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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-1 Unit 3: Employer Sponsored Pension Plans Welcome to Employer Sponsored Pension Plans. In this unit, you will learn about the nature of various types of pension plans. You will also learn about the distribution of pension benefits and the rules and regulations that govern registered pension plans. This unit takes approximately 4 hours and 30 minutes to complete. You will learn about the following topics: • Supplemental Pension Plans & Defined Contribution RPPs • Defined Benefit Pension Plans • Case Study • Individual Pension Plans • Profit Sharing Plans • Distribution Options • Rules and Regulations

Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-2 Lesson 1: Supplemental Pension Plans & Defined Contribution RPPs Welcome to Supplemental Pension Plans & Defined Contribution RPPs. In this lesson, you will learn about the nature of supplemental pension plans and defined contribution pension plans and how to calculate contributions. This lesson takes 35 minutes to complete. At the end of this lesson, you will be able to do the following: • describe the nature of a supplemental pension plan in Québec • describe the basic nature of a defined contribution pension plan • describe how a defined contribution pension plan compares with other types of registered plans • explain how employee contributions are calculated • describe how pension benefits at retirement are projected

CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-3 Supplemental Pension Plans (SPPs) In Québec, a supplemental pension plan (SPP) is a broad based term that can refer to pension funds, a registered pension plan (RPP), a company plan, etc. In the case of a registered pension plan, it represents a contract under which either an employer alone or an employer along with its employees, makes regular and ongoing contributions to a fund designed to ultimately provide a monthly pension to retired employees. Contributions and any investment returns on those funds accumulate in a patrimony trust that is segregated from the other assets of the company sponsoring the pension plan and is also protected from the claims of the company's creditors which may arise if the company becomes insolvent. A supplemental pension plan can be for the benefit of all employees of the company or, more commonly, for employees that meet certain criteria (e.g. full-time workers with at least two years service). Membership in an SPP may be a condition of employment and is therefore, mandatory or it can be left to the discretion of the employee. A supplemental pension plan can be in the form of a defined contribution plan (which can be established as a simplified pension plan) or a defined benefit plan. Supplemental Pension Plans Act In Québec, a pension plan to which an employer is required to make contributions is regulated by the Supplemental Pension Plans Act . Specifically, the SPP Act applies to: • employer sponsored pension plans in the private, municipal and parapublic sectors whose activities are Québec-based; these plans are registered with the Régie des rentes du Québec who is responsible for ensuring the plan is operated in accordance with the SPP Act • employer sponsored pension plans registered in a province outside of Québec but, whose activities are Québec-based The Supplemental Pension Plans Act does not apply to: • pension plans established for employees in the public sector (i.e. provincial and federal government employees) • pension plans of private or parapublic companies whose activities are federally-based (e.g. banks, telecommunications companies, air transportation)

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-4 Nature of Defined Contribution Pension Plans In a defined contribution pension plan, the amounts of contributions required from the employer (and the employee in contributory plans) are known up-front, but the ultimate benefits are not. The contributions of the employer and employee are accumulated in a pension investment fund until the member retires. At that time, the contributions and any accumulated investment income are used to purchase a life annuity for the employee. The value of the pension depends on what can be purchased by the total accumulation of contributions plus investment income (hence the alternate name of money purchase plan). From the Employer's Viewpoint Many employers prefer money purchase plans to defined benefit plans because they know in advance what their contributions will be. With defined benefit plans, employers face the possibility that they will have to make additional contributions in the future if an actuary predicts that current pension funds are insufficient to pay the promised defined benefits. For defined contribution plans, the employer does not run this risk of an unfunded liability — the benefits are simply whatever can be purchased with the accumulated funds at the time of retirement. George, an employee of Walters Inc., earns $50,000 per year. The company has a defined contribution pension plan to which the employee and employer each contribute 5% of George's pensionable earnings. Walters Inc. will only have to contribute $2,500, calculated as (pensionable earnings × employer's contribution rate) or ($50,000 × 5%), to the RPP on George's behalf for this year of service and 5% each subsequent year. Popularity of Defined Contribution Plans Because of the cost control and ease of administration, defined contribution plans are a popular choice for small employers. The following graphs illustrate the frequency of defined contribution plans.

CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-5 From the Employee's Viewpoint Defined contribution pension plans may be less desirable from the viewpoint of an employee because, although he or she is guaranteed a pension, he or she has no guarantee of the amount of that pension. Typically, he or she has no control over the growth or investment of the assets in the pension fund as this is handled by the pension administrators, and if the investments do poorly, less money will be available to purchase an annuity. In addition, the cost of annuities may be unfavourable at the time of his or her retirement, further reducing his or her retirement income. To help offset this latter disadvantage, most jurisdictions permit the accumulated contributions to be transferred at retirement and at the discretion of the employee to a locked-in RRSP. Where a supplemental pension plan is registered by the Régie des rentes du Québec, it must be administered by a pension committee. Among other roles, the pension committee will assume the day-to-day investment management of the assets held in the patrimony trust although, to varying degrees, it is possible for the plan to allow members to make investment decisions as well. George will also have to contribute $2,500, calculated as ($50,000 × 5%), to the RPP this year. Accumulation of Pension Benefits In defined benefit plans, later career earnings have a more pronounced effect on final pension benefits than early career earnings, particularly for final earnings plans, where the benefit formula is based on a percentage of final earnings for each year of service. In contrast, the early career earnings play a more significant role in defined contribution plans because these early contributions have a longer time to compound prior to retirement. The larger salaries that usually occur late in a career have less of an impact on pension entitlements because contributions on those salaries have less time to accumulate. However, depending on investment performance, it may be possible to accumulate a higher level of pension benefits in a defined contribution plan. Contributions to defined benefit plans are limited to whatever is needed to provide the legislated maximum pension benefit per year of service. There are no such limitations on the maximum pension paid by a defined contribution plan. In reality, a defined contribution plan does not actually pay a pension. Rather, at retirement, the funds that have accumulated in the patrimony trust on behalf of the employee (i.e. the employer's contributions, the employee's contributions and investment returns) over his or her period of membership in the plan are simply used to purchase a life annuity. George has $48,362 in the RPP. If he were 65 years of age and retired today, he would receive a very small pension each month. If he left Walters Inc., he could rollover the $48,362 to a locked-in retirement account.

Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-6 Gender Inequalities The same level of contributions has the potential to result in a lower annual pension benefit for a female than a male with the same entry and retirement ages, due to the lower mortality of females. Because women tend to live longer than men, the annuity provider will likely have to make more payments to women pensioners, and thus the cost of the annuity is higher. However, most jurisdictions now require the use of unisex mortality tables, which combine the mortality experience of males and females, so that identical contributions provide identical amounts of pension benefits, regardless of gender. As a result, a male beneficiary would be better off to rollover the RPP funds to a locked-in RRSP and later purchase an annuity based on male life expectancies, as long as this is permitted by provincial legislation. In some provinces, the Pension Act specifies that if the funds are transferred to a LIRA, any immediate or deferred annuity subsequently purchased with the funds shall not differentiate the amount based on the recipient’s sex. If George were retiring now at age 65, he would have a life expectancy of 15.72 years. If he chose to take the pension, he would receive a pension based upon unisex mortality tables, which assume that he is going to live a couple of years longer. This reduces his pension. Exercise: Defined-contribution Plans Comparison Table Contribution Levels The contributions of the employer and the employee in a contributory plan are typically expressed as a percentage of salary, often in the neighbourhood of 5% each. However, the formula can be adapted easily to allow the employee a range within which he or she can choose the amount that he or she wants to contribute (for example, between 2% and 5%), with it being understood that the employer will make a matching contribution. The maximum combined contribution for the employer and employee is the lesser of : 18% of earnings and the current money purchase contribution limit The Income Tax Act requires the employer to make a minimum contribution of 1% in these plans. Past Service Contributions The defined contribution formula cannot be applied to provide past service benefits. Past service benefits can only be provided with a defined benefit formula. The pension entitlement for a defined benefit plan is based on a percentage of earnings per year of

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-7 service, and there is thus the opportunity to purchase another unit of service. In the case of defined contribution plans, however, there are no units to purchase. George did not join the pension plan until he had two years of service. Because he belongs to a defined contribution plan, he cannot apply for this past service and cannot ask his employer to make up these two years of contributions. Projection of Pension Income For those who are some years away from retirement, benefits under defined contribution pension plans can be projected using a financial calculator. The employer or plan administrator is not required to provide this information on the plan member’s annual statement. A number of variables must be specified before the calculations can be completed. These variables, and the resulting calculations, can be most easily presented in the form of a table. Pensionable earnings and contribution rate The contributions are based upon the pensionable earnings of the employee and the contribution rate of both the employer and the employee. In some plans, the contribution rates may be based upon the age of the employee and may change over the years prior to retirement. Click the icon to view a Projection of Pension Income for Amid Rabil. You will note that the combined employee and employer contributions is $5,700, calculated as ((pensionable earnings × (employee + employer's contribution rates)) or (($38,000 × (7.5% + 7.5%)). Integration with CPP/QPP Some plans have been designed to recognize that the employee and the employer are also contributing to the Canada or Québec Pension Plans. In principle, the pensionable earnings for the defined contribution pension plan would exclude the amount of Yearly Maximum Pensionable Earnings for the CPP/QPP. In practice, integration is usually accomplished by simply reducing the contributions by 3.6% of the YMPE. This rate of 3.6% used to be the contribution rate to the CPP/QPP. The current rate is now much higher, but most plans are entrenched in the old rate. Amid works for a university which has a defined contribution pension plan requiring employer and employee contributions of 7.5% of pensionable earnings. To keep the calculations manageable, we have assumed that neither his pensionable earnings nor the contribution rates will change. Also, the plan is not integrated with the Canada or Québec Pension Plans. These simplifications permit the calculations to be done with a financial calculator. Otherwise, financial planning computer software would be required. With the simplifications, it will only take a few minutes to calculate the projected savings at retirement.

Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-8 Current Savings and Rate of Investment Return The current savings in the defined contribution plan are also taken into account. Based upon a specified investment return on these savings, the total projected savings in the plan at the intended retirement age can be calculated. Amid's current savings of $23,000 plus the contributions made over the next fifteen years will accumulate to $227,727 at retirement, calculated by entering DISP = 0, P/YR = 1, ×P/YR = 15, I/YR = 8%, PV = -$23,000, PMT = -$5,700, MODE = END, and solving for FV of an ordinary annuity. If we took into account changes in his earnings, the calculations would become more complicated. Calculation of Pension Benefits Upon retirement, the employee can choose to purchase an annuity with the entire amount accumulated at retirement (or at some date after retirement, in which case it is necessary to calculate how much the savings will grow until that time). The annual pension income is determined by multiplying the current annuity rate (usually specified as $X per $1,000 of savings). In some cases, the annuity may be indexed for inflation. Alternatively, the employee can choose to transfer the savings to a locked-in retirement account (for example, a locked-in RRSP), in which case the calculation of savings is based upon the time at which the transfer will be completed. It may be possible that some of the savings, if they arise from employee contributions made prior to the date of legislative changes (usually in the mid to late 1980s, depending on the province), can be transferred into a non-locked-in RRSP. If this is the case, the amount of total savings must be allocated between a locked-in and non-locked-in RRSP. It is always preferable to have the savings in a non-locked-in RRSP because of the increased flexibility in using the funds. Click the icon to view the Projection of Pension Income for Amid Rabil. You will note that based upon the current annuity rate and a purchase at the time of retirement, Amid can purchase an annuity which pays $80 per $1,000 of savings, which results in annuity payments of $18,218, calculated as (capital × rate per $1,000) or ($227,727 × ($80 ÷ $1,000)). Alternatively, Amid can transfer the savings to a locked-in retirement account (LIRA). His employer would advise him as to how much of the savings, in this case $31,883, can be transferred to a non-locked-in RRSP. Tax Treatment of Defined Contribution Plans The employer’s contributions to a money purchase pension plan are tax deductible to the employer and are not considered to be taxable income for the employee. The employee’s contributions are tax deductible to the employee. Investment income earned on the pension fund is also tax-deferred during the accumulation period. However, payments from the fund are taxed in the hands of the recipient.

CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-9 You can refer to IT-167R6, Registered pension plans-employee’s contributions, if you want more information. Maximum contributions The contributions to defined contribution pension plans are limited to the lesser of 18% of earned income and a money purchase limit specified by the Income Tax Act. The following table includes the money purchase limits from 1997 to the present. Contribution Limits to a Defined Contribution Pension Plan Year Money Purchase Limit 1997 to 2002 $13,500 2003 $15,500 2004 $16,500 2005 $18,000 2006 $19,000 2007 $20,000 2008 $21,000 2009 $22,000 2010 and beyond indexed Most defined contribution plans are based on combined employer/employee contributions in the range of 10% or less, so the limits above only tend to restrict high-income earners. Constance belongs to her employer's defined-contribution pension plan, which requires both her and her employer to contribute 5% of earnings. Her earnings are $210,000. If the money purchase limit for the year is $22,000, total contributions to Constance's pension plan are limited to $22,000, calculated as [the lesser of (18% of earned income and the money purchase limit)] or [the lesser of (($210,000 × 18%) and $22,000)]. So, even though Constance's plan requires her to contribute 5% of her earnings, her contributions will be limited to $11,000, calculated as (limit of total contributions × 50%) or ($22,000 x 50%). Contributions to a defined contribution pension plan will reduce the amount that the employee may contribute to an RRSP. The pension adjustment for a defined contribution pension plan is simply the total of employer and employee contributions for the year.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-10 Simplified Pension Plan (SIPP) A simplified pension plan is a variation of the basic defined contribution plan; it is offered and managed by a financial institution. Essentially, contributions to the plan are split between a locked-in account and a non locked-in account. In addition to capturing the same benefits of a defined contribution plan, a SIPP also provides advantages that are characteristic of a group RRSP and a DPSP. Except in the case of the family patrimony and support obligations to a former spouse, the funds in a SIPP are creditor-proof. SIPP from the perspective of the employer A SIPP is less burdensome to administer from the employer's standpoint and does not require a pension committee to make investment decisions with respect to the assets in the plan. A SIPP also offers flexibility, as employers can vary the level of their contributions by making additional payments or reducing the level of contributions if the business is undergoing difficulties. Of particular benefit to small businesses, contributions to a SIPP are not subject to payroll taxes and unlike a DPSP, the owner of a small business and his or her family members are able to participate in the plan. The employer can choose whether or not employee contributions are to be locked-in. SIPP from the perspective of the employee From the perspective of an employee, a simplified pension plan provides them with the opportunity for hands-on management, as they get to choose from a selection of investments offered by the financial institution. This can be a significant advantage as the plan member can customize his or her investments according to his or her comfort level. With a basic defined contribution plan, the asset allocation of the investments is generally a function of a pension committee with minimal, if any, input from plan members. Members can make additional voluntary non locked-in contributions; the non locked-in funds can also be transferred to an RRSP and then used to make eligible withdrawals under the Home Buyers' Plan and the Lifelong Learning Plan. Unlike a typical defined contribution plan and a DPSP, employer contributions to a SIPP vest immediately.

CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-11 Characteristics of a SIPP Contributions Both employer and employee contributions (in a contributory plan) are divided between a locked-in account and a non locked-in account. Employer contributions are locked-in and are designed to provide a retirement income for employees. Assuming it is a contributory plan, employee contributions can be either locked-in or non locked-in at the discretion of the employer at the time the plan is established. If the employer does not make a decision in this regard, by default, employee contributions are deemed to be locked-in. At any time, an employer can make additional locked-in contributions on behalf of employees. Similarly, an employee can also make optional, non locked-in contributions subject to the terms of the plan (even if the plan is setup such that the employee's regular contributions are locked-in). Non locked-in account Withdrawals from the non locked-in account can be made at anytime by the employee either in cash or as a transfer to an RRSP or a RRIF. If received in cash, the withdrawal is taxable. All funds in the non locked-in account must be withdrawn when the plan member terminates his or her employment with the sponsoring company. Locked-in account As with other registered pension plans, the purpose of the locked-in portion is to generate a monthly retirement pension payable over the life of the employee following retirement. Accordingly, these funds can only be accessed beginning at age 55. When the plan member terminates his or her employment with the sponsoring company, the funds must be withdrawn from the locked-in account by transferring the funds to a LIRA, a LIF, another supplemental pension plan or the funds must be used to purchase a life annuity from an insurer. If the balance in the locked-in account is relatively small (i.e. less than 20% of the MPE) or if the plan member has a shortened life expectancy that can be medically certified, a withdrawal in cash is permitted. Death of the plan member Upon the death of the plan member, both the locked-in and non locked-in funds are payable in a lump sum to the surviving spouse of the plan member. If there is no surviving spouse or if he or she has renounced the settlement, the funds are paid to a designated beneficiary or the heirs of the deceased plan member.

Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-12 Reflection Take a moment to reflect on this lesson and identify three main points. It could be information you can apply when serving a client, or it could be something that surprised you, or something you feel you should review. You may want to add these points to your study notes, so that you can review them at any time. If you would like to add them to your study notes, click Take Notes now. Review You have completed Supplemental Pension Plans & Defined Contribution RPPs. In this lesson, you have learned how to do the following: • describe the nature of a supplemental pension plan in Québec • describe the basic nature of a defined contribution pension plan • describe how a defined contribution pension plan compares with other types of registered plans • explain how employee contributions are calculated • describe how pension benefits at retirement are projected • Assessment Now that you have completed Supplemental Pension Plans & Defined Contribution RPPs, you are ready to assess your knowledge. You will be asked a series of 5 questions. When you have finished answering the questions, click Submit to see your score. When you are ready to start, click the Go to Assessment link.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-13 Lesson 2: Defined Benefit Pension Plans Welcome to Defined Benefit Pension Plans. In this lesson, you will learn about the nature of defined benefit pension plans and how to calculate contributions. This lesson takes 35 minutes to complete. At the end of this lesson, you will be able to do the following: • describe the basic nature of a defined benefit pension plan • explain how employee contributions are calculated • describe the actuarial assumptions and methods used to estimate the contributions required from the employer • describe the opportunities for past service contributions • describe the tax treatment for contributions made to defined benefit pension plans Nature of Defined Benefit Pension Plans A defined benefit pension plan is any plan that defines the amount of the pension benefit payable at retirement by a formula that relates the value of the pension benefits to earning levels and years of service. The benefit is defined up-front. Employee contributions (if required), are usually set at a fixed percentage of employment earnings. The employer must then contribute sufficient money to ensure that the pensions of plan members are adequately funded. There are three basic forms of defined benefit pension plans: • career-average • final and best-earnings • flat-benefit Career-average Pension Plans A career-average, defined benefit pension plan relates the amount of pension benefit payable at retirement to average earnings during an employee’s career and the number of years of credited service. The employee earns a pension unit during each year of employment, which is usually expressed as a percentage (say 1.5% or 2%) of his or her income for that year. His or her pension at retirement is the sum of all of the units accrued while he or she was a member of the pension plan. Camille works for an employer who offers a career-average, defined benefit pension plan with a 2% unit. Assuming that Camille earns a constant $20,000 over the 25 years that she is enrolled in the pension plan, her annual pension entitlement at retirement would be $10,000, calculated as ((unit percentage × pensionable earnings) × years of membership) or ((2% × $20,000) × 25). An employee’s earnings usually increase from year to year, so the value of each unit will change accordingly. The result is that the final pension can be expressed as the unit percentage of average earnings, times the years of credited service.

Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-14 Frank joined a career-average pension plan with a 1.5% unit just 5 years before retirement. When he first joined the pension plan, he earned $40,000 per year and his salary increased $5,000 each year thereafter. His pension entitlement can be calculated as follows: Alternatively, Frank’s pension entitlement of $3,750 could be calculated as ((average earnings × unit percentage) × years of credited service)or (((($40,000 + $45,000 + $50,000 + $55,000 + $60,000) ÷ 5) × 1.5%) × 5). A career-average pension plan does have a serious drawback from the employee’s point of view. The eventual pension is based on average earnings, including amounts of earnings that may be significantly outdated as a result of job promotions and inflation. This could leave the employee with a low and unsatisfactory pension. The following graphs illustrate the frequency of career-average plans. Final and Best-earnings Pension Plans Final and best-earnings plans are also unit-based plans, where the ultimate pension entitlement is based on a unit percentage for every year of credited service. In final- earnings plans, the unit percentage is applied to the final three to five years of service. In best-earnings plans, the unit percentage is applied to the average of the best three or five years of pensionable service. This could be the final three years of service or an earlier period of service when the employee’s best earnings were achieved. Trevor is planning to retire at the end of this year. He has been a member of his employer’s pension plan for the past 30 years. The plan is based on the best-earnings over three consecutive years, and a 2% unit. His salary increased each year, except for this year. His salary over the last 5 years was as follows: Trevor’s annual pension would be $37,200, calculated as ((average best-earnings × 2%) × 30 years) or (((($60,000 + $60,000 + $66,000) ÷ 3) × 2%) × 30).

CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-15 If the plan were based on final-earnings over 3 years, and a 2% unit, his annual pension would be $36,800, calculated as ((average final-earnings × 2%) × 30 years) or (((($60,000 + $66,000 + $58,000) ÷ 3) × 2%) × 30). The following graphs illustrate the frequency of final or best-earnings plans. Final or best-earnings plans are favoured by large employers, including many municipal plans, such as OMERS (the Ontario Municipal Employees Retirement Savings plan) and school board plans. Flat-benefit Pension Plans Retiring members of a flat-benefit pension plan receive a flat-rate benefit, regardless of their earnings. However, the full benefit may only be available to those who have achieved a minimum number of years of service, such as 25 years, with a proportionally reduced pension available to those with lesser service. The flat-rate benefit may be expressed in different ways. Some plans offer a fixed amount, such as $500 per month, to retiring employees with the required level of service, and prorate that amount for employees with less service. Other plans provide a flat amount of pension per month, for every year of service. Emilio’s employer provides a flat-rate pension of $500 per month to retiring employees with at least 25 years of service, and a prorated pension for employees with less service. Emilio is retiring with 20 years of service, so his pension entitlement is $400 per month, calculated as (( 20 ÷ 25) × $500). Nadia’s employer provides a flat-rate pension of $12 per month at retirement for every year of service, and she is retiring after 30 years of service. Her monthly pension entitlement is $360 per month, calculated as (30 × $12). Flat-benefit pensions are commonly available to unionized employees and the amount of the benefit is often the subject of union negotiations. Most flat-benefit plans are not contributory and the employer pays the entire cost. The following graphs illustrate the frequency of flat-benefit plans.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-16 Exercise: Types of Defined Benefit Plans Employee Contributions In most defined benefit pension plans, especially those in the public sector (that is, plans for government employees), the employee is required to make regular contributions to the pension fund. These types of pension plans are called contributory plans. Current Service Contributions The required contribution is usually specified as a percentage of current contributory earnings. Contributory earnings are the earnings subject to pension contributions and may not be the same as actual income or earned income as reported for income tax purposes. For example, overtime pay and bonuses are usually not considered to be contributory earnings. An integrated pension plan is one that is designed to build upon the Canada or Québec Pension Plans. Most integrated plans call for stepped contributions to provide some relief for those earnings that are already subject to CPP/QPP contributions. In stepped plans, a lower contribution rate applies to earnings up to the Year’s Maximum Pensionable Earnings (YMPE), while a higher rate applies to earnings above the YMPE. In some integrated plans, the contributions are stepped but the ultimate pension benefits are not. In other cases, both the contributions and the benefits might be stepped. Ruel is a member of a contributory best-earnings defined-benefit plan. Assume Ruel's contributory earnings are $60,000 and the YMPE is $46,300. The first contribution rate on amounts up to the YMPE is 7%; the second contribution rate on amounts above the YMPE is 8.5%.

CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-17 Ruel's required contribution would be $4,405.50, calculated as [((the lesser of (pensionable earnings and YMPE)) × 1 st contribution rate) + ((the greater of ($0 and (pensionable earnings – YMPE))) × 2 nd contribution rate)] or [((the lesser of ($60,000 and $46,300)) × 7%) + ((the greater of ($0 and ($60,000 –$46,300))) × 8.5%)]. Past Service Contributions Some defined benefit plans allow members to make extra contributions to purchase a pension for services that they provided in the past. There are a number of different scenarios that could allow a plan member with an opportunity to make past service contributions: • Some plans require potential members to achieve a minimum numbers of years of employment (often 2 years) before they are permitted to join the plan. These plans often provide the new member with the option of purchasing pension credits for the service that they performed prior to becoming members of the plan. • An employer may establish a new pension plan with pension benefits accruing from the time the plan is first established. These plans may provide existing employees with the opportunity to purchase pension credits for the service that they provided prior to the establishment of the pension plan. • An employer may upgrade the benefits provided by the pension plan (for example, from a 1.5% plan to a 2% plan), with the upgrades applying only to future benefits. The employer may provide the plan member with an opportunity to make a past service contribution to upgrade previously earned pension credits to the same unit level. Past service contributions may be paid in a lump sum or by installments. If the payment is by installments, interest may also be required and this interest is also considered to be a past service contribution. This year, Barbara became a member of her employer's defined benefit RPP after completing one year of employment. The RPP allows her to buy back her service from last year. Her part of the cost to purchase this past service is $4,100, which she can pay in a single lump sum this year, or spread out in annual installments over a period of several years. The Income Tax Act may restrict an individual’s ability to purchase or upgrade past service credits, depending on that individual’s RRSP contribution room. Exercise: Employee Contributions

Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-18 Employer Contribution Levels Most defined benefit plans require both employee and employer contributions. The employee contributions are typically a fixed percentage of employment earnings, so the employee knows exactly how much he or she must contribute to the plan. He or she also knows how the value of his or her pension entitlement will be calculated at retirement. By law, the employer must contribute sufficient money to the pension fund to ensure there will be enough money accumulated to fund future pension obligations. Actuarial evaluations substantiating the required level of contributions must be carried out every three years. Predicting the value of future benefits requires actuarial projections and assumptions. An actuary will make a number of actuarial assumptions regarding possible future trends. These assumptions will be based primarily on the knowledge of past trends concerning mortality, interest, expenses, and so on. The actuary also relies heavily on guidance from professional standards and the appropriate pension legislation. The actuarial assumptions and calculations are usually applied to a group of people, not to a single plan member. The actuary tries to predict the average experiences of the group. The actual experience of individual plan members varies significantly. On the next page, we will describe some basic acturial assumptions. Basic Actuarial Assumptions Here are some basic actuarial assumptions that are used to calculate employee contributions and projected future benefits. Click each assumption to read a description. Tax Treatment of Contributions In general, contributions made to pension plans may be deducted in calculating the taxable income of the contributor, whether that is the employee or the employer, provided that the contributions are required by the terms of a registered, employer-sponsored plan. The plan must be approved by and registered with Canada Revenue Agency (CRA) in order for contributions to be deductible. However, there are limits to the total amount that can be deducted. Maximum Pension Benefits According to the Income Tax Act, the maximum yearly pension that can be provided through a defined-benefit plan and for which the contributions can be deducted for tax purposes by the employer and employee is the lesser of: • a dollar limit of the maximum yearly pension x the number of years of pensionable service and • a percentage limit of 2.0% of earnings per year of service

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-19 Since 2003, the dollar limit of the maximum yearly pension is calculated as the greater of: • $1,722.22, and • 1 / 9 of the money purchase limit for the year Year Money Purchase Limit Maximum Yearly Pension 1997 to 2002 $13,500 $1,722.22 2003 $15,500 $1,722.22 2004 $16,500 $1,833.33 2005 $18,000 $2,000.00 2006 $19,000 $2,111.11 2007 $20,000 $2,222.22 2008 $21,000 $2,333.33 2009 $22,000 $2,444.44 2010 indexed indexed 1 (1) indexed annually to the increase in the average industrial wage as measured by Statistics Canada. 1 Evan belongs to a defined-benefit pension plan based on 2.0% per year of service. He currently earns $125,000 per year. If the dollar limit of the maximum yearly pension is $2,444.44, Evan's maximum benefit entitlement for the current year of service will be $2,444.44, calculated as [the lesser of ((the year's maximum dollar limit) and (earnings × percentage limit))] or [the lesser of (($2,444.44) and ($125,000 × 2%))]. With a defined benefit pension plan, the yearly benefit entitlement is usually calculated based on the plan's benefit rate, years of service and a measure of earnings. The formula the plan uses is described in the employee's pension plan booklet. Kevin belongs to a defined-benefit pension plan based on 1.5% per year of service. He currently earns $100,000 per year. This year, the legislated dollar limit of the maximum yearly pension per years of service is $2,444.44. Under the Income Tax Act, Kevin's maximum possible yearly pension is $2,000, calculated as [the lesser of ((the year's maximum dollar limit) and (earnings × percentage limit))] or [the lesser of (($2,444.44) and ($100,000 x 2.0%))]. However, Kevin's plan only provides for 1.5% x earnings per year of service, so his benefit entitlement for this year is $1,500, calculated as (earnings x plan's benefit rate per year of service) or ($100,000 x 1.5%). Benefits generally take the form of a life annuity, which is purchased by the plan when you retire. This annuity provides regular pension payments, and must also provide a benefit for your spouse of no less than 50% of your original benefits in the event of your death.

Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-20 Comparison of Defined Benefit and Defined Contribution Pension Plans There are significant differences between the two types of plans, as described below. Amount of pension The amount of pension provided by a defined benefit plan is known in advance, at least in terms of the formula that relates the benefit to earnings and years of service. In contrast, the pension that may be provided by the defined contribution plan depends entirely upon the investment returns and contributions. The amount of pension provided by a defined benefit plan is restricted by legislation, to a dollar limit per years of service, indexed annually to changes in the average industrial wage. There is no restriction on the pension that may arise from a defined contribution plan - instead the contributions are limited to the money purchase limit. Thus, defined contribution plans have the potential to yield a larger pension, particularly if they are started at a young age and accumulate over a large number of years of service. Investment risk In a defined benefit plan, all of the investment risks lie with the employer. If investments do not perform as expected, the employer must increase its contributions to ensure that sufficient funds accumulate to meet future pension obligations. In contrast, all of the investment risks lie with employee for defined contribution plans. The employer’s obligation is limited to making a contribution. If the pension fund’s investments do not perform as expected, the employee will have less funds at retirement. Inflation Defined contribution plans do not build in any protection for inflation, other than the fact that contributions are limited by the money purchase limit, which will eventually be indexed to reflect increases in the average industrial wage. In contrast, inflation protection can be built into defined benefit plans, although it will require higher contribution levels than a non- indexed, defined benefit plan. Since 2006, both the money purchase limit for defined contribution plans and the maximum yearly pension for defined benefit plans have been indexed to changes in the average industrial wage as reported by Statistics Canada. Conclusion Here is a table with some additional features of defined contribution and defined benefit pension plans. Comparisons Defined Benefit Plans Defined Contribution Plans % of registered plans 43.6% 47.0% % of RPP members 89.8% 8.6% Amount of Pension known in advance depends on investment returns

CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-21 Maximum amount of Pension annual maximum per year of service no maximum, depends on investment returns Investment Risk lies with employer lies with employee Inflation protection can be built in with higher contribution levels no built in protection Annuity income Yes, an Yes, an option option Transfer to LIRA Yes, an option Yes, an option Locked-in Yes, with exceptions Yes, with exceptions Control member determines how pension is paid member determines how pension paid Reflection Take a moment to reflect on this lesson and identify three main points. It could be information you can apply when serving a client, or it could be something that surprised you, or something you feel you should review. You may want to add these points to your study notes, so that you can review them at any time. If you would like to add them to your study notes, click Take Notes now. Review You have completed Defined Benefit Pension Plans. In this lesson, you have learned how to do the following: • describe the basic nature of a defined benefit pension plan • explain how employee contributions are calculated • describe the actuarial assumptions and methods used to estimate the contributions required from the employer • describe the opportunities for past service contributions • describe the tax treatment for contributions made to defined benefit pension plans Assessment Now that you have completed Defined Benefit Pension Plans, you are ready to assess your knowledge. You will be asked a series of 5 questions. When you have finished answering the questions, click Submit to see your score. When you are ready to start, click the Go to Assessment link.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-22 Lesson 3: Case Study Welcome to Case Study. In this lesson, you will be presented with a case study to help you learn how to perform pension calculations. This lesson takes 45 minutes to complete. At the end of this lesson, you will be able to do the following: • describe a typical defined benefit pension statement • explain how to perform various pension calculations A Sample Defined Benefit Pension Statement OMERS (Ontario Municipal Employees Retirement System) is one of the largest pension plans in Canada with 200,000 members. It is a contributory, defined benefit plan based on best-earnings over 5 consecutive years. The plan provides a pension of 2% per year of service, of average pensionable earnings for the best five years of service reduced by a CPP offset of 0.7% of the average YMPE for the last three years of service. Janet Doe is a 34-year old police officer with the City of Kingston, Ontario. Last year, was her fifth year on the force; her salary was $51,691.42. She is a member of OMERS. Throughout this lesson you will work with information for Janet Doe. First you will look at her annual statement and later in this lesson, you will look at her Projection of Pension statement. The statements are typical of those distributed by the administrators of defined benefit pension plans. Explanatory comments are also provided. Click the icon to view Janet Doe's annual statement. We will describe the parts of this statement on the following pages.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-23 Calculating Early Retirement Age The first section on the annual statement provides basic information about the employee (Janet Doe) and her employment status. The OMERS plan operates with two normal retirement ages (NRA): age 65 for most members, and age 60 for police officers and fire fighters. Members may also be eligible for an unreduced early retirement pension provided that they are within 10 years of their NRA and either: • their age plus years of qualifying service, referred to as the Qualifying Factor, is at least 90 for NRA 65, or 85 for NRA 60 or • they have at least 30 years of qualifying service Below is the formula for calculating the earliest retirement age for an unreduced pension. According to her annual pension statement, Janet joined the Kingston police service 4.75 years ago, when she was 29 years and 5 months old or 29.4 years of age. Because she is a police officer, Janet may retire with an unreduced retirement pension at a normal retirement age of 60, or whenever her age is such that the Qualifying Factor is 85. Using Equation 2, the earliest age at which Janet can retire and still receive an unreduced retirement pension is 57.2, calculated as: earliest retirement age = ((age of joining the plan + qualifying factor) ÷ 2) = ((29.4 + 85) ÷ 2) = 57.2 Her unreduced early retirement date is January 31 st in 23.12 years calculated as (early retirement age – current age) or (57.2 – 34.08). Note: Janet’s hire date and enrollment date are the same. This is not always the case, especially in situations where a part-time or temporary employee is upgraded to full-time, permanent status. Janet’s Pension Information for Last Year Section 2 of Janet's annual statement (i.e. 'Your Information for Last Year as Supplied by Your Employer') provides information on Janet’s contribution to her pension plan last year. OMERS pensions are integrated with the Canada Pension Plan, such that a pensioner retiring prior to reaching age 65 receives a higher pension in his or her earlier years, until he or she reaches age 65 when his or her CPP benefits commence. Once the pensioner reaches age 65, his or her pension is reduced by a CPP offset amount. The contributions are also stepped, to reflect this integration.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-24 Basic employee contributions to OMERS are shown in the following table: According to her statement, Janet's contributory earnings for the year were $51,691.42 and her NRA is 60. Last year, based on a YMPE of $44,900, Janet's contribution to the pension fund was $3,720.27, calculated as [(YMPE x contribution rate up to YMPE) + ((the greater of ($0 and (pensionable earnings – YMPE))) x contribution rate above YMPE)] or [($44,900 x 7%) + ((the greater of ($0 and ($51,691.42 – $44,900))) x 8.5%)]. Because Janet worked for the entire year, she accumulated 12 months of credited service. Accumulated Contributions and Interest Section 3 of Janet’s pension statement (i.e. 'Accumulated Contributions and Interest as at December 31 st of Last Year') outlines her total contributions to date, along with the interest earned on those contributions. Janet has made only basic contributions, which are those payable for current pensionable earnings. Under the terms of the OMERS plan, some employees may make additional contributions for past service (supplementary service), or to cover periods of absence (broken service) from the plan due to temporary situations such as maternity leave. If Janet had purchased a period of broken service or made contributions to buy back past service, these contributions would be noted in this section. Janet’s statement shows both contributions and interest, even though OMERS is a defined benefit plan and her pension entitlement does not depend on the growth of the pension fund. This is to help Janet assess the value of her contributions in the event that she decides to terminate her employment. However, Janet’s statement also indicates that her contributions are locked-in, meaning that if her employment is terminated, she cannot elect to receive a refund of her contributions. Instead, the funds must still be used to provide her with a lifetime income, commencing no later than the end of the year in which Janet turns age 71. Under the terms of the OMERS plan, contributions are automatically locked-in for employees who enrolled in the plan after January 1, 1987, and who have two years of plan membership. Pension Calculation Section 4 of the annual statement (i.e. ‘Pension Contribution’) provides an explanation of how Janet’s benefit entitlement is calculated. OMERS’ pension plan is a defined benefit plan based on best earnings over five consecutive years, and a 2% unit per year of credited service. It also uses a 0.7% CPP offset to step down the pension payments at age 65, when CPP benefits are assumed to commence. The first three columns of Section 4 summarize Janet's best five years of earnings. Since Janet does not yet have five years of service, her numbers are pro-rated.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-25 Because CPP contributions are only made on earnings up to the YMPE, the CPP offset is only applied to earnings up to the average YMPE of the previous three years. The fourth column under Section 4 of Janet's statement shows the average YMPE for the last three years. If Janet’s earnings had been below the YMPE, the offset would have been applied to her CPP pensionable earnings over that same time period. Directly below the YMPE calculation, Janet’s statement provides a summary of her credited service. Because Janet has not purchased any broken service or bought back any past service, her credited service is simply the duration of her enrollment at the time of the annual statement (that is, 57 months or 4.75 years). Finally, the bottom part of Section 4 calculates Janet’s current basic pension entitlement at age 60 calculated as [(2% of her best-earnings) x her credited service]. At age 65, this would be reduced by the CPP offset calculated as [(average YMPE x 0.7%) x her credited service]. It is important to note that the pension entitlement calculated in Section 4 reflects the pension that Janet has earned to the end of the statement date (that is, if she terminated her employment and participation in the plan on December 31 st of last year). It is not a projection of the actual pension that she will receive at retirement if she continues to work for her current employer and remains a contributing member of the OMERS plan. Projection of Pension Income For those who are some years away from retirement, benefits under defined benefit plans can be projected using a financial calculator. The employer is not required to provide this information on the member’s annual pension statement. There are several variables required and several calculations. These are most easily presented in the form of a table. Note: It is imperative that you pay close attention to the base year considered in these calculations, so that you incorporate the correct amount of pay periods and anticipate accurately how many pay increases the subject will get. Click the icon to view Janet Doe's Projection of Pension Income statement. These projections are based on the assumption that she will work for 25 more years. Please keep this statement handy as you will need to refer to it throughout the rest of this lesson. Explanations of the various calculations found in Janet's statement are provided on the following pages. Current Pensionable Earnings Pensionable earnings (PE), as defined in the pension plan agreement, are the individual’s earnings, which are eligible for inclusion in determining the annual pension income at retirement. Pensionable earnings include basic salary, but may or may not include bonuses, overtime, and taxable benefits. The PE is used to calculate the annual pension income at

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-26 retirement and the annual pension adjustments. This amount may or may not be the same as earned income. Assuming Janet's pensionable earnings increase by 3% each year, next year, Janet's pensionable earnings will be $53,242, calculated as [current PE × (1 + projected annual increase in PE)] or [$51,691.42 × (1 + 3%)]. Annual increase in PE expected This rate is used to calculate the annual pensionable earnings at retirement. Years of Service Expected at Retirement The years of service expected at retirement is used in calculating the annual pension income. We have assumed that Janet will work for another 25 years. This means, when she retires she will have a total of 29.75 years of service with the Kingston Police force calculated as (current years of service + projected additional years of service) or (4.75 + 25). Age at which Pension Payments Commence This is used to determine the number of years until the pension commences. As of December 31 st of last year, Janet was 34 years old. Therefore, when she retires she will be 59 years old calculated as (current age + projected add As of December 31 st of last year, Janet was 34 years old. Therefore, when she retires she will be 59 years old calculated as (current age + projected additional years of service) or (34 + 25). Indexation of Annual Pension Income This rate is used to index the pension income each year after retirement. Usually it is specified as a percentage of the Consumer Price Index in the pension plan documents. For example, if the rate specified in the plan is 70% of the CPI, and you have assumed the CPI will be 5%, the indexation of pension income is 3.5%, calculated as (CPI × indexation rate) or (5% × 70%). The OMERS plan is not indexed. Year's Maximum Pensionable Earnings (YMPE) The YMPE is the maximum employment (pensionable) earnings on which the Canada and Québec Pension Plans are based. The YMPE is used to determine the maximum annual contributions to the CPP/QPP and the resulting retirement benefits. It may also be used in the determination of pension benefits from a defined benefit plan. Percentage of Pensionable Earnings per Year of Service The percentage of pensionable earnings per year of service, as defined in the plan, is used to determine the size of the pension benefit at retirement. Many pension plans specify one

