Pension PlansPension Plans

In Canada Registered Pension Plans (RPPs) are the In Canada Registered Pension Plans (RPPs) are the plans established by either employers or unions to plans established by either employers or unions to provide retirement income to employees; by law they provide retirement income to employees; by law they need to be registered with Canada Customs and need to be registered with Canada Customs and Revenue Agency for tax purposes.Revenue Agency for tax purposes.

There are two basis classifications of RPPs:There are two basis classifications of RPPs: Defined Contribution Plan (DCpp)Defined Contribution Plan (DCpp) Defined Benefit Plan (DBpp)Defined Benefit Plan (DBpp)

Pension PlansPension Plans

A DCpp is designed based on the employer’s and A DCpp is designed based on the employer’s and employee’s promise of providing contributions on a employee’s promise of providing contributions on a specified basis. Pension benefits will vary depending on specified basis. Pension benefits will vary depending on the amount of contributions accumulated and the return the amount of contributions accumulated and the return on the investment of these funds.on the investment of these funds.

A DBpp is designed based on the employer’s promise A DBpp is designed based on the employer’s promise of providing benefits according to a specific schedule. of providing benefits according to a specific schedule. Such a plan uses a formula to determine in advance the Such a plan uses a formula to determine in advance the amount of the retirement benefit. The employee’s amount of the retirement benefit. The employee’s contributions are clearly defined and the employer’s contributions are clearly defined and the employer’s contributions vary with actual experience in order to contributions vary with actual experience in order to accrue the amount of the DB at retirement.accrue the amount of the DB at retirement.

Which type of PP is most Which type of PP is most beneficial? :beneficial? :

It depends in who wants to answer it! Under a DCpp the employer will make contributions

and at retirement age the employee’s retirement benefits will be provided by whatever pension benefits can be purchased with the accumulated fund.

DBpp are usually funded entirely by the employer; there is a need to have a proper funding strategy to enhance the security of the benefit. Employers generally contribute enough annually to cover the normal cost of the plan (an amount that is at least the value of the benefits that participants in the plan earned that year).

……..but…...but….Bureau of Labor Statistics figures for 2000 show that median job tenure for those aged Bureau of Labor Statistics figures for 2000 show that median job tenure for those aged 25 to 34 was 2.6 years, and for all employees it was 4.7 years.25 to 34 was 2.6 years, and for all employees it was 4.7 years.

Employees faced with choosing between DB and DC plans should take into account the Employees faced with choosing between DB and DC plans should take into account the consequences of leaving before vesting in a DB plan.consequences of leaving before vesting in a DB plan.

Under DB plans, those who leave before becoming vested not only miss out on the Under DB plans, those who leave before becoming vested not only miss out on the retirement benefit, but also have an opportunity cost in the form of lost investment retirement benefit, but also have an opportunity cost in the form of lost investment returns on their contributions. The importance of the opportunity cost depends on returns on their contributions. The importance of the opportunity cost depends on duration of employment, time to retirement and the returns associated with defined-duration of employment, time to retirement and the returns associated with defined-

contribution asset allocation decisionscontribution asset allocation decisions .

Suppose an employee has a choice between a DB plan with three years to vest and a Suppose an employee has a choice between a DB plan with three years to vest and a DC plan with immediate vesting. Assume an annual salary of $40,000 with no growth, a DC plan with immediate vesting. Assume an annual salary of $40,000 with no growth, a five percent deduction from the participant’s salary for either plan, a corresponding five percent deduction from the participant’s salary for either plan, a corresponding employer match for the DC plan and a return on DC plan funds of eight percent. If the employer match for the DC plan and a return on DC plan funds of eight percent. If the employee departs at the end of year three without vesting in the DB plan, he or she employee departs at the end of year three without vesting in the DB plan, he or she receives $6,000, the sum of the annual contributions with no interest. On the other hand, receives $6,000, the sum of the annual contributions with no interest. On the other hand, the DC plan will accumulate a value of $12,985.60 ($4,000 a year at eight percent),5 the DC plan will accumulate a value of $12,985.60 ($4,000 a year at eight percent),5 giving a difference of $6,985.60 between the plans at the end of the third year. giving a difference of $6,985.60 between the plans at the end of the third year.

Theory:Theory:The actuarial present value of a life annuity of $1 per year, payable in monthly instalments while alife-aged-r employee survives is:

Under the traditional Unit Credit (TUC) cost method (strategy for building up proper funds to providethe promised pension at retirement) , the actuarial liability is the present valueat the valuation date of the pension benefit accrued from the date of entry into the plan to the dateof valuation.

