Finance

Angel Wise

A1.pptx

Home >Business & Finance homework help >Management homework help >Finance

Module 15

Pension Funds

Outline

Pension Funds Defined

Pension Fund Industry

Employer-Sponsored Registered Pension Plans

Types of Pension Plans

Government-Funded Pension Plans

Personal Savings Plans

Regulation of Pension Plans

Pension Funds Defined

Pension funds are retirement savings accumulated from contributions of employers, employees or both when individuals are still working.

Funds are collectively managed and invested with influence from government regulations.

The primary objective is to provide individuals who have reached retirement age with income in the form of a lifetime pension or capital.

Pension Funds Defined

Three ways of saving money for retirement:

Government-funded plans

E.g., Canada Pension Plan and Quebec Pension Plan

Employer-sponsored pension plans

E.g., trusted pension funds, profit-sharing plans and group RRSPs

Individual savings plans

E.g., RRSPs

Employer-Sponsored Registered Pension Plans

A private pension plan is organized by a company that provides individuals with retirement income.

Plans must be registered with the government to have tax-sheltered status.

Under these plans, employee and employer (or just the employer) regularly contributes money to the plan.

Upon retirement, individuals collect benefits from the plan.

If they are vested, employees can transfer the old pension to a new plan when they switch jobs and work with a different employer.

Employer-Sponsored Registered Pension Plans

Plan members may wonder if the money kept in the pension account sufficiently supports the promised payments.

If the exact amount of money needed is available, the plan is fully funded.

If funds are inadequate, it is underfunded.

If excess funds are in the account, it is overfunded.

The assets of pension plans must be managed under the “prudent person rule.”

Private pension plans offered by employers can vary widely along different dimensions:

Contributory or non-contributory: employer does or does not match employee’s contributions.

Voluntary or compulsory: the employee may or may not choose whether to join the plan.

Trusteed or insured: the plan is managed by a committee of trustees and contributors or by an insurance company.

Types of Pension Plans

How retirement benefits are earned divides employer pension plans into two main types:

Defined-benefit plans

Employers use a specific formula to promise to pay employees a set amount of retirement income.

Both parities contribute to the plan.

Employers invest and manage the fund while employees do not involve themselves with any investment decisions.

Pension benefit does not depend on how well the investments perform, but it may be inflation-adjusted.

Types of Pension Plans Example: Defined-Benefit Plan

Annual benefit is calculated with this formula: 2% × avg salary from last three years × # of years worked.

An individual has worked 20 years for a company, and their salaries for the last three years were $45,000, $50,000 and $55,000.

Benefit = 2% × $50,000 × 20 years = $20,000/year

Yearly payment of $20,000 under this defined-benefit plan lasts throughout retirement, making budgeting easier for the employee.

Types of Pension Plans

Defined-contribution plans

Employees know how much they pay into the plan, but benefits are unknown and depend on how the plan is managed and how the investments perform.

Contributions by employees and the employer are fixed and the assets grow on a tax-deferred basis.

Employees may choose how the money is invested, but with limited options.

Funds cannot be withdrawn before the owner retires.

Types of Pension Plans Example: Defined-Contribution Plan

An individual making $60,000/year joins a defined-contribution plan at 45 and retires at 65.

This employee puts 5% of their earnings into the plan, and their employer agrees to match the contribution.

A 4% return per year is assumed over 20 years.

Total contribution is 10% of the worker’s annual salary = 0.1 × 60,000 = $6,000/year ($3,000 from employee and $3,000 from employer).

A lump sum retirement income = 6,000 {[(1 + 0.04)20 – 1] /0.04} = 6,000 × 29.778 = $178,668.

Types of Pension Plans

The increased prevalence of defined-contribution plans is reflected in nearly all plan sizes but almost exclusively in the private sector.

The changing labour market structure and different business practices of employers have encouraged the growth of this type of plan.

Although defined-contribution plans have some undeniable advantages for employees, their increased prevalence suggests a transfer of risk from employers to worker.

Types of Pension Plans

A cash balance pension plan was developed in the US as a response to the shortcomings of defined-benefit and defined-contribution plans.

Benefit in this plan is a lump sum amount determined by a formula rather than a periodic contribution.

Is an offshoot of the traditional defined benefit plan.

Due to the pension adjustment requirements and other restrictions on calculating the cash balance, this hybrid pension plan is not popular in Canada yet.