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-27 percentage for earnings up to the YMPE and a different percentage for earnings in excess of the YMPE. The OMERS plan provides a pension of 2% per year of service of average pensionable earnings for the last five years of service reduced by a CPP offset of 0.7% of the average YMPE for the last three years of service. For earnings below the YMPE, the benefit per year of service is 1.3%, calculated as (basic benefit - CPP offset) or (2.0% - 0.7%). Number of Years Averaged for Final Pensionable Earnings Typically, the pension plan specifies that the final pensionable earnings on which the pension income is based, is the average of the last 3 or 5 years of pensionable earnings. Janet’s membership in the OMERS plan provides a pension based upon average pensionable earnings for the last five years of service. Average Final Pensionable Earnings The average final pensionable earnings is the pensionable earnings for the last year of employment, or the earnings average over the number of years specified in the number of years averaged for final pensionable earnings. Janet's average pensionable earnings for her final five years of service will be $102,106, calculated as (the average of her pensionable earnings in her final five years) or [($108,230 + $105,078 + $102,017 + $99,046 + $96,161) ÷ 5]. The pensionable earnings approaching retirement are calculated by entering DISP = 0, P/YR = 1, ×P/YR = 25, 24, 23, 22, and 21, I/YR = 3%, PV = – $51,691.42, PMT = $0, and solving for FV. The last year's earnings are based upon ×P/YR = 25 years. Janet's pension statement is based as of the end of last year. Assuming Janet's salary for the year is set at the beginning of each year, Janet will have 25 more pay increases. Number of Years Averaged for Final YMPE Typically, the pension plan specifies that the final YMPE on which the pension income is based is the average of the last three years YMPE. If the YMPE is not a factor in determining the pension income, you can leave the number of years as zero. Average Final YMPE at Retirement The average final pensionable earnings is the pensionable earnings for the last year of employment, or the earnings average over the number of years specified in the number of years averaged for final pensionable earnings. For Janet, the average YMPE at retirement will be $91,299, calculated as (the average of the YMPE over her final three years of employment) or [($94,011 + $91,272 + $88,614) ÷ 3]. Given that the YMPE last year was $44,900, the YMPEs in the final three years before Janet's retirement are calculated by entering DISP = 0, P/Yr = 1, ×P/Yr = 25, 24, and 23, I/Yr = 3%, PV = – $44,900, PMT = $0, and solving for FV of the YMPE.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-28 Annual Pension Income at Retirement The annual pension income is calculated as: Janet's annual pension income at retirement will be $41,740, calculated as [((final average YMPE × 1.3%) + ((the greater of ($0 and (final average pensionable earnings – final average YMPE))) × 2%)) × years of service] or [(($91,299 x 1.3%) + ((the greater of ($0 and ($102,106 –$91,299)) x 2%)) × 29.75]. Annual Pension Income at Retirement with Any Survivor's Benefits The annual pension income at retirement may be reduced if the pensioner chooses survivor’s benefits for a spouse or common-law partner. Based upon the pension formula, Janet is entitled to an annual pension of $41,740 for the duration of her life. If she has a spouse or common-law partner, some plans call for this amount to be reduced to provide survivor's benefits. However, in some other plans, the basic amount already includes a survivor's benefit. In Janet's case, assume that there is no reduction, so her pension will remain $41,470 per year. CPP Supplement until Age 65 The OMERS plan is a 2% defined benefit RPP that is integrated with the CPP. The intent of the plan is to provide a pension such that the annual pension plus the CPP will provide 2% per year of service. For employees who retire before age 65 a CPP supplement is added to the employer pension until age 65 to provide a 2% benefit. At age 65, this supplement is discontinued. Meanwhile, the former employee has the choice as to when to start collecting CPP. The actual CPP received at age 65 is not necessarily the amount of the CPP supplement. Based upon 2% per year of service, Janet would be entitled to a pension of $60,753 per year, calculated as [($102,106 × 2%) × 29.75]. Her CPP supplement from retirement until age 65 would be $19,013, calculated as (her pension at 2% – her integrated pension) or ($60,753 – $41,740).

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-29 Summary The calculation of the future value of the retirement benefits from a defined benefit plan requires a fair bit of number crunching. However, the projected retirement benefit at retirement is usually not provided by the employer. You must therefore perform these calculations when preparing a retirement plan for a client who belongs to a defined benefit plan. The task can be expedited through the use of professional retirement planning software. Reflection Take a moment to reflect on this lesson and identify three main points. It could be information you can apply when serving a client, or it could be something that surprised you, or something you feel you should review. You may want to add these points to your study notes, so that you can review them at any time. If you would like to add them to your study notes, click Take Notes now. Review You have completed Case Study. In this lesson, you have learned how to do the following: • describe a typical defined benefit pension statement • explain how to perform various pension calculations Assessment Now that you have completed Case Study, you are ready to assess your knowledge. You will be asked a series of 5 questions. When you have finished answering the questions, click Submit to see your score. When you are ready to start, click the Go to Assessment link.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-30 Lesson 4: Individual Pension Plans Welcome to Individual Pension Plans. In this lesson, you will learn about the nature of individual pension plans (IPPs), how they compare with other types of registered plans, how the contributions are calculated, and the suitability of IPPs. This lesson takes 45 minutes to complete. At the end of this lesson, you will be able to do the following: • describe the basic nature of IPPs • describe the suitability of IPPs • describe the advantages and disadvantages of IPPs Nature of Individual Pension Plans Prior to Pension Reform of 1991, employees who owned or controlled a substantial number of the voting shares of their employer's company were restricted in their ability to earn benefits under a defined benefit pension plan. At that time, the Income Tax Act would not permit the registration of a pension plan if more than 50% of the benefits earned under the plan were for employees who were significant shareholders. Jerome Jones is the sole shareholder of Swell Inc. He is also an officer, director, and employee of the corporation. Swell Inc. has sales of $1 million, net income after-tax of $160,000, and Jerome takes a salary of $120,000 per year. The corporation was founded in 1982. However, Jerome did not want to establish a pension plan to cover all employees and he could not establish a plan for just himself. Specified individual Pension reforms that came into effect in 1991 have relaxed the restrictions. An individual pension plan (IPP) is an employer-sponsored, defined benefit registered pension plan. As much as it is a pension plan, it is often referred to as an RRSP upgrade due to its potential for significant tax deductions and higher pension benefits. Under the right circumstances an IPP can provide an appealing alternative to RRSPs and other retirement savings vehicles. An IPP is established specifically for the benefit of those defined under the Income Tax Regulations as Specified Individuals. These are significant connected individuals (defined as shareholders owning at least 10% of the issued shares or who do not deal at arm's length with the employer) or for other highly paid employees (defined as those earning more than 2.5 times the YMPE as defined by the Canada Pension Plan). An IPP is often referred to as an executive pension plan. In 1991, under the new rules, Swell Inc. could establish a pension plan for just Jerome. However, he could only count service from 1991, not back to 1982 when he incorporated Swell Inc. and became an employee. An IPP that is established primarily for connected persons or high earners is called a designated plan by CRA, and is subject to numerous special rules related to funding, pensionable service and the salary on which benefits can be based. An IPP is typically established for a single participant however, a spouse or even the children of the IPP member may be added to the plan if those individuals work for the same or a related company.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-31 In Québec, most IPPs in the private sector are registered with the Régie des rentes du Québec (RRQ) and are regulated by the Supplemental Pension Plans Act. IPPs not registered with the RRQ are only subject to certain aspects of the Supplemental Pension Plans Act (e.g. beneficiary designations, partition of earnings and contributions on the breakdown of a relationship). Suitability of IPPs An IPP is most advantageous for an owner/manager or executive of an incorporated business or a professional that is allowed to incorporate (e.g. a doctor, lawyer, dentist, engineer or accountant). These individuals should have a steady income, should have attained a minimum age between age 40 and age 45 and have minimum T4 employment earnings of approximately $100,000. Typically, an IPP is best suited to an individual who maximizes his or her RRSP contribution each year. Generally, for an individual who does not meet these criteria, contributing to a regular RRSP makes more sense. Bonita is 50 years of age and in 2008, she had earned income of $140,000. For 2009, Bonita is restricted to an RRSP contribution of $21,000, calculated as [the lesser of 18% of her previous year's earned income and the RRSP contribution limit] or [the lesser of ($140,000 x 18%) and $21,000]. For the year, Bonita may be able to contribute more funds to an IPP—also, a tax-deferred savings vehicle—than the maximum amount permissible to her RRSP. Guidelines with respect to income A guiding principle with respect to maximizing the impact of an IPP is that at minimum, 18% of the T4 employment earnings of a candidate should amount to the RRSP contribution limit for the year. For 2009, this means the IPP candidate should have earnings of at least $116,667 calculated as (RRSP contribution limit ÷ 18%) or ($21,000 ÷ 18%). Guidelines with respect to age The target group for an IPP is comprised of those over 40 years of age because these individuals have less time in which to accumulate funds to provide their desired level of income at retirement. It is at about age 40 that the maximum IPP contribution begins to exceed the maximum RRSP contribution for the year. By setting up an IPP at that time, ideally, a business owner or an executive will be able to contribute higher amounts to an IPP than the maximum amount he or she would be permitted to contribute to an RRSP. As much as there are recommended income and age thresholds with respect to the suitability of an IPP, this vehicle can still offer significant benefits to those with an income below $100,000 or those under age 40. For example, where lower income earning individuals or younger individuals are eligible to buy back past service years, an IPP can present attractive opportunities. Pension Benefit and Contribution Levels IPP pension benefits An IPP is designed to provide the highest level of pension benefits that is permissible. It is a defined benefit plan and therefore, is meant to provide a known level of income at retirement. The benefit must be based upon career-average earnings, and cannot be based

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-32 upon best or final earnings. As with other defined benefit plans, the maximum pension that can be funded is restricted to the legislated maximum yearly pension per years of service. Since 2006, the maximum pension benefit has been indexed annually to changes in the average industrial wage. So, unlike a Retirement Compensation Arrangement (RCA), an IPP is an alternate method of funding a pension benefit as opposed to an additional method of pension benefit funding. IPP contribution levels IPP contributions are based on an individual's age, his or her T4 employment earnings and actuarial calculations approved by CRA. Contributions are tiered according to the individual's age—the older the individual is, the higher the level of contributions he or she can make to the plan. Contributions are based on Actuarial Valuation Reports which essentially calculate the degree of funding required to provide the stipulated pension benefit at retirement. Lynette has T4 employment earnings of $132,000 as the sole shareholder of Virtuality Inc. She was advised to establish an IPP. Based on a dollar limit of the maximum yearly pension of $2,444, Lynette's maximum pensionable earnings would be $122,200, calculated as [the lesser of (dollar limit for this year ÷ benefit rate) and salary] or [the lesser of ($2,444 ÷ 2.0%) and $132,000]. Lynette could establish some lesser amount as her pensionable earnings. Lynette would earn the maximum benefit of $2,444 for this year of service, calculated as (pensionable earnings × maximum benefit rate) or ($122,200 × 2%). The 50% rule The administrators of IPPs use actuarial methods and assumptions to determine the annual contributions needed to fund the desired retirement pension. However, unlike most other defined benefit plans, most IPPs are non-contributory, meaning they are totally funded by the employer. According to the 50% rule, in plans where the employee does make a contribution, his or her contributions must make up less than 50% of the accrued benefits. If the IPP is contributory and, this year, Lynette contributes 10% of her pensionable earnings to the plan, Lynette could claim a tax deduction based on her contribution of $12,220, calculated as (pensionable earnings × contribution rate) or ($122,200 × 10%). Assuming a marginal tax rate (MTR) of 46%, Lynette would reduce her taxable income by approximately $5,621, calculated as (contribution × marginal tax rate) or ($12,220 × 46%). If the plan is non-contributory, Virtuality Inc. would pay an additional $12,220, for which it would receive an income tax deduction. Lynette could adjust her pensionable earnings as she sees fit to take into account her and the corporation's income tax profiles. So, for Lynette and Virtuality Inc., there is no advantage or disadvantage to a contributory plan. Past Service Contributions One of the most attractive features of an IPP is the extremely generous funding formulas compared to RRSP contribution limits. Some IPP members may be able to make additional contributions to purchase past service pension credits. Connected persons may only make past service contributions for service prior to 1991 if the employer has provided, or is willing to provide, past service benefits to non-connected employees that amount to at least 50% of all of the accrued benefits in all of the RPPs operated by the employer. In essence, a

