Retirement Planning. July 30, 2014

Transcription

1 Retirement Planning July 30, 2014

2 Retirement Planning Retirement planning involves long-term estimates of future consumption and the basis of those estimates needs to understood (nominal $ / real $ / before tax / after tax); Retirement planning typically involves a combination of income streams / cash flows with some amounts in nominal $, some amounts in real $ (indexed pensions), some amounts in before tax $ (RRSP income) and some amounts in after-tax $ (unsheltered savings). Must select a common base for all projections.

3 Retirement Income OAS At age 65, almost all Canadian residents receive the OAS (Old Age Security); OAS is indexed (real dollars) & included in taxable income; The 2014 maximum benefit was $551.54/month ($6,618); To receive maximum OAS, the individual must have been a resident of Canada for 40 years since age 18; However, government requires the repayment ( clawback ) of OAS benefits above a specified income thresholds (> $70,954, at rate of 15% with full repayment at $115,716); Repayment is determined on personal income tax return.

4 Retirement Income OAS New rules for OAS were introduced in 2012 federal budget; Rules gradually increase the age of eligibility for the OAS pension and the Guaranteed Income Supplement (GIS) between the years 2023 and 2029, from 65 to 67; Current recipients of OAS benefits will not be affected by the changes; Also introduced a voluntary deferral of the OAS pension that provides the option to defer take-up of OAS pension by up to five years past the age of eligibility, and receive a higher, actuarially adjusted pension (+ 0.6 percent per month of deferral (or 7.2 percent for a full year of deferral).

5 Retirement Income - GIS Guaranteed Income Supplement (GIS) provides additional retirement income, on top of the OAS, to low-income seniors; Income-tested pension supplement for OAS recipients that have little other income; A single person with no other sources of income (except OAS) receives GIS of $747.86/ month ($8.974); Once annual income, not including OAS pension, exceeds $16,728 (single) or $22,080 (couple), pensioners no longer qualify for GIS; The amount received is adjusted on an annual basis according to the OAS recipient s prior year income; GIS is indexed (real dollars) and not included in taxable income;

6 Retirement Income Cda Pension Mandatory pension plan with equal contributions from employees / employers; Self-employed individuals pay both sides through their personal tax return; 2014 max contribution = 4.95% * (Earnings - $3,500), up to pensionable earnings of $ 52,500; Max. cont n = $2,425.50; Maximum CPP retirement benefit is currently $1,038.33/mo at age 65 ($12,460); A person's CPP retirement pension is calculated as 25% of his average pensionable earnings during his contributory period. The period starts when an individual turns 18 and ends when he starts collecting the pension.

7 Retirement Income Cda Pension Canada Pension Plan (CPP) offers some protection against periods where an inidividual had low or zero earnings this by automatically dropping a number of months of your lowest earnings when calculating CPP benefits. In 2014, up to 8 years of lowest earnings can be dropped from the calculation.

8 Retirement Income Cda Pension May draw CPP starting at age 60, at a penalty of 0.56% / month, in 2014; If draws at 60, retiree gets 66.4% (100% - (60 mo. * 0.54%)) or $8,273/year; By 2016, when the CPP retirement pension is taken early, it will be reduced by 0.6% per month for each month that the pension is taken before the 65th birthday (overall = 64%). Monthly penalty is set to increase over each of the next few years (2015 = 0.58%; and 2016 = 0.60%) CPP is indexed (real dollars) and incl. in taxable income;

9 Retirement Income Employer Pension Some employers sponsor pension plans for employees; Employee contributions are tax deductible; income is sheltered until funds are withdrawn during retirement; Employers typically match employee contributions and their funds become vested with the employee after a specified time frame (2-5 yrs); Pension funds remain locked in until retirement; Employer plans may be indexed (real $) or non-indexed (nominal $);

10 Retirement Income Employer Pension Defined Benefit Pension Plan: provides a specified pension benefit to the employee upon retirement; pension benefit can be specified $ amount/year or be based on a % of salary (e.g. 2% x years of services x average of the best three years salary); employer bears responsibility for ensuring there are sufficient funds in the plan to cover future pension obligations (i.e employer bears the investment risk);

11 Retirement Income Employer Pension Defined Contribution (Money Purchase) Pension Plan: provides employee with a pension benefit based on funds accumulated within the plan at retirement; employee bears the investment risk in a money purchase plan;

12 Retirement Income Employer Pension Participants in employer sponsored plans will have their RRSP contribution room reduced by a Pension Adjustment (PA) The PA accounts for the tax sheltered income accumulated through employment; Designed to maintain a level playing field with other taxpayers in terms of retirement savings; Employer calculates PA and reports it on the T4. The current year s PA is applied in determining next year s RRSP room;

13 Retirement Income Employer Pension In circumstances where a pension plan participant changes employment, pension funds may: remain in former employer s plan until retirement; transfer to the new employers pension plan; transfer to a locked-in RRSP.

