Post on 24-Dec-2015
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!
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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
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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
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Survivor Benefits Surviving spouse may be eligible
Partial pension E.G. 60%
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Indexation Adjusted for inflation Reflects changes in CPI
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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
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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.
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Harold
582
85312
factor qualifying plan thejoining of age
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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
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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
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Types of RRSP’s Basic RRSP Self-directed RRSP Group RRSP
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Basic RRSP Established by the issuer to hold
specific investments GIC’s Compound CSB’s Many mutual funds
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Self-directed RRSP Established by the taxpayer to
hold virtually any eligible investment Common stocks Mortgages Regular CSB’s Some mutual funds
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Group RRSP Variation on basic RRSP’s
Sponsored by union, employer, or professional association
Tend to offer limited choice of investments
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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
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The Annuity Principle A pool of funds used to generate
an income for life Protects against the risk of outliving
one’s financial resources
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The Life Insurance Principle Pooling of funds
To cover the risk of premature death of person with dependants
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Benefits of Buying an Annuity Provided fixed, guaranteed income
for life Eliminates concerns about
handling investments
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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
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Characteristics of Annuities Accumulation and liquidation
period Method of paying Starting liquidation period Number of lives covered Refund features
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Accumulation Period Period during which payments
made to annuity fund Installment payments Lump sum payments
Must be completed before the liquidation period starts
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Liquidation Period Period during which payments
received from the annuity fund Deferred payments Immediate payments
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Life Annuities Investment Monthly income for life Sold by life insurance companies Protect level of living
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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
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Cost of Annuities Influenced by Size of payments Life expectancy Interest rates Length of accumulation period Refund features Number of lives covered
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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
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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
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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
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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%