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-33 business owner may be able to make contributions to an IPP for past service that even pre- dates the setup of the IPP (dating as far back as 1991). Given this, it's not uncommon for first-year, deductible contributions to an IPP to be in the hundreds of thousands of dollars in the case of an older individual. Past service contributions can be funded over a maximum period of 15 years provided it is fully funded by retirement. In order to take advantage of an individual's past service, a qualifying transfer must be made from the member's RRSP to the IPP. As a rollover, there are no tax implications on the transfer. Non-connected IPP members may make past service contributions subject to the conditions for all defined benefit pension plans. As the owner of Absolut, Manon established an IPP. Under the plan, Manon is eligible to capture past service benefits dating back to January 1, 1991. Based upon Manon's average annual earnings since that time, the actuary has determined the pension liability from those benefits to be $113,884. In order to acquire these past service benefits, Manon will have a past service pension adjustment (PSPA) of $87,086, which will require her to make a qualifying transfer of $87,086 from her RRSP to the IPP. There will no tax implications as a result of this rollover of funds into the IPP. This will leave Absolut with a liability of $26,798, calculated as (pension liability - PSPA) or ($113,884 - $87,086). Absolut can pay the amount immediately or amortize it over a maximum of 15 years. Absolut will be able to deduct the $26,798 from its taxable income as it pays this amount to the pension trust. Tax Treatment The largest benefit of an IPP is that it gives connected owner/managers and high earners an option for accumulating significant funds for retirement, while deferring taxes. Prior to Pension Reform in 1991, many of these individuals were not eligible to be members of a defined benefit pension plan, and their only option for deferring income taxes to retirement was to contribute to RRSPs. As the age of a member at commencement of the IPP increases, the level of contributions needed to provide the desired level of pension benefits also increases. While it might take contributions of $10,000 per year to provide an individual who is 20 years away from retirement with a desired level of retirement income, it might take significantly more than $20,000 per year to provide that same level of retirement income if the contributions did not commence until 10 years prior to retirement. Typically, the contribution required to fund the maximum permitted benefits from an IPP exceeds the RRSP contribution limit where the new IPP plan member has attained a minimum age between age 40 and age 45. Thus, the tax advantages associated with an IPP do not develop until mid- to late-career. Generally, tax deferral for a high-income individual below this age threshold would be best realized by contributing the maximum amount to his or her RRSP. These individuals should defer the establishment of an IPP until they attain the target age. As the annual RRSP contribution limit continues to increase, the age at which maximum benefits from an IPP can be derived will also correspondingly increase.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-34 The following summarizes the tax advantages stemming from an IPP: • all eligible contributions to the IPP are tax deductible including 'shortfall' contributions required to bring the plan funding back on target and terminal funding contributions at retirement • tax-deferred growth of assets held within the IPP • contributions are a non-taxable benefit to the plan member while the assets remain in the IPP • no deemed disposition based on the fair market value of the plan assets upon the death of the IPP member; assets still in the plan at death can be used to provide benefits to surviving dependants • unlike an RRSP, eligible expenses of the IPP are tax deductible when paid directly by the company sponsoring the IPP (e.g. actuarial consulting fees, fees associated with investments within the IPP and the interest expense on funds borrowed to make contributions to the IPP) Exercise: IPPs Advantages and Disadvantages of IPPs Most employees do not get to choose the type of pension plan in which they participate — either their employer has a plan or does not. However, because IPPs are designed for a specific individual, usually the owner/manager, he or she has some choice as to whether an IPP is best suited to his or her needs, or whether other vehicles, such as RRSPs, are more appropriate. The following advantages and disadvantages should be considered by anyone considering participation in an IPP especially as they relate to a conventional RRSP. Advantages Disadvantages • potential for significant tax relief and tax deductions • administration of plan may be costly • forced savings • inaccessibility of funds • generally, fund assets are protected from creditors • mandatory contributions under most circumstances • guaranteed level of retirement income • unlike a spousal RRSP, spousal contributions cannot be made (however, a spouse or common-law partner may join IPP under certain circumstances)

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-35 • indexing of pension benefits • reduced payroll taxes • can be tailored to meet individual needs • estate preservation These advantages and disadvantages are described in the following pages. Tax Advantages As previously mentioned, starting at approximately age 40, an IPP may allow an individual to make a larger tax-deductible contribution to his or her pension than to his or her RRSP. In addition to providing a tax deduction in the year of contribution, these larger contributions in turn accumulate tax-deferred investment income, ultimately producing a higher pension fund, which pays out a higher pension. Gautam, age 55, is the sole owner of a private corporation and has paid himself a salary of over $100,000 per year since he incorporated in 1991. Gautam would like to retire at 65 with an annual income of $100,000 before tax. Gautam's financial advisor has presented him with an estimate, prepared by an actuary, of his IPP contributions for each year until retirement. He has also included the maximum RRSP contribution limit for comparison. Year IPP Contribution RRSP Contribution Annual IPP Advantage 1 2006 $149,933 $18,000 $131,933 2007 $27,105 $19,000 $8,105 2008 $29,138 $20,000 $9,138 2009 $31,323 $21,000 $10,323 2010 $33,672 $22,000 $11,672 2011 $36,197 $23,210 $12,987 2012 $38,912 $24,487 $14,425 2013 $41,830 $25,833 $15,997 2014 $44,967 $27,254 $17,713 2015 $48,340 $28,753 $19,587 2016 $51,966 $30,335 $21,631 1 RRSP Contribution limit indexed after 2010 Regardless of the government's efforts to allow taxpayers the same amount of tax assistance for retirement savings, whether they used pension plans or RRSPs, there is still a very large advantage to any type of defined benefit pension plan, including the IPP. Based on scenarios developed by designers of IPPs, an IPP may have as much as 65% advantage over an RRSP. Accordingly, in the right circumstances, a business owner or executive can benefit considerably from the IPP.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-36 Forced Savings Once an IPP is established, the prescribed contributions must be made every year if the plan is registered provincially. With RRSPs, individuals are more easily tempted to reduce contributions in order to meet their current lifestyle. As the sole shareholder of Swell Inc., Jerome is contemplating establishing an IPP. If he does in fact establish an IPP and registers it provincially, Swell Inc. has a legal obligation to make annual payments to the plan. If it is a contributory plan, Jerome must also make payments. If he opts not establish an IPP, Jerome could choose each year whether or not to contribute to an RRSP. Impact on RRSP contribution room An IPP will impact the RRSP contribution room of the member in the year the IPP is established and in subsequent years. In most cases, RRSP room will be limited to $600 annually which is the pension adjustment offset for defined benefit pension plans. Obviously, care must be exercised to ensure an overcontribution is not made to an RRSP or else penalties will apply. Protection from Creditors As a registered pension plan, an IPP is generally creditor-proof. This feature is particularly attractive to entrepreneurs as it mitigates the risk of losing the assets in the plan in the event their business fails. While the assets in an IPP are safe from creditors under normal circumstances, is it is important to keep in mind that this is not an absolute right. For example, the assets in the IPP may be subject to seizure in situations where a tax liability is owed to CRA or where the member is delinquent in making court-ordered alimony or child support payments. IPP property may also be subject to division in the event of a breakdown of a relationship between spouses or common-law partners. Traditionally, the creditor-proofing inherent with an IPP meant it held a significant advantage over an RRSP because assets in an RRSP (and in a RRIF or DPSP for that matter) were generally vulnerable to creditor claims unless those assets were invested in certain insurance contracts (e.g. segregated funds). However, following amendments to the federal Bankruptcy and Insolvency Act, an IPP and an RRSP are now essentially on a level playing field as it pertains to creditor-proofing. As of July 7, 2008, all registered assets now enjoy the same creditor protection as pension and insurance investments. The amendment does stipulate that creditor protection will only apply to those assets that have already been invested in a registered plan for at least 12 months (or possibly longer if so determined by the courts) prior to the bankruptcy action. For an individual who plans on filing for bankruptcy, this provision reduces the likelihood that he or she can take advantage of the creditor protection feature, by intentionally placing assets in a registered plan. Guaranteed Level of Retirement Income As a defined benefit pension plan, an IPP guarantees a set level of retirement income up front — something that cannot be accomplished through an RRSP.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-37 If the IPP is not performing up to expectations, as required by pension legislation, additional tax-deductible contributions must generally be made to in an attempt to put the plan back on track. In contrast, if assets in an RRSP do not perform up to expectations, there is no opportunity to top up the plan with additional tax-deductible contributions above and beyond the normal contribution room of the annuitant. Indexing of Pension Benefits Provisions can be made to index the pension benefits under an IPP. While the funding of this increased benefit may require substantially larger contributions, keep in mind, those contributions are tax deductible. In contrast, an individual is not permitted to make additional tax-deductible contributions (beyond the allowable limits) to his or her RRSP just so he or she can index his or her retirement income. Each year, on the anniversary of his retirement date, Jerome can have his pension indexed according to changes in the Consumer Price Index. Reduced Payroll Taxes Instead of establishing an IPP, some employers may choose to provide key employees with an increase in salary for the purpose of making RRSP contributions. However, this additional salary is subject to payroll taxes, such as the Ontario employer health tax. In contrast, the money that an employer contributes to an IPP on behalf of the employee is not subject to any payroll tax. Tailored to Individual Needs To some degree, an IPP can be tailored to meet the specific needs of an individual. For example, there is flexibility with respect to the actual retirement date, the distribution options of the plan assets at retirement and the level of pension. IPPs are sometimes used as an incentive to entice individuals in high demand to join a new employer. Jerome may not need the maximum income possible from the IPP. Accordingly, he could establish a plan that provides only 1.5% per year of service. He could also take early retirement at a reduced pension. Estate Preservation With a standard company pension, retirement benefits are paid to a former employee for his or her lifetime. Following the death of the plan member, either full or reduced benefits continue to be paid to the surviving spouse or common-law partner of the deceased plan member. Upon the second death between the spouses or common-law partners, the obligation of the company pension is finished — any unpaid entitlements remain the property of the pension plan. However, with an IPP the assets in the plan belong to the plan member. Upon his or her death and the death of his or her spouse or common-law partner, any remaining benefits will be paid to the estate of the later to die and will be distributed according to his or her

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-38 will. The death of the plan member does not trigger a deemed disposition for tax purposes based on the fair market value of the plan assets. When Jerome and his spouse are deceased, there could still be $1 million in the IPP. This money could be left to the estate of the later spouse to die. Administration Among the drawbacks of an IPP relative to an RRSP is that an IPP is more complex and costly to set-up and requires a greater degree of ongoing administration. An annual statement must be prepared for the plan member, and the plan must be evaluated by a qualified actuary every three or four years depending on provincial legislation. A trust must be established to collect and invest contributions, and to distribute the pension benefits. The cost for administering an IPP can vary widely and in recent years, has become less expensive. Traditionally, the pricing has fallen within the following ranges: These fees are tax deductible, if they are paid directly by the corporation; the fees are indirectly deductible if paid by the pension plan. Given these administration costs, IPPs are generally not cost effective for individuals with low incomes. The fees for the IPP established by Swell Inc. were $4,000 to establish the plan, $750 per year for filing returns and $750 every third year for an actuarial valuation. Inaccessibility of Funds and Retirement Options Bearing in mind an IPP is a pension plan, in most provinces, the accumulated funds are locked-in (i.e. funds cannot be withdrawn in cash prior to retirement) and can only be used to provide an income at retirement. Retirement options Once the plan member retires and depending on his or her province of residence, the plan member will have options with respect to the vehicle through which pension benefits will be paid: • leave the assets in the IPP such that benefits are paid directly from the plan • use the plan assets to purchase a life annuity • transfer the plan assets into a life income fund (LIF), a locked-in retirement income fund (LRIF) or a registered retirement income fund (RRIF) Retirement can be as early as age 55 and as late as age 71.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-39 Mandatory Contributions Once an IPP is established, there is not much in the way of flexibility regarding contributions—in most circumstances (subject to provincial legislation), regular contributions must be made each year. These mandatory contributions, regardless of the employer’s annual income, could cause problems for businesses that experience reduced cash flow as a result of declining sales or increasing expenses. The good news is that the mandated actuarial assumptions for investment returns are conservative meaning that pension surpluses are common. Shortfalls and surpluses It is assumed annual contributions to an IPP compound at a net annual rate of 7.5%. As previously mentioned, if the assets in an IPP do not perform to these actuarial expectations, as required by pension legislation, additional tax-deductible contributions must generally be made to put the plan back on track. This shortfall funding can be made over a period of five years. By comparison, poor investment returns within an RRSP cannot be offset by additional contributions beyond the normal contribution room of the annuitant. If the IPP realizes a surplus, the sponsoring company may be required to take a contribution holiday. Terminal funding With an IPP, there may be a window of opportunity just prior to the commencement of pension benefits whereby, a significant lump-sum contribution—over and above regular prescribed contributions—can be made to the plan. This circumstance could arise following the sale of company assets or the sale of the company itself. As an eligible contribution, this lump sum amount will also be tax-deductible. No Spousal or Common-law Partner Contributions With an RRSP, a spouse or common-law partner in a high marginal tax bracket, can make tax-deductible contributions to a spousal RRSP under which the lower income spouse or common-law partner is the annuitant. Under an IPP, there is no provision for spousal or common-law partner contributions. Pension benefits are provided directly to the plan member and will only be paid to the member’s spouse or common-law partner as survivor’s benefits after the member’s death. This being said, if a spouse or common-law partner of an IPP member also happens to work for the same company or a related company and has T4 employment earnings, the non- member spouse or common-law partner can join the IPP. In fact, this also holds true for the children of an IPP member who work for the same company as the member parent.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-40 Exercise: Advantages and Disadvantages of IPPs Retirement Compensation Arrangements Due to limits on RRSP and Registered Pension Plan (RPP) contributions, often employers have difficulty providing sufficiently attractive retirement benefits for their top-performing and highest earning employees. Sometimes, employers have no pension plan in place. Retirement compensation arrangements (RCAs) are a method for employers to provide adequate retirement benefits for these employees. How they work An employer, or in some cases an employee, makes tax-deductible contributions to a custodian who acts as trustee for the RCA. The custodian holds the funds in trust until they are eventually paid out to the employee, who is the beneficiary of the trust. When the money is invested with the custodian, it is divided equally between two accounts: the RCA Investment Account, which is controlled by the employer/employee, and the RCA Refundable Tax Account, which is held at the Canada Revenue Agency (CRA). This means that 50% of all contributions to the RCA is paid to the CRA as a refundable tax. The other 50% in the Investment Account is invested and grows over time. Investment income, which includes interest, dividends, and capital gains, accumulates in the investment account, of which 50% must be paid to CRA as a refundable tax. When benefits are eventually paid to the employee, CRA refunds $1 for every $2 of benefits paid. This way, the 50% that was initially taxed is fully refunded to the plan.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-41 Structure of an RCA RCA Contributions and Distributions How much can you contribute? There are no set limits on how much an employer can contribute to an RCA. CRA guidelines limit these contributions to what is reasonable under the circumstances. Usually, an actuary will determine the contribution amount according to what is necessary to provide the employee with a reasonable pension based on a percentage of that employee's average annual income.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-42 How is it funded? An employer will often make contributions using funds that have accumulated in the company's retained earnings, or will use outstanding bonuses owed to key employees instead of paying those bonuses directly to the employee. An employer can also fund an RCA by obtaining financing from a financial institution or using a life insurance policy. RCA investments Unlike registered pension plans, there are no investment rules for RCAs. The assets held in the investment account may be invested in vehicles such as stocks, bonds, mutual funds, GICs, or an interest in a life insurance policy. Often a strategy is chosen that minimizes how much investment income must be reported to the refundable tax account. Suitability RCAs are suitable for owner/managers, executives, and key personnel of companies with significant income. They are beneficial for employees who may be non-residents of Canada when retired. They are also suitable for employers who want to attract, reward, and retain key employees in excess of traditional retirement planning methods. Distribution of benefits Distribution of the benefits of an RCA may be paid by the custodian to the beneficiary upon: • the employee's retirement • severance from employment • any substantial change in the services the employee provides. He or she may still work for the employer but in a completely different capacity. There are no minimum or maximum withdrawals and the beneficiary is taxed when retirement income is received from the plan. Advantages of RCAs Higher contribution limits Retirement Compensation Agreements (RCAs) may have significantly higher contribution limits than RRSPs, Individual Pension Plans (IPPs), or RPPs. CRA only limits contributions to those that are reasonable given the specific circumstances of the employee. CRA provides guidelines for employers. RCA contributions do not affect, and may be made in addition to, regular RRSP or IPP contributions. Tax benefits Contributions made by an employer to an RCA are 100% tax-deductible when the contribution is made, and are not subject to payroll tax. Benefits are not taxable to the employee until paid. This provides an element of tax deferral for employees who have their bonus paid into an RCA instead of paid to them directly in the year it is earned. When the benefit is finally received, the beneficiary may be in a lower tax bracket. For an