14 Retirement Income Pooled RPP Introduced in Budget retirement savings option for employed and self-employed individuals who do not have access to a workplace pension plan or where a workplace pension plan does not exist; PRPP is administered by a financial institution or insurance company, and manages funds pooled from individuals and their employers - should they choose to participate; A PRPP enables members to benefit from lower administration costs that result from participating in a large, pooled pension plan;

15 Retirement Income Pooled RPP investment options within a PRPP are similar to those for other registered pension plans - members can benefit from greater flexibility in managing their savings and meeting retirement objectives. A PRPP is portable - moves with its members from job to job; the maximum amount that a member or employer can contribute to a PRPP in a given tax year without tax implications is determined by the member's RRSP deduction limit;

16 Retirement Income Pooled RPP Any voluntary contributions made by the employer are not included in the member's income, and they are not deductible on the member's income tax and benefit return; Pension benefits from a PRPP would be determined similar to a defined contribution pension plan; and would not be indexed

17 Retirement Income RRSP RRSP = do it yourself pension plan; RRSPs allow withdrawals before retirement; Funds are more accessible than $$ accumulated in employer plans; RRSP contribution limit for the 2013 tax year: 18% of previous year s (2012) earned income to max. of $23,820; less any 2012 Pension Adjustment as reported by employer (if you also contribute to RPP), plus unused contribution room accumulated and carriedforward from previous years; Three types of RRSPs: Basic, Self-directed, and Spousal;

18 Retirement Income RRSP Taxpayer has single RRSP contribution limit, regardless of the type of RRSP they are contributing to (incl. spousal); Self-directed RRSPs = allow the beneficiary to select and manage investments held within the plan (eg $125/yr fee); Funds may be borrowed tax free from RRSP for specific purposes (Home Buyers Plan / Lifelong Learning Plan) but taxpayer to follow a specific repayment schedule;

19 Retirement Income RRSP RRSPs must be wound up by Dec 31 st of the year in which the beneficiary turns 71; At termination, funds accumulated in the RRSP can be: Transferred to a Registered Retirement Income Fund (RRIF) from which taxable payments will be withdrawn throughout retirement; Used to purchase a life or term annuity with payments taxable as received; Withdrawn, with tax payable immediately on the full balance.

20 Retirement Income - Annuities Annuities typically purchased from insurance companies; Life Annuity - annuitant receives payment until death; Joint Life and Last Survivor annuitant and/or a beneficiary receive payment until death; Life Annuity with Guaranteed Term annuitant receives payment until death; However if he / she dies before a guaranteed term, beneficiary receives the balance for the term (as lump sum or payments); Annuity payments may be a fixed amount or escalate each year to provide a measure of indexing;

21 Retirement Income - RRIFs Registered Retirement Income Fund (RRIF) - similar in nature to RRSP withdrawals are fully taxable, while income earned on the remaining plan balance accumulates tax free; RRIFs set a minimum withdrawal schedule based on market value of plan asset at the start of each year, but beneficiary can always withdraw more than minimum;

22 Retirement Planning Retirement planning should focus on: Accumulating sufficient savings prior to retirement to support a desired standard of living (consumption) throughout retirement; Protecting retirement income against inflation indexed pensions / continue saving in early retirement years; Maintaining sufficient income for the surviving spouse / family in the event of a spouse death spousal RRSP, split CPP benefits, life annuity with guaranteed term; survivor benefits on employer pension; Minimizing tax on retirement income use unsheltered savings first, spousal RRSP to split income, etc.

23 Retirement Planning In Class Problem 17-3 Estimate their required savings per annum in today s dollars to retire at age 60.

24 In-Class Problem # 17-3(a) Assumptions: i) Retirement income requirements must be in real dollars; ii) Must provide the retirement income to age 90; iii) CPP will be maximum (Currently = $1,038.33/mo at age 65); iv) Before-tax real returns: Mutual fund = 6%; GIC = 2%; v) All future savings is to be done within RRSPs; vi) vii) Retirement income will be split equally; Bruce s mutual funds are also held in an RRSP. viii) Average tax rate on retirement income = 12% ix) Post retirement rate of return = GIC rate of 2%

25 In-Class Problem # 17-3 Determine income the Maynes will receive at retirement: CPP, retire at Age 60: $1,038.33/mo * 66.4% (w/penalty) * 12mo * 2 = 16,547 p.a. OAS from Age 67: $ /mo * 12 * 2 = 13,237 p.a. GIS from Age 65: None - Income from other sources exceeds eligibility threshold

26 In-Class Problem # 17-3 Determine how much the Maynes will need at retirement, in before tax income: Before tax income = $50,000 after-tax requirement / (1 0.12) Before tax income = $56,818 total / $28,409 each; When the Maynes retire at age 60, they will require: Age 60-67, no OAS. For 7 years = 56,818 16,547 = $40,271 Thereafter = 56,818 (16, ,237) = $27,034