The actuarial liability at age x would be:

x employee’s age at time of valuation and r is scheduled retirement agev=(i+i)^(-1) is the present value of $1 to be paid at the end of 1 year, assuming a discount rate of ii is the assumed valuation rate used to discount future cashlows* is the actuarial present value of a life annuity of $1 per year, payable in installments of 1/m at the beginningof each month while a life-aged-r employee survives.

*

The Municipal PP is a Defined Benefit plan. The pension formula is:

At an after age 65:

2% X HAS X Total Pensionable Service (TPS) – Bridge Benefit

•Bridge Benefit = 0.7% X Lesser of HAS or YMPE X TPS

•HAS : 5-year highest average salary

• TPS, I.e. years of service : (Age at retirement - Age at time of entry)

Prior to age 65: 2% X HAS X Total Pensionable Service (TPS)

(The basic pension formula is based on the single life pension, with no guarantee)

The YMPE (Yearly Maximum Pensionable Earnings), is an annual salary amount set each year by the federal government. It is the maximum annual salary that the federal government uses for deducting contributions to the Canada Pension Plan.

Municipal Pension PlanMunicipal Pension Plan

Eg. You have 25 years of pensionable service, are age 60 or older, earned a HAS of $50,000 and the previous year’s YMPE is $40,500 (2004).

Your basic Municipal annual pension to age 65 will be: (2% X 25 X $50,000) = $25,000

Your basic Municipal annual pension to age 65 will be: (2% X 25 X $50,000) - (.7% X 40,500 X 25) =

25,000- 7,087= $17,913 or $1,493 monthly

(You earn one month of pensionable service when you work full time in that month. You can earn up to a maximum of 35 years of pensionable service)

What are our contributions to the plan?

The current contribution rate to the Municipal Pension Plan is approximately 6.9% of your salary up to $41,100 (the YMPE for 2005) and 7.5% of your salary above this amount.

Municipal Pension PlanMunicipal Pension Plan

Some possible changes:Some possible changes:

Not enough money to pay for benefits as currently designed:Not enough money to pay for benefits as currently designed: demographic changes result in greater usagedemographic changes result in greater usage MSP changes increase premium costs MSP changes increase premium costs PharmacarePharmacare changes shift costs to health plans changes shift costs to health plans drug costs and usage soarsdrug costs and usage soars

Costs increase $20 million (65%) in three yearsCosts increase $20 million (65%) in three years Available funding not growing to match cost increasesAvailable funding not growing to match cost increases 90% of funding used to pay 2002 costs90% of funding used to pay 2002 costs Cost projections indicate further increasesCost projections indicate further increases Benefits for current retirees paid from limited employer contirubutionsBenefits for current retirees paid from limited employer contirubutions

* From: Municipal PP “Report on pension and other benefits” Nov 8, 2003

MPP:MPP:

Member's age Avg pensionable Total pensionable Commutedearnings (per year) service (years) value

35 $40,000 5 $13,00040 $40,000 10 $32,00045 $45,000 15 $70,00050 $50,000 20 $150,00050 $55,000 20 $170,000

Examples give an indication of how much would be payable in certain situations,applying current interest rates.

The commuted value of a benefit is the estimated amount of money you would have to put aside today to grow with investment earnings to provide a future benefit

Life Tables Comparison

Age

55

60

65

Male

82.50

83.18

84.07

Female

86.66

87.05

87.60

MPP Life

Male

79.89

80.75

81.88

Female

84.14

84.77

85.54

BC LifeCanadian Life

Male

78.91

79.81

81.04

Female

83.40

84.06

84.90

Basic Account

SupplementalBenefitsAccount

InflationAdjustmentAccount

Employee ContributionsEmployer Contributions

Basic Pension Future Indexing Group BenefitsNon-Pension Benefits

• Post Retirement Group Post Retirement Group BenefitsBenefitsHow Are They Funded?How Are They Funded?

1.0% of plan members salariespaid by Employers

are used to pay Group Benefit costs, with the

balance to Inflation

Adjustment5% to 13% of plan members salaries

6.5% of pensionable

salary1.0% of

pensionable salary

Every person in Canada over 18 who earns more than the basic exempted amount ($3,500 per year) must pay into the CPP. You and your employer each pay half the contributions (we’re paying 4.5% up to the YMPE).

It is designed to replace about 25% of the annual earnings on which a person’s contributions were based (note maximum of $41,100 and minimum of $3,500).

The CPP retirement pension is indexed to the Consumer Price Index annually.

(Avg. monthly retirement pension in 2004 was $458 and max of $823).