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-43 owner/operator of a company, this provides a deduction at current high tax rates and a deferral of that income until retirement, when he or she may be taxed at a lower rate. It may be that the employee has moved to a jurisdiction with a lower personal tax rate. If the employee dies, tax deferral can still be maintained because the RCA benefits continue to be paid to the employee's beneficiaries. Security of the funds Funds within an RCA are held by a custodian in trust, which is a greater guarantee that the funds will be there when needed at retirement. As well, funds held within an RCA are protected from both the employer's and employee's creditors. Attractive to prospective employees RCAs are a way for employers to attract and retain talented employees to their company. They are a formal promise of a retirement benefit that far exceeds what they could achieve with normal RRSPs or RPPs. They are often referred to as "golden handcuffs" as a reward for continuing service that an employee is reluctant to give up. Flexibility of investments There are no investment restrictions for the funds within the RCA investment account. Disadvantages of RCAs There are some elements of Retirement Compensation Arrangements (RCAs) that may be considered disadvantages. The refundable tax account of the RCA held by CRA does not pay interest. If you hold interest-bearing securities in the investment account, remember that 50% of that investment income must be paid to the refundable tax account. This means that in effect the RCA is only earning half of the return that could be earned had the entire amount been invested in a registered plan. The flexibility of the investment options within the RCA may counteract this perceived disadvantage. Like other pension plans, an employee has very limited access to the funds held with the RCA while employed.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-44 Reflection Take a moment to reflect on this lesson and identify three main points. It could be information you can apply when serving a client, or it could be something that surprised you, or something you feel you should review. You may want to add these points to your study notes, so that you can review them at any time. If you would like to add them to your study notes, click Take Notes now. Review You have completed Individual Pension Plans. In this lesson, you have learned how to do the following: • describe the basic nature of IPPs • describe the suitability of IPPs • describe the advantages and disadvantages of IPPs Assessment Now that you have completed Individual Pension Plans, you are ready to assess your knowledge. You will be asked a series of 5 questions. When you have finished answering the questions, click Submit to see your score. When you are ready to start, click the Go to Assessment link.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-45 Lesson 5: Profit Sharing Plans Welcome to Profit Sharing Plans. In this lesson, you will learn about the nature of profit sharing pension plans, how they compare with other types of registered plans, and how the profits are allocated among plan members. This lesson takes 30 minutes to complete. At the end of this lesson, you will be able to do the following: • describe the basic nature of profit sharing pension plans • describe contribution levels • describe how pension benefits are typically allocated to plan members Nature of Profit Sharing Pension Plans A profit sharing pension plan is basically a defined contribution plan, where the contributions made by the employer reflect the profits from that year. The employer’s contribution is usually determined using a formula such as 25% of gross profits after reserving 10% of net capital employed. The Income Tax Act requires that the employer make a minimum contribution of 1% of the combined payroll of plan members even in years with no profit. It should be noted that profit sharing pension plans are different from deferred profit sharing plans or employee’s profit sharing plans. These latter plans are not registered pension plans and, as such, differ significantly in their tax treatments. As far as the legislation is concerned, profit sharing pension plans are treated just like defined contribution pension plans. Generally, all legislative changes that apply to defined contribution plans also apply to profit sharing pension plans. From the Employer's Viewpoint A profit sharing plan is ideal for employers because it relieves them of the responsibility of making significant pension contributions in years where profits are low. They may also feel that a profit sharing plan provides a positive inducement to employees, encouraging them to work harder to help increase company profits and thus their pensions. From the Employee's Viewpoint This supposed inducement to work harder may turn sour if the company does not do well for several years in a row. The company must be profitable for the plan to succeed. Regardless of the profits in any one year, plan members have difficulty projecting the value of their pensions at retirement. Thus, profit sharing pension plans provide less security for retirement.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-46 Combined Defined Contribution/Profit Sharing Pension Plans To circumvent some of the negative aspects of profit sharing pension plans, some employers offer a hybrid plan that combines a minimum level of defined contribution with additional contributions related to profits. This provides employees with a basic level of security, while still encouraging them to help increase profits to earn additional pension credits. Contribution Levels Profit sharing pension plans may be either non-contributory or contributory. As already mentioned, the amount of the employer’s contribution for any one year is usually directly related, by way of a prescribed formula, to the profits earned in that year. However, the Income Tax Act requires that the employer make a minimum contribution of 1% of the salary of plan members even in years with no profit. Allocation of Benefits The pension benefits are typically allocated to plan members based on some form of point system. For example, members might be allocated one point for each year of service plus one point for each $1,000 of annual earnings. Each member would then receive an allocation of that year’s contribution in proportion to the number of total plan points that he or she holds. ABC Company offers a profit sharing pension plan to its three employees, and contributed $10,000 of profits to the pension fund last year. During the past year, Jack earned $40,000 and finished his 7th year of service. Rebecca earned $45,000 and finished her 6th year of service. Stanley earned $27,000 and finished 3 years of service. The benefit allocation is based on a point system — one point for each year of service and one point for each $1,000 of earnings. The allocation of benefits is calculated as follows: Jack: 40 pts for earnings + 7 pts for service = 47 pts Rebecca: 45 pts for earnings + 6 pts for service = 51 pts Stanley: 27 pts for earnings + 3 pts for service = 30 pts Total plan points = 47 + 51 + 30 = 128 Allocation of last year’s profit contribution: Jack: (47 ÷ 128) × $10,000 = $3,672 Rebecca: (51 ÷ 128) × $10,000 = $3,984 Stanley: (30 ÷ 128) × $10,000 = $2,344 In addition, interest earnings and capital gains (or losses) are allocated to active members in proportion to their assets. Jack would be allocated 36.72%, calculated as (47 ÷ 128), of any interest or capital gains that can be attributed to that year’s contributions.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-47 Tax Treatment The employer’s contributions are tax deductible to the employer. Employee contributions are tax deductible and employees are not taxed on their employer’s contributions or on investment earnings placed to their credit. However, as with other pension plans, the pension benefits will be taxable when they are received. Maximum Contribution Levels As with other defined contribution pension plans, the combined contributions of the employer and employee must not exceed the money purchase limit if they are to be tax deductible. As a condition of registering the plan with CRA, the plan sponsor must agree that the combined contributions will not exceed the money purchase limit. As with other defined contribution plans, contributions to the pension plan reduce the amount that the employee can contribute to his or her RRSP. Exercise: Profit Sharing Pension Plans Comparing the Plans You have now finished reviewing the characteristics of four types of employer sponsored pension plans: • defined contribution pension plans • defined benefit pension plans • individual pension plans • profit sharing pension plans For a summary of these four plans, click this icon.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-48 Reflection Take a moment to reflect on this lesson and identify three main points. It could be information you can apply when serving a client, or it could be something that surprised you, or something you feel you should review. You may want to add these points to your study notes, so that you can review them at any time. If you would like to add them to your study notes, click Take Notes now. Review You have completed Profit Sharing Plans. In this lesson, you have learned how to do the following: • describe the basic nature of profit sharing pension plans • describe contribution levels • describe how pension benefits are typically allocated to plan members Assessment Now that you have completed Profit Sharing Plans, you are ready to assess your knowledge. You will be asked a series of 5 questions. When you have finished answering the questions, click Submit to see your score. When you are ready to start, click the Go to Assessment link.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-49 Lesson 6: Distribution Options Welcome to Distribution Options. In this lesson, you will learn about the various options for distribution upon normal retirement, early retirement, termination of employment, death, or disability. This lesson takes 40 minutes to complete. At the end of this lesson, you will be able to do the following: • describe the various options for distribution upon normal retirement, early retirement, termination of employment, death, or disability • identify and explain the most common pension arrangements Distribution Upon Termination Prior to Retirement Once an employee becomes a member of his or her employer’s pension plan, he or she cannot withdraw his or her contributions or cease to make contributions until retirement, unless the plan is terminated, or his or her employment ceases. If the employee terminates employment prior to reaching the end of his or her vesting period, he or she may receive a full refund of his or her contributions, plus interest, in cash, but not the employer’s contributions. However, if he or she ceases employment after his or her contributions have vested, his or her contributions, as well as the contributions made by the employer on his or her behalf, are usually locked-in, meaning that he or she cannot receive a cash settlement. Instead, the funds must be used to provide a retirement income. In some provinces, employee contributions made prior to the qualification date specified in that province’s legislation, usually some point in the mid to late 1980s, do not have to be locked-in. The provision of a life income is often done through a deferred life annuity, either as a paid- up contract under the employer’s group annuity plan, or as an individual annuity contract purchased from a life insurer at the time of termination of employment. Other options now permitted in most jurisdictions include transferring the funds directly into the pension fund of a new employer, or into a locked-in retirement account. A locked-in retirement account (LIRA) is an RRSP that is established with vested pension benefits and that has a trust agreement attached to it, which restricts the use of funds to the provision of a retirement income. These accounts are also referred to as locked-in RRSPs. In Québec, when an employee ceases his or her active membership in a defined benefit pension plan more than 10 years prior to the normal retirement age, the pension benefits that have accrued on his or her behalf can be transferred to: • the pension plan of his or her new employer if so permitted • a locked-in retirement account (LIRA) • a life income fund (LIF) • an insurer for the purpose of purchasing an immediate or deferred life annuity If an employee ceases his or her active membership in a defined benefit pension plan within 10 years of the normal retirement age, the Supplemental Pension Plans Act does not

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-50 provide for such transfer rights. This said, it is possible for the plan itself to offer this right to the plan member. A transfer from a defined contribution plan upon the termination of active membership is permitted irrespective of the employee's age. Distribution at Death The distribution of pension funds upon death of a member depends on the jurisdiction in which the fund operates, as well as whether death occurred: • before retirement • before retirement, but after the early retirement age • after retirement Death Prior to Retirement The federal Pension Benefits Standards Act (PBSA) requires that the pre-retirement death benefit be at least equal to the value of the deceased member’s vested termination benefits accrued after 1986 and until the time of death, including both employer and employee contributions, plus interest. In Québec, the Supplemental Pension Plans Act stipulates the death benefit must be paid to the surviving spouse of the deceased plan member. If there is no surviving spouse or if the surviving spouse has renounced his or her entitlement to the death benefit, it will be paid to a designated beneficiary or the heirs of the plan member. Death prior to early retirement age If death occurs more than ten years prior to the member’s normal retirement age, the surviving spouse or common-law partner may opt to receive a deferred annuity from the pension plan, based on 100% of the commuted value of the deceased’s post-1986 benefits. Alternatively, the spouse or common-law partner may transfer the commuted value of the decease's accrued pension to: • his or her own RPP if that plan permits • a locked-in retirement account (LIRA) • a financial institution for the purpose of purchasing an immediate or deferred annuity This final option may have immediate tax consequences, unless he or she first transfers the funds to an RRSP or RRIF before purchasing the annuity. Death after early retirement age However, if death occurs within ten years of normal retirement age, the deceased is deemed to have been eligible for a reduced early retirement pension, payable on a joint and last survivor basis. In this case, the spouse or common-law partner would receive at least 60% of the reduced early retirement pension earned by the deceased member. These benefits would be in addition to a refund of the employee’s contributions plus interest with respect to plan membership prior to 1987.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-51 If there is no surviving spouse or common-law partner, the death benefit to a designated beneficiary or estate must at least equal the employee’s contributions plus interest. Minor variations to the required death benefits occur from jurisdiction to jurisdiction. Death After Retirement The disposition of benefits when death occurs after retirement depends on the nature of the pension distribution, and is described in Retirement Distribution Options. Exercise: Death Prior to Retirement Retirement Distribution Options All pension plans must define the normal pension, which specifies what form the pension payments take and what benefits, if any, a member’s beneficiary or estate receives if the member dies after retirement. The pension needs of individuals differ, and this fact is recognized in most registered pension plans by providing options in which the pension benefit may be received. These options do not result in any additional cost because they are actuarial equivalents of what is otherwise considered to be the normal pension. The monthly benefits payable by each different form of pension vary. The most common pension arrangements are the following: • straight-life annuities • refund annuities • annuities with a guaranteed period • joint and last survivor annuities • variable annuities and cost of living supplements • cash options Each arrangement is described in more detail on the following pages. Straight-life Annuities In a non-contributory plan, the normal pension is often in the form of a straight-life annuity, where a pension is payable for the lifetime of the member, with no further payments after the member dies. Straight-life annuities are still used for single beneficiaries, but they are no longer permitted for married beneficiaries and, in some provinces, common-law partners. Refund Annuities If the pension plan was contributory, the plan typically includes a qualification that ensures that employees at least get back the value of their contributions. If death occurs before the total pension benefits received to the date of death are at least equal to the employee’s

