment Monthly income for life Sold by life insurance companies Protect level of living


Number of Lives Covered Straight life annuity

Simplest and cheapest Pays income for life of the annuitant Payments cease at death

Joint-life-and-last-survivorship annuity Most expensive Pays income while both are alive Pays income during the lifetime of the

survivor In full or at a reduced rate


Cost of Annuities Influenced by Size of payments Life expectancy Interest rates Length of accumulation period Refund features Number of lives covered


Mutual Funds No promises regarding

Principal or interest Availability

Banks, mutual funds companies, life insurance companies, trust companies, investment dealers

Types of funds Equity funds Bond funds Balanced funds Money market funds


Guaranteed Funds Promised return

Principal And guaranteed amount of interest

Availability Banks trust companies credit unions

Types of accounts Savings accounts Term deposits Guaranteed investment certificates


Life Insurance / Annuity Plans Combination of life insurance and

retirement savings Cash value is registered as an RRSP Sold by life insurance companies May require fixed annual payments

Limits investor’s flexibility Usually heavy commissions in early years Think carefully before investing here


Segregated Funds Sold by life insurance companies Invested by professional managers Opened with little money Increased by automatic monthly deposits 75% of principal guaranteed No contribution fees Can’t be touched by creditors Funds go directly to beneficiary when

contributor dies High management expense ratio (MER) E.G. 5%

copyright © 2008 pearson education canada 6-1 defined-contribution pension plans the reverse of...

Documents

pearson education canada

harold slide

investment income slide

pension plan

cpi slide

years of nra slide

contribution pension

unreduced pension