Government-Funded Pension Plans

While many funds are privately run, a public pension plan is one sponsored by a government body.

Old Age Security (OAS) pension is one of the two pillars of Canada’s retirement income system.

Benefit is not based on employment history.

It is a monthly payment available to seniors aged 65 and older with Canadian legal status, having lived at least 10 years in the country since age 18.

For seniors with lower income, this pension is supplemented by the Guaranteed Income Supplement (GIS), which is added to the monthly OAS payment.

Government-Funded Pension Plans

The other pillar is the Canada Pension Plan (CPP) and the Quebec Pension Plan (QPP).

The CPP is now managed by the CPP Investment Board.

The Caisse de depot et placement du Quebec (CDPQ) is in charge of the QPP.

Membership in both plans is mandatory for all persons in the labour force between the ages of 18 and 65.

The demographic change has almost crashed the system, forcing government to restructure the pension plan with aggressive investment strategies.

Government-Funded Pension Plans

Unlike the OAS, CPP and QPP benefits are based on the collecting time, an individual’s total lifetime contributions and pre-retirement income level.

CPP pension is a monthly, taxable benefit that replaces part of an individual’s income at retirement.

Once a person is qualified, the benefit will be paid for their remaining lifespan.

CPP payments are not automatic.

Recipient should apply six months in advance of when they want their pension to start, as early as age 60.

Government-Funded Pension Plans

Taking CPP at age 60 will cause the retiree to lose up to 36% of their pension permanently due to a 0.6% reduction for every month before the normal retirement age of 65 (7.2% per year).

Payments will be permanently increased by 0.7% for each month after age 65 up to age 70 (8.4% per year) by delaying CPP.

There is no further increase after age 70.

Most people start receiving CPP the month after their 65th birthday.

Government-Funded Pension Plans

CPP payment for new beneficiaries receiving benefit for the first time as of January 2020:

Type of benefit	Average monthly amount	Yearly average amount	Monthly maximum amount
Retirement pension, age 65+	$679.16	$8,149.92	$1,175.83
Retirement pension, delayed to age 70	$944.40	$11,572.89	$1,669.61

Government-Funded Pension Plans

The maximum pensionable earnings under the CPP for 2020 increased to $58,700 (from $57,400).

Contributors who earn more than $58,700 in 2020 are not required or permitted to make additional contributions to the CPP.

Anyone earning less than $3,500 is automatically exempt from CPP contribution.

At age 70, a person stops contributing to CPP even if they are still working.

Government-Funded Pension Plans

Top 10 public pension funds by asset size:

Canada Pension Plan Investment Board (CPPIB)

Caisse de depot et placement du Quebec (CDPQ)

Ontario Teachers’ Pension Plan Board (OTPP)

British Columbia Investment Management Corporation (BCIMC)

Public Sector Pension Investment Board (PSP Investment)

Ontario Municipal Employees Retirement System (OMERS)

Healthcare of Ontario Pension Plan (HOOPP)

Alberta Investment Management Corp (AIMCo)

Ontario Pension Board (OPB)

OPSEU Pension (OP Trust)

Personal Savings Plans

Registered Retirement Savings Plans (RRSPs) are not truly pension plans.

Like pension plan contributions, no tax is assessed on this income or on its yield as long as the fund remains in the account.

After age 71, the RRSP account must be converted to a Registered Retirement Income Fund (RRIF).

RRSP is a tax-free savings plan used to invest for the retirement .

RRIF is a tax-sheltered account allowing individuals to withdraw income in retirement.

Personal Savings Plans

RRSPs are registered with the Canada Revenue Agency (CRA), which determines the maximum annual contribution limit for every individual taxpayer.

In 2020, the RRSP contribution limit was still 18% of earned income in the previous year, with a dollar limit of $27,230.

Contribution limit will be adjusted with other employer-sponsored registered pension plans.

All Canadians are eligible to purchase RRSPs regardless of age.

Regulation of Pension Plans

Pension regulation in Canada falls mostly within provincial jurisdiction by virtue of the property and civil rights power granted by the Constitution Act, 1867.

Emphasis is on the best interests of the owners or beneficiaries of the pension plans.

The Financial Services Commission of Ontario (FSCO) is responsible for the administration and enforcement of matters like pension plan funding, vesting of benefits, fiduciary responsibility, pension fund transferability and pension fund insurance.