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-52 contributions plus interest, then the balance is paid in a lump sum to the beneficiary or estate. A pension with this provision is known as a refund annuity. Annuities with a Guaranteed Period Some pensions include a qualification that the pension is payable for life, with a provision that payments are guaranteed to continue for a minimum number of years, usually five or ten years, even if death occurs before the end of the guaranteed period. This is known as a guaranteed annuity. Joint and Last Survivor Annuities Another form of pension common in the public sector is a joint and last survivor annuity. In this case, the monthly benefit is usually reduced, in comparison to a straight-life annuity. However, if either the member, the spouse, or the common-law partner dies payments continue throughout the surviving spouse or common-law partner’s lifetime. In some plans, the payments to the surviving spouse or common-law partner are reduced, and in others they are not. Some plans only call for the reduction if it is the plan member who dies. If the plan member’s spouse or common-law partner dies, the plan member continues to receive full payment. Under the Supplemental Pension Plans Act, in Québec, the surviving spouse of a deceased plan member receives 60% of the pension that was payable while the plan member was alive unless the surviving spouse has renounced his or her entitlement or has agreed to a lower survivor's benefit. The joint and last survivor provision is probably the most useful of all pension options because it provides the assurance that both the member and his or her spouse or common- law partner receive a retirement income for the duration of their lifetimes. This assurance usually comes with a price in the form of a reduced monthly benefit. The size of the reduction depends on the ages of both the member and his or her spouse or common-law partner, as well as the degree of reduction (if any) in the monthly payment after the first spouse or common-law partner dies. The following table provides an example of the reduction in monthly benefit that can be expected in comparison to a male with a single life annuity of $100 per month commencing at 65 years of age.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-53 Some public sector plans use the joint and last survivor annuity as the normal pension for all members, giving a distinct advantage to married couples over single pensioners. In most jurisdictions it is now mandatory for pensions to be paid as a joint and last survivor annuity if the member has a spouse or common-law partner. Variable Annuities and Cost of Living Supplements One of the drawbacks of pensions is that, while the amount of monthly payment may be adequate at retirement, over a few years, inflation can consistently erode the purchasing power of those payments. One method that has been suggested to overcome this problem is that the pension legislation be changed to permit at least part of all contributions to be placed in a segregated fund of equity investments. With a variable annuity, the amount of pension payments related to those contributions would vary in accordance with the market value of this fund. Some financial advisors claim that this would reflect the changes in the cost of living. However, there is no real evidence that stock market values are related in any reliable way to changes in the cost of living. Also, while pensioners are eager to accept increased pensions in times of market increases, most would resent any cut in pension payments that would result from a downturn in market conditions. Some insurance companies offer fully indexed annuities as an optional form of settlement for pension plan proceeds. However, these are usually not popular with pensioners because of the lower initial pension payments. Employers administering defined benefit plans are also reluctant to offer indexed pensions because of the high cost of providing indexation on top of the prescribed benefits. It has been estimated that the cost of an indexed plan with indexation of 5% per year would account for 25% to 33% of total costs. Some defined benefit plans, particularly those in the public sector, already have indexation built into the normal pension benefits, and these plans are funded in advance by employee and employer contributions. However, indexed plans are less common in the private sector because of the uncertainty and high costs involved. Private plans are more likely to provide ad hoc supplements to pensioners, with a value of 2% to 3% for each year since retirement. However, this benefit is not guaranteed. Cash Options The purpose of a pension plan is to provide a continuous income upon retirement. Thus, in most cases a pension cannot be commuted to cash at retirement. Most jurisdictions only permit a cash option if the annuity is small (under $25 per month), or if the member has a short life expectancy due to disability or poor health. Similarly, most jurisdictions prohibit a cash settlement unless the pension is less than 2% of the YMPE in the year that employment is terminated. In Québec, the Supplemental Pension Plans Act mirrors the premise adopted by the rest of the country: funds accumulated in a pension plan are intended to provide a monthly retirement income and are not available to be paid as a cash settlement. This said, the Act does provide for a refund of contributions in cash under the following circumstances:

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-54 • the value of pension benefits is lower than 20% of the maximum pensionable earnings (MPE) in the year the employee is no longer an active member of the plan and he or she is not receiving a pension under the plan • due to a medically certified physical or mental infirmity, the life expectancy of the employee has been shortened • generally, where voluntary contributions have been made (i.e. employee contributions that were not matched by the employer) • the employee has resided in Canada for less than two years, is no longer an active member of the plan and has terminated his or her employment with the company • specifically in a defined benefit plan: • the pension benefit exceeds the amount permissible for a tax-free transfer to another plan • the additional pension benefit exceeds the limit permissible under tax laws • specifically in a defined contribution plan, where contributions exceed the limit permissible under tax laws Exercise: Distribution Options Commencement of Distributions Pensions are designed to provide a retirement income, and thus benefits do not commence until retirement (with the exceptions of termination, death, or disability). However, retirement is becoming less well defined. Normal Retirement Normal retirement age (NRA) is the age specified in the pension plan at which time the member has the right to retire and receive a full, unreduced pension. While the typical NRA used to be 65, there is a tendency towards lower retirement ages. Several jurisdictions prohibit an NRA later than age 65 or 66. Again, the more generous public pension plans are tending towards an earlier NRA, particularly for emergency personnel such as police officers, fire fighters, and air traffic controllers. This trend to an earlier age is somewhat anomalous with increasing life expectancies — people are living longer but retiring earlier, thereby significantly increasing the length of time over which a retirement income is needed. Qualifying Factor Some pension plans specify a normal retirement age (for example, age 65), with an optional alternate calculation for unreduced early retirement, such as 30 years of service regardless of age. Other plans specify a qualifying factor, which is the combination of age and years of service required to entitle a pension plan member to an unreduced pension upon early retirement. Recall that the earliest retirement age = ((age of joining the plan + the qualifying factor) ÷ 2). In these cases, a person meeting the alternate qualifications would be eligible to receive an unreduced pension commencing at an age prior to the NRA.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-55 Stu is a fire fighter and belongs to a pension plan that has an NRA of 60, with an alternate factor of 85. Stu joined the fire department when he was 29 years old. He is eligible for an unreduced retirement pension at age 57, calculated as follows: earliest retirement age = ((age of joining the plan + qualifying factor) ÷ 2)) = ((29 + 85) ÷ 2) = 57 Eligibility for an unreduced early retirement pension should not be confused with taking early retirement. Early Retirement Most pension plans will permit members to retire early, up to ten years before the normal retirement age, and still collect a pension. However, the entitlement from a defined benefit plan will be reduced to account for the reduced years of service. In addition, the pension will be reduced (based on actuarial assumptions) to account for the fact that the pension will likely be paid for a longer period of time. The following is the process of actuarial reduction: 1. The present value of the expected pension benefits at normal retirement age is calculated. 2. This present value is discounted to the current time. 3. The pension benefits are recalculated based upon the smaller present value and longer life expectancy. Actuarial equivalents can result in quite dramatic decreases in monthly pension payments. An actuarial equivalent pension taken at age 60 will have a monthly payment of about 35% less than the same pension taken at age 65. Jack's pension benefit entitlement is a constant $1,000 per year of service. If Jack joined the plan when he was 40 and the plan has an NRA of 65, he would be entitled to an annual pension of $25,000 at age 65. Now suppose Jack decides to retire at age 60. He would only have 20 years of service, and thus he would be entitled to a smaller pension of only $20,000 per year. However, because he is commencing the pension at age 60, he will receive pension payments for five years longer than if he retires at age 65. Thus, his $20,000 pension may be actuarially reduced by about 35%, to reflect the cost of providing the pension payments over a longer period of time. The actuarial equivalent of taking the $20,000 pension at age 60 instead of the normal retirement age of 65 would be about $13,000. In practice, most pension plans do not do a full actuarial evaluation to determine the actuarial equivalent of a pension taken at early retirement. Instead, the plan may call for a standard, but somewhat arbitrary, percentage reduction for every year of early retirement. Janette belongs to a defined benefit plan that offers 2% per year of service times final earnings, at age 65. At age 62, when her final earnings had stabilized at $50,000 per year and she had 25 years of service, she decided to retire early, but she does not qualify for an unreduced early retirement pension based upon the plan's qualifying factor. Her

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-56 pension plan requires a 4% reduction per year of early retirement. Her annual pension would be $22,000, calculated as follows: Her pension at NRA is $25,000, calculated as ((final earnings × benefit rate) × years of service) or (($50,000 × 2%) × 25). Her pension reduction is 12%, calculated as (reduction per year × years before NRA) or (4% × 3 years). Her early retirement pension is $22,000 calculated as (Pension at NRA × (1 - Pension Reduction)) or ($25,000 x (1 -12%)). Janette will receive this reduced pension of $22,000 per year for the rest of her life. Late Retirement The normal retirement age specified in the pension plan should not be interpreted as the mandatory retirement age for plan members. In fact, mandatory retirement is banned in most provinces for most occupations. Some pension plans require pension payments to commence at normal retirement age, even if the employee continues to work. Others allow pension credits to continue to accumulate after the normal retirement date, with the employer (and the employee in contributory plans) continuing to make contributions and building a larger pension fund. Still other plans call for contributions to cease at normal retirement age, but allow the commencement of pension payments to be delayed, with the actuarial equivalent of a normal pension payable when retirement commences. Under federal taxation regulations, pension payments must commence no later than the end of the year in which the member turns 71 years of age. Exercise: Commencement of Distributions Integration of RPPs with CPP and OAS There are three types of RPPs: • normal plans • notched pension plans • bridged pension benefits Each type is described in more detail on the following pages.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-57 Normal Pension Benefits Unless their pension plans provide otherwise, individuals retiring prior to age 65 will realize a jump in income at 65, when Canada Pension and Old Age Security benefits commence. This is illustrated in the graph below. The normal pension benefit is paid continuously from the time of retirement. At age 65, total income jumps as CPP and OAS benefits are received. Notched Pension Benefits Some pensions provide a notched option for those retiring before age 65. The provision allows for higher than normal monthly pension payments in the retirement years prior to age 65. The payments are then reduced to below normal once the government benefits commence, resulting in a level income, as shown in the following graph. The notched option does not impose any additional cost on the pension plan because the increase in benefits prior to age 65 is actuarially offset by the reduction in benefits after age 65.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-58 Bridged Pension Benefits The notched option differs from the bridging option offered by some plans. With this option, a bridging supplement equivalent to the anticipated government benefits is provided by the plan in the years prior to age 65, in addition to the normal level of benefits, as shown in the following graph. While the bridging supplement also serves to level the retirement income, it is an additional benefit, and as such it imposes an additional cost to the employer. Exercise: Types of Pension Benefits Retirement Due to Disability Pension plans may have special provisions relating to the payment of a retirement pension to a member who becomes disabled prior to being eligible for a retirement pension. Unlike early retirement, which results in a reduction in pension payments, most disability provisions stipulate that full credit must be given for pensions earned up to the date of retirement, without any reduction. Thus, the cost to a pension plan for a disability pension commencing at age 50 will be greater than if the same individual had simply elected to retire at age 50 and receive a reduced pension. This additional cost is assumed by the pension plan. If disability payments are instead made to the employee under a long-term disability insurance contract, the credit earned under the pension plan may be deferred until normal retirement age. In this case, the period between the time disability payments commence and normal retirement age may be considered to be pensionable service, and the pension at retirement would be based on the full credited service.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-59 Reflection Take a moment to reflect on this lesson and identify three main points. It could be information you can apply when serving a client, or it could be something that surprised you, or something you feel you should review. You may want to add these points to your study notes, so that you can review them at any time. If you would like to add them to your study notes, click Take Notes now. Review You have completed Distribution Options. In this lesson, you have learned how to do the following: • describe the various options for distribution upon normal retirement, early retirement, termination of employment, death, or disability • identify and explain the most common pension arrangements Assessment Now that you have completed Distribution Options, you are ready to assess your knowledge. You will be asked a series of 5 questions. When you have finished answering the questions, click Submit to see your score. When you are ready to start, click the Go to Assessment link.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-60 Lesson 7: Rules and Regulations Welcome to Rules and Regulations. In this lesson, you will learn about the rules and regulations pertaining to employer sponsored pension plans and how they can affect different client situations. This lesson takes 45 minutes to complete. At the end of this lesson, you will be able to do the following: • explain the rules and regulations pertaining to employer sponsored pension plans • describe the different ways pension plans must be documented • identify the eligibility requirements to join a pension plan Rules and Regulations Although most of the provinces have similar rules, there are enough differences to make matters complicated for the administrators of pension plans that support employees in a number of provinces. It also makes it difficult for financial advisors with clients in more than one province, or with clients who work for a national corporation and who are members of a pension plan that is governed by the pension legislation of the province where the company’s head office is located. Furthermore, the rules are always changing, often with one or two provinces leading the way, and the remaining provinces eventually adopting similar changes. Pension plans that have been organized and administered for the benefit of employees, in any province, who perform service in connection with any federal works, undertakings, or businesses that are within the legislative authority of Parliament are governed by the federal Pension Benefits Standards Act (PBSA). This includes employees working in air transportation, railways, banks, Crown corporations, radio stations, and so on. The PBSA also covers employees in the Yukon, Nunavut and Northwest Territories. Employees of the federal government are not covered by the PBSA. In Québec, supplemental pension plans monitored by the Régie des rentes du Québec are regulated by the Supplemental Pension Plans Act. For the most part, this would apply to SPPs in the private, municipal and certain parapublic sectors whose activities are Québec- based. For pension plans whose activities may be based in jurisdictions outside of Québec, the plan is monitored by a body that has a similar mandate to that of the Régie (e.g. in Ontario, the Financial Services Commission of Ontario). This body is charged with the responsibility of ensuring the rights of Québec members are protected in accordance with the Supplemental Pension Plans Act. Private sector SPPs whose member activities are federal in nature (e.g. banks, telecommunications companies, etc.), are regulated by the Pension Benefits Standards Act, 1985 and are supervised by the Office of the Superintendent of Financial Institutions. Some of the more common rules defined by pension legislation are described on the following pages. The description of pension rules and regulations draws heavily on the PBSA, although significant differences among the provinces are noted.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-61 Documentation Pension plans rely on a number of documents including: Plan text: A document that specifies the mechanics of the pension plan, including its benefits, contributions, membership eligibility, and conditions. Trust agreement for a trusteed plan: Almost always a separate document that authorizes trustees to collect contributions, make investments, etc. Insurance contract for an insured plan: The contract includes a funding policy that explains how the plan will be funded. Non-technical explanatory materials: Written information provided to plan members that explains the plan’s terms and conditions, rights and duties of plan members, and other information such as annual statements. Administration The administrator of a pension plan may be the employer, or an administrative board or committee. Also, administration can be handled with joint representation of the employer and the employee’s union. The administrator maintains the employee records and operates the plan. A trusteed plan is a fund established according to the terms of a trust agreement between the employer or plan sponsor, and an individual or corporate trustee. The trustee is responsible for the administration of the fund and/or the investment of the monies. The employer is responsible for the adequacy of the fund to pay the promised benefits. Alternatively, an insured plan is a pension plan funded through an investment contract with an insurance company. Age Eligibility Although the various provincial or federal pension benefits acts do not prohibit eligibility requirements based upon age, the provincial and federal employment standards acts do. Therefore, a minimum or maximum age for joining the plan is not permitted. Eligibility No employer is required to set up a pension plan for employees. However, if an employer does choose to operate a pension plan, then according to the PBSA, all full-time employees belonging to the class of employees for which the plan was intended must be permitted to join the plan after two years of continuous service. Most jurisdictions also specify that part-time employees be eligible to join the plan after two years of consecutive service, provided that their annual earnings are at least 35% of the YMPE each year for two consecutive years. A few jurisdictions provide the optional qualification for part-time employees who have at least 700 hours of service each year for two consecutive years. One province makes membership compulsory for any employees who have access to an employer-sponsored pension plan.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-62 Gender Discrimination All other factors being equal, it costs more to provide pensions for women than for men. Women have lower mortality rates and longer life expectancies. However, most jurisdictions prohibit any form of discrimination in terms of eligibility, contributions, and benefits related to gender. Even though it costs the employer more to provide the same level of pension benefits for a female employee than a male employee, the employer may not require the female to make higher contributions than her male counterpart. Furthermore, the employer cannot provide the female with a lower level of pension benefits. Either the employer can make higher contributions on behalf of the female employee, or the actuarial valuations can be based on unisex, averaged mortality tables. Vesting Vesting refers to the point in time when the employer’s contributions become the property of the employee, so that the employee has the right to receive the benefit of those contributions even following termination of employment prior to retirement. Once the employer’s contributions have vested with the employee, they legally belong to the employee, and must be used to provide him or her with a retirement income. Once the contributions have vested, the earned benefit entitlements are referred to as vested benefits. The importance of vesting is twofold. First, because the retirement pension is a form of deferred compensation for the employee’s services, there should be entitlement to it after meeting certain conditions. Second, employees should not be penalized for employment with several employers and should be guaranteed portability of their benefits. In contributory plans, employees automatically and immediately have a vested right to their own contributions, along with interest accumulated on those contributions. However, under contingent vesting provisions, employees cannot take their contributions out of the fund if they also want their employer’s contributions to vest with them. Previous federal legislation provided for vesting of the employer’s contributions once the employee had reached age 45 and had 10 years of service or plan membership (the 45 and 10 rule). All pension credits accruing after January 1, 1987 in federal plans must vest after two years of membership. Some jurisdictions still follow the 45 and 10 rule or have not changed it retroactively, and other jurisdictions have vesting periods as long as five years. In most provinces vesting also automatically occurs when the member reaches normal retirement age, or when the plan is terminated. Many union-negotiated, non-contributory plans provide for graded vesting. This enables employees to change their jobs without losing all of their vested rights if they have not yet met the full vesting requirements. Thus, employees in a 45 and 10 plan with five years of service may be eligible for a portion of their vested rights.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-63 Locking-in Pension legislation specifies that, after a period of time as a member of a plan, both the employee and employer contributions are locked-in, meaning that they can no longer be taken out of the pension fund in a lump sum, and must be used to provide a lifetime retirement income. Beginning in 1998, pensions must commence by no later than the end of year in which the annuitant reaches age 69 (Reg. 8502e). Budget 2007, increased the maturing age for registered plans such that effective 2007, pension benefits must now commence no later than the end of the year in which the plan member turns 71 years of age. The locking-in provision applies to the employee’s contributions, as well as the employer’s. However, it usually does not apply to additional voluntary contributions. The times for vesting and for locking-in do not necessarily coincide. In some provinces, the pension benefits are locked-in immediately upon plan membership, while in others they are not locked-in until the vesting provision is met. Normal Retirement Age (NRA) is defined as the age at which a member is permitted to retire and receive full, unreduced retirement benefits. There are a few exceptions to the locking-in rule, in cases where an employee is terminated prior to the NRA, as follows: • A portion of the funds may be distributed during a breakdown in marriage. • The pension benefits may be commuted (that is, converted to a single sum that represents the present value of all future payments) if the life expectancy of the annuitant is significantly reduced due to illness or disability. • Employee contributions that were voluntary in nature (such as those used to purchase past service pension credits or to upgrade current service credits) may be refunded. • All employee contributions may be refunded if the member terminates employment prior to meeting the vesting qualifications. • Up to a maximum of 25% of the commuted value of benefits earned prior to 1987 (that is, the calculated present value) of the pension may be paid in cash if the pension legislation and the plan allow it. • The anticipated pension benefits may be commuted to cash if the expected annuity payments are relatively small (less than 2% of the YMPE). • An employee’s contributions made prior to the qualification date, which is the date that the particular provincial pension legislation or regulation entered into force may be refunded. In other words, the provisions of the legislation will not apply retroactively. Portability A major shortcoming of the pension system has been that employees who changed jobs were often prevented from taking their pension entitlements with them. Pension reforms have sought to overcome this drawback by supporting the concept of portability.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-64 Portability refers to the ability to transfer pension credits to another pension plan or to a locked-in RRSP when the employee changes jobs. This does not violate the locked-in provisions of the original pension because the funds must still be used to provide a life income. Under the provisions of the federal Pension Benefits Standards Act, if a member ceases to be a member or dies before becoming eligible to retire, the member or the surviving spouse or common-law partner is entitled to: • retain the vested benefits within the pension fund, for provision of a pension at retirement • transfer the vested benefits to another registered pension plan, if the plan permits • transfer the vested benefits to a locked-in RRSP, which is an RRSP from which the release of funds is prohibited, by pension legislation, unless the release is in the form of a retirement income • transfer the benefits to an insurance company of his or her choosing, to be used to purchase an immediate or deferred annuity Alexis has been employed by Trillium Enterprises (TE) for the past five years, and has been a member of TE’s defined benefit pension plan, which had a 2-year vesting period for the duration of her employment. She has decided to leave TE so that she can relocate closer to her aging parents. She has contributed a total of $15,000 to the pension plan, and her employer has paid a similar amount. Together with interest, the commuted value of her total pension entitlement is $40,000. Upon her termination from TE, Alexis may choose to: • leave these funds in the pension fund to provide her with a pension at retirement • transfer the value of her existing pension to the RPP of her new employer, if that plan permits • transfer the money to a locked-in RRSP • transfer the funds to her insurance company to purchase a deferred annuity Alexis’ husband, Ralph, is also leaving TE, where he has worked for about 18 months. He has contributed a total of $4,500 to the pension fund, and TE has contributed a similar amount on his behalf. The commuted value of his pension entitlement is about $9,500. However, because Ralph has not met TE’s vesting requirement, he has no right to his employer’s contributions. He is only entitled to receive a cash refund of his contributions of $4,500, plus interest.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-65 Most jurisdictions have similar portability provisions, although they may differ in the permitted time frame for transfers. Exercise: Rules and Regulations Minimum Employer Contributions Most jurisdictions specify that the employer must contribute at least 50% of the cost of the pension benefits accrued by each employee after a qualification date specified in each jurisdiction’s legislation. The PBSA provides an exemption to the 50% rule for defined benefit plans that provide indexing of benefits at a rate at least equivalent to 75% of (CPI less 1%). When a member of a defined benefit pension plan retires or terminates his or her employment, the plan administrator must compare the employee’s total contributions plus interest with the commuted value of the pension benefits accrued after the qualification date. If the employee has contributed more than 50%, the employee is entitled to either an increased pension or a refund of contributions, depending on the province. Minimum Interest on Employee Contributions For the purpose of determining the value of accrued pensions, either for the evaluation of the 50% rule or for determining the value of benefits accrued by a terminated employee, most jurisdictions specify a minimum interest rate to be used in the calculations. Survivor's Benefits Because pensions are a form of deferred compensation, pension legislation typically requires that a member’s beneficiaries or estate receive at least a refund of the employee’s contributions in the event of the member’s death. The extent of the survivor’s benefits often depends on whether death occurs before or after retirement. Many employers offer life insurance, instead of building pre-retirement survivor’s benefits into their pension plan. Post-retirement deaths: Most jurisdictions require retirement pensions to be paid as a joint and last survivor annuity if the pensioner has a spouse or common-law partner. Under the joint and last survivor annuity, the pension continues to be payable after the death of either spouse or common-law partner, but with a survivor’s benefit of at least 60% to 66.66% of the initial pension depending upon the jurisdiction. Some jurisdictions permit this to be waived if both the member and the spouse or common-law partner sign a prescribed form. Single members receive a single life pension. Pre-retirement deaths: Pre-retirement death benefits vary significantly from one jurisdiction to another, and may also depend on whether the member was within early retirement age at the time of death, as well as the member’s marital status. Under the PBSA, 100% of the commuted value of the post-1986 accrued pension is payable to the surviving spouse or common-law partner’s locked-in RRSP, or as a deferred annuity.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-66 However, if the deceased was within his or her eligible early retirement period, the surviving spouse or common-law partner may receive 60% of the monthly pension accrued by the date of death. If the member did not have a surviving spouse or common-law partner, the estate would receive a refund of the employee’s contributions plus accumulated interest. Remarriage: All jurisdictions specify that the survivor benefits must continue if the surviving spouse or common-law partner remarries or enters a common-law relationship. Relationship Breakdown In the event of marriage breakdown, under provincial family law legislation, the non- member spouse may be entitled to a share of the pension benefits accrued to the time of divorce. In the event of relationship breakdown, under provincial family law legislation, the non-member, common-law partner may be entitled to a share of the pension benefits accrued to the time of the relationship breakdown. The division of pension credits may be done by agreement or by court order, in accordance with provincial laws. In Québec, benefits accrued in a supplemental pension plan during the marriage or civil union will be subject to partition under the family patrimony or the rules relating to the dissolution of the matrimonial regime. The dissolution of the marriage, civil union or de facto union effectively terminates any claim the non-plan member former spouse will have to the death benefit or the joint and last survivor pension that is payable following the death of the plan member spouse. Early and Postponed Retirement Most jurisdictions require that members must be eligible to receive an actuarially reduced pension within ten years of normal retirement age (that is, the earliest age at which an unreduced pension is available). If a member chooses to continue to work after normal retirement age, most jurisdictions allow for membership in the pension plan to continue and additional credits to be earned. Integration with Government Pensions Some pension plans are integrated with the Canada Pension Plan/Québec Pension Plan or the Old Age Security System, so that members who retire prior to age 65 receive higher pension benefits in the early years of their retirement, until they reach age 65 when CPP/QPP and OAS benefits normally commence. Indexation for Inflation The greatest shortcoming of many pensions is the lack of indexation of retirement benefits for inflation. Some pension plans, particularly those in the public sector or with major corporations, provide annual payment increases to cover a portion or all of the increase in inflation as measured by the Consumer Price Index. The majority of pension plan beneficiaries have no such protection and can expect to see the "real value" of their pension benefits shrink each year. The value of a pension will be reduced by 65% over a period of 20 years if inflation averages 5% per year. In advising a client who is not the member of a plan that is fully-indexed for inflation, you should allow for the loss of purchasing power by determining any additional capital required at retirement to provide for the desired degree of inflation protection of retirement incomes.

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CIFP Retirement Planning Certificate™ Course – Québec www.CIFP.ca © 2010 3-67 Pension Plan Amendments Employees should be aware that their employer can amend their plan, or freeze the existing plan and start a new one. Termination of Plans The plan documentation must specify how the pension fund will be distributed if the plan is terminated. The employer’s contributions are irrevocable and on termination both the employer and employee’s contributions will usually be locked-in and must be transferred to another registered plan of the employee. If it can be shown that there are excess funds in the pension fund that can be attributed to the employer’s contributions, the employer may be granted a refund of those excess contributions. Reflection Take a moment to reflect on this lesson and identify three main points. It could be information you can apply when serving a client, or it could be something that surprised you, or something you feel you should review. You may want to add these points to your study notes, so that you can review them at any time. If you would like to add them to your study notes, click Take Notes now. Review You have completed Rules and Regulations. In this lesson, you have learned how to do the following: • explain the rules and regulations pertaining to employer sponsored pension plans • describe the different ways pension plans must be documented • identify the eligibility requirements to join a pension plan Assessment Now that you have completed Rules and Regulations, you are ready to assess your knowledge. You will be asked a series of 5 questions. When you have finished answering the questions, click Submit to see your score. When you are ready to start, click the Go to Assessment link.

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Employer Sponsored Pension Plans www.CIFP.ca © 2010 3-68 Review Let’s look at the concepts covered in this unit: • Supplemental Pension Plans & Defined Contribution RPPs • Defined Benefit Pension Plans • Case Study • Individual Pension Plans • Profit Sharing Plans • Distribution Options • Rules and Regulations You now have a good understanding of employer sponsored pension plans. At this point in the course you can describe the various types of pension plans, how contributions to these plans are calculated, and the distribution options for pension funds. You can also explain the rules and regulations pertaining to employer sponsored pension plans. Assessment Now that you have completed Unit 3: Employer Sponsored Pension Plans, you are ready to assess your knowledge. You will be asked a series of questions. When you have finished answering the questions, click Submit to see your score. When you are ready to start, click the Go to Assessment link.

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Unit3

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