27 In-Class Problem # 17-3 Present value of Maynes retirement income needs: Age PVA (40,271, 7 yrs, 2%) = $ 260,634 Age PVA. $ 430,502 Total Required = $ 691,136 Age PVA (27,034, 23 yrs, 2%) = $ 494,511 at Age 60 PV = (494,511, 7 yrs, 2%) = $ 430,502

28 In-Class Problem # 17-3 Determine how much the Maynes have at retirement, in before tax income: Elizabeth s RRSP FV (5,000, 25 yrs, 2%) $ 8,203 Bruce s RRSP FV (10,000, 25 yrs, 6%) = $ 42,918 Elizabeth s TFSA FV (15,000, 25 yrs, 2%) = $ 24,609 Bruces s TFSA FV (15,000, 25 yrs, 2%) = $ 24,609 Total Available = $ 100,339 Difference to be accumulated (691, ,339) = $590,797.

29 In-Class Problem # 17-3 The Maynes annual savings plan requirement would be: FV = $590,797 N = 25 (Retire at age 60; Currently 35) I/Y = 2% (Assumes future savings through GICs) Calc PMT = $18,451

30 Retirement Planning Retirement planning focuses on having sufficient wealth accumulated to fund household consumption for the entire post employment / self employment period; Several factors / variables impact retirement planning; Estimating annual consumption requirements; Changing consumption req ts as family members age; Variable investment returns during retirement years; Actual vs. estimated life span of family members; Inflation rate impact on consumption;

31 Retirement Planning Because of the long time horizon involved in retirement planning, consumption is should be considered in real dollars; Remember: Discount real dollars using real discount rate Real Discount Rate kr = [ (1+knom) / (1+i) ] 1 Some retirement income streams like Old Age Supplement (OAS) and some employer pensions are indexed, and therefore represent real cash flows; Other income, like RRSP withdrawals, are not indexed = nominal dollars;

32 Retirement Planning The bottom line... Retirement planning involves long-term estimates of future consumption and the basis of those estimate needs to understood (nominal $ / real $ / before tax / after tax); Retirement planning typically involves a combination of income streams / cash flows with some amounts in nominal $, some amounts in real $ (indexed pensions), some amounts in before tax $ (RRSP income) and some amounts in after-tax $ (unsheltered savings). Determine a common base for all projections.

33 Retirement Planning In-Class Problem Ch 17, Problem 4 (a) How much will she have to save each year to reach her retirement goal if she saves in an RRSP? Assumptions: i) Joan s post-retirement average tax rate is 20%

34 In-Class Problem # 17-4 Calculate required income during retirement: Req d before tax income = $40,000 after-tax income / (1-0.20) Req d before tax income = $50,000/yr. Some of Joan s post-retirement income will be met through pension income streams: At 65 At 67 Post Retirement Income $50,000 $50,000 Old Age Security - - $6,618 Canada Pension (12,460 max x 75%) - $ 9,345 - $9,345 Employer Pension - $ 22,000 -$22,000 Balance to funded by retirement svgs $ 18,655 $12,037.

35 In-Class Problem # 17-4 Note: The OAS, CPP and employer pension are indexed payments and therefore represent real dollars. Therefore, estimates for the remaining balances to be funded should be likewise be considered in real dollars.

36 In-Class Problem # 17-4 Calculate the present value of her retirement savings requirement: From Age PMT 18,655 N 2 I/Y (Real) 5.77 [(1+0.10) / (1+.04)] PV at Age 65 $ 34,312

37 In-Class Problem # 17-4 Calculate the present value of her retirement savings requirement: PMT 12,037 N 28 I/Y (Real) 5.77 [(1+0.10) / (1+.04)] PV at Age 67 $165,243 PV at Age 65 (FV = 165,243, N=2, I/Y = 5.77) = $147,706 Retirement Savings Goal = (34, ,706) = $182,018

38 In-Class Problem # 17-4 Part of Joan s retirement savings requirements will be achieved through the growth of her RRSP: PV 20,000 I/Y 5.77 N 22 FV 68,708

39 In-Class Problem # 17-4 The remainder of Joan s retirement savings requirements of $113,310 (182,018 68,708) must be achieve through annual RRSP contributions: FV 113,310 (Remaining Retirement Savings Goal) I/Y 5.77 N 22 PMT $ 2,685 Joan must deposit $ 2,685 in real $ into her RRSP each year.

40 In-Class Problem # 17-4 Joan must deposit $2,685 in real $ into her RRSP each year. In nominal terms, this is Year 1 = $2,685 Year 2 = $2,685 x (1.04) = $2,792 And so on Since the RRSP is tax sheltered, the required savings amount represents before tax dollars, which is a basis that is consistent with the retirement savings goal.