The Municipal Pension Plan is integrated with the Canada Pension Plan for those years during which you contributed to both Plans. You may apply for a reduced Canada Pension Plan benefit as early as age 60. This will not affect your Municipal pension. You will continue to receive your Municipal pension, with the bridge benefit, at the same time as you receive your reduced CPP benefit, until you turn 65.

Consumer Price Index

Statistics Canada developed the CPI to measure changes in the cost of living. The CPI tracks cost changes in common household expenses. This "basket" of goods consists of food, shelter, clothing, transportation, health care and other average household expenditures.

Statistics Canada is currently using 1992 as the base year. In 1992, the CPI was equal to 100. This means that the basket of goods in 1992 cost Canadians $100.00. The CPI in January 2003 was measured at 121.4, meaning that the same basket of goods that cost $100.00 in 1992 now costs $121.40.

Canadian Pension PlanCanadian Pension Plan

Canadian Pension PlanCanadian Pension PlanCPI increase compared to the CPP increase

The following table illustrates the changes in the cost of living compared to the changes in the CPP rates over a 10-year period. It shows that the CPI has increased by 19 percent over the 10-year period, using the 1992 base year. CPP rates have increased by 20 percent in the same period.

CPP rates are adjusted once a year using a 12-month moving average method.

Starting at retirement, there will be a pension amount paid each month which will end when you die, or at the end of the guarantee period if later. A survivor pension of equal or lesser amount may be payable to your surviving spouse if you choose that particular option. The pension amount is reduced at age 65 by the bridge benefit. The bridge benefit is designed to “bridge” the gap between your early retirement income and your income after age 65.

Gross Retirement income by age

What do I get when I retire?What do I get when I retire?

6060 6565RetirementRetirement

Lifetime PensionLifetime Pension

Bridge BenefitBridge Benefit Old Age SecurityOld Age Security

Canada Canada Pension PlanPension Plan

Canada Canada Pension PlanPension Plan

• Our pension:Our pension:

Municipal pension planDefined BENEFIT

plan

Canadian Pension Plan (CPP) Defined BENEFIT plan

Basic Pension=Service X HAS X 2%

-Bridge Benefit

Pension=Up to the maximum

retirementPension at age 65, now:

$838

Total Retirement Pension

Not looking good???

What can we do???

RRSPs, defined contribution plans. In these types of plans, your retirement income will be directly related to the amount of contribution you made and how those contributions have been invested over the years. The value and benefit of defined contribution plans can only be determined at retirement, and rely more directly on the return on investments than a defined benefit plan.

Do your numbers and make sure your income replacement at retirement (for all but the highest paid employees) meet or exceed the 70% rule of thumb often suggested as a target replacement ratio to ensure that lifestyle can be maintained .

Make up for the difference in pension you won’t get from your MPP+CPP.

Banks websites have those annoying calculators that help you estimate the amount you should be saving in your RRSP.

Good Luck!

RRSPsRRSPs

Report: Defined benefit pension plans in danger in Canada

Last Updated Wed, 24 Aug 2005 17:04:55 EDT

CBC News

The Association of Canadian Pension Management said that defined benefit pension plans are in danger unless governments change the rules.

The association -- which represents 700 public and private pension plan sponsors, managers and administrators -- said Wednesday fewer Canadians will be covered by defined benefit plans in the future, and many plans will be underfunded.

The pension managers group released a report that said Canada's current rules and legislation do not encourage employers to continue offering company-sponsored defined benefit plans as a retirement savings option for their employees.

Defined benefit plans typically guarantee members a retirement income based on a pre-set formula and a member's years of service with a company. For example, an employee who had 35 years of pensionable service, might get 70% of the average of his/her best five years salary upon retirement.

The percentage of Canadian workers covered by such plans dropped to 34 per cent from 44 per cent from 1992 to 2003, with the decline most significant in the private sector.

Many companies have switched to defined contribution plans, in which the employer and employee put a set amount of funds into the plan, but there is no guarantee what the value will be when the employee draws a pension.

The association said existing rules do not encourage adequate funding -- which results in less security for workers.

Paul Litner, chairman of the association's funding issues task force, said governments should review current funding rules for these pension plans and remove the barriers to rational plan funding.

For example, one barrier that plan sponsors face is that they are responsible for funding shortfalls, but are prevented from accessing excess funds. The pension managers say this can lead to minimum funding strategies which put benefit security at risk.

The report recommends strengthening disclosure requirements around plan funding and ensuring that plans have a written funding policy. It suggests amending the Income Tax Act to enable plan sponsors to better manage the funding of their plans