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!

Copyright © 2008 Pearson Education Canada 6-2 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

Copyright © 2008 Pearson Education Canada 6-3 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

Copyright © 2008 Pearson Education Canada 6-4 Survivor Benefits Surviving spouse may be eligible Partial pension E.G. 60%

Copyright © 2008 Pearson Education Canada 6-5 Indexation Adjusted for inflation Reflects changes in CPI

Copyright © 2008 Pearson Education Canada 6-6 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

Copyright © 2008 Pearson Education Canada 6-7 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.

Copyright © 2008 Pearson Education Canada 6-8 Harold

Copyright © 2008 Pearson Education Canada 6-9 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

Copyright © 2008 Pearson Education Canada 6-10 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

Copyright © 2008 Pearson Education Canada 6-11 Types of RRSP’s Basic RRSP Self-directed RRSP Group RRSP

Copyright © 2008 Pearson Education Canada 6-12 Basic RRSP Established by the issuer to hold specific investments GIC’s Compound CSB’s Many mutual funds

Copyright © 2008 Pearson Education Canada 6-13 Self-directed RRSP Established by the taxpayer to hold virtually any eligible investment Common stocks Mortgages Regular CSB’s Some mutual funds

Copyright © 2008 Pearson Education Canada 6-14 Group RRSP Variation on basic RRSP’s Sponsored by union, employer, or professional association Tend to offer limited choice of investments

Copyright © 2008 Pearson Education Canada 6-15 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

Copyright © 2008 Pearson Education Canada 6-16 The Annuity Principle A pool of funds used to generate an income for life Protects against the risk of outliving one’s financial resources

Copyright © 2008 Pearson Education Canada 6-17 The Life Insurance Principle Pooling of funds To cover the risk of premature death of person with dependants

Copyright © 2008 Pearson Education Canada 6-18 Benefits of Buying an Annuity Provided fixed, guaranteed income for life Eliminates concerns about handling investments

Copyright © 2008 Pearson Education Canada 6-19 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

Copyright © 2008 Pearson Education Canada 6-20

Copyright © 2008 Pearson Education Canada 6-21 Characteristics of Annuities Accumulation and liquidation period Method of paying Starting liquidation period Number of lives covered Refund features

Copyright © 2008 Pearson Education Canada 6-22 Accumulation Period Period during which payments made to annuity fund Installment payments Lump sum payments Must be completed before the liquidation period starts

Copyright © 2008 Pearson Education Canada 6-23 Liquidation Period Period during which payments received from the annuity fund Deferred payments Immediate payments

Copyright © 2008 Pearson Education Canada 6-24 Life Annuities Investment Monthly income for life Sold by life insurance companies Protect level of living

Copyright © 2008 Pearson Education Canada 6-25

Copyright © 2008 Pearson Education Canada 6-26 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

Copyright © 2008 Pearson Education Canada 6-27

Copyright © 2008 Pearson Education Canada 6-28 Cost of Annuities Influenced by Size of payments Life expectancy Interest rates Length of accumulation period Refund features Number of lives covered

Copyright © 2008 Pearson Education Canada 6-29

Copyright © 2008 Pearson Education Canada 6-30 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

Copyright © 2008 Pearson Education Canada 6-31 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

Copyright © 2008 Pearson Education Canada 6-32 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

Copyright © 2008 Pearson Education Canada 6